We often tell our clients that a great deal of what we do as lawyers is applying preventative measures to avoid entering legal battles that need not be fought. As much as I would like to take credit for this approach, this concept is not novel, and in fact is rooted in the ancient eastern philosophy of Sun Tzu, a Chinese general who believed that the finest strategy in dealing with conflict when deployed appropriately can lead to victory without the requirement for fighting. By truly understanding conflict, we can avoid it altogether. This notion is of particular importance to family businesses.
Dealing with disharmony in a family business can end up being crippling to operations, creating a toxic culture and eventually leading to the complete and utter collapse of the entire organisation. A wise real estate solicitor once told me that our role as lawyers is to anticipate the worst possible scenario and prepare for it. Those words although somewhat cynical, captured me when I heard them for the very first time. I am now of the view that they apply to every aspect of legal practice, contentious or otherwise.
To survive, family businesses like any other business, must adapt with the everchanging environments that they are operating in. There are, without a doubt, many family businesses in Saudi Arabia and the region that are very dynamic and are aware of this continuous need to adapt. Otherwise, we would not have seen some of these very businesses now being led by third and in some cases fourth generation family members. However, this adaptation should not only be focused on business aspects such as financials, market strategies, employee turnover, diversification or joint ventures. It must go beyond the business side of the organisation and be entrenched within its very fabric. Here we are referring to corporate governance, identifying talent in the family, separation of ownership and control, and the overall legalities concerning shareholders’ affairs. These matters are some of the key areas that are ripe for potential disputes if not addressed.
Family businesses must account for the inevitable eventuality that a shareholder will want to exit or that an internal shareholders’ dispute may arise. Traditionally, the above areas were set out in shareholders’ agreements and, in some instances, family constitutions. However, in the instance that families were prudent enough to attempt to codify these concepts in the aforementioned instruments, a different challenge was created around the issue of enforceability. This was even more so the case for family constitutions.
Now with the new Companies Law enacted by Royal Decree (M/132) on 30 June 2022 and came into force on 19 January 2023 (the “New Companies Law”), Article 11 specifically allows for both a family constitution and a shareholders’ agreement to become binding, and it has permitted for such instruments to form part of the constitutional documents either through the articles of association for a limited liability company or the bylaws for a joint stock company. Article 11 (2) clearly mentions a non-exhaustive list of matters that can be included in a family constitution: ownership structures, governance, management, policies in relation to family members employment, disposal of shares and disputes resolution.
This is a profound shift which has created a new legislative and regulatory environment for family businesses to operate in. There now exists an opportune moment in time when families can revisit the arrangements they have in place, build upon them and ensure that shareholders are on board for the greater good of the enterprise.
While there is no one size fits all approach and these matters must be handled with a delicate set of hands, the ultimate goal remains the same: to preserve wealth and ensure the continuity of the business. Having a family constitution in place can end up protecting both the company and its shareholders. There will be clear guiding principles and mechanisms for dealing with various shareholders’ matters, including a potential departure. Shareholders, on the other hand, will take the view that the family constitution codifies their rights. Moreover, it gives them greater transparency as they will be aware of why and how things are done rather than there being a set of unwritten rules.
Family businesses form an entire economic ecosystem that most certainly requires protection. This duty does not rest solely with one individual. It ultimately falls upon a number of individuals who in every business tend to be spread out across the various classes of stakeholders such as the management of the business, patriarchs, shareholders, and their advisors. The patriarch (or matriarch in some cases) cannot accomplish succession planning alone. They are often aided by veteran members of the management team, one or two influential shareholders who are able to whip the votes required, and finally, savvy advisors who assist them in navigating what will undoubtedly appear to be unchartered waters.
With that being said, it is often the case that there is an apprehension and somewhat of a reluctance to challenge the status quo and the way things have been done. It is a daunting task for many who have to undergo it, to challenge the way upon which age-old practices have been established. This can have a crippling effect on the evolution of the business, more so for those trying to push through certain agendas, in particular to address questions that concern corporate governance and succession planning. It is unfortunate however that the more common position seems to be to leave things as they are. This passive approach creates a scenario where the family is unprepared when disagreements occur, or when a shareholder is exiting the company or passes away. This lack of clarity is what ultimately leads matters to be fought out in courts and for the foremost part at the detriment of all parties involved (other than the lawyers of course).
I mention this with a heavy heart as there are many traditions that are found in family businesses that are to be admired and which I personally do have a fondness for. When one visits any successful family business, it is apparent from the minute one sets foot on its premises, the employees are filled with pride to be a part of it. They are close to the owners and might interact with them on a regular basis. A sense of loyalty exists that has become rare in other types of companies. Family businesses are resilient, and this is mainly due to the fact that those at the helm view themselves as custodians for the subsequent generations, thinking in the long term and willing to forgo short term profits for stability and longevity.
This very mindset is what I have come to learn is one of the secrets to their success. Now with this change in legislation, there is a sensible moment to have a look in the mirror. See where things are and what areas need to be covered, for succession planning and corporate governance are ongoing exercises. They are not checklists to go through once and file away, combined they form an ongoing discipline that must be maintained, tweaked and revisited from time to time. With the entry of the New Companies Law, it is the perfect time to get the conversation started.
By Hassan W. Zawawi
Partner, Private Wealth