Protecting The Family Business ... managing generational change
by Damien Bowen and Morgan Solomon, WA Business News, January 2013
Bev and Dan Whitfield are fairly regular Aussies in their early 60s, who’ve been through the ups and downs that most couples do. Twenty years ago they started their own business distributing coffee beans from premises in Osborne Park, Perth. From humble beginnings, Whitfield Coffee has grown in scale beyond anything they expected, not only generating good income for themselves, but also for their eldest son Luke (32) and daughter Daniela (29), who not only work in the business but are also partners.
In many ways Bev and Dan Whitfield (not their real names) have everything a couple could wish for at their time of life. So what is it that’s had Bev sleepless with worry, Dan turn uncommunicative, and the atmosphere at Osborne Park unbearably tense? In a word: Sharmayne. Luke’s girlfriend of less than 6 months, is a high-maintenance, fickle and headstrong girl to whom he has just announced his engagement. Comfortably off thanks to the proceeds of her first divorce, if things went wrong down the line it could potentially be a lot more than Luke’s loss. In paying out Sharmayne, Whitfield Coffee might have to be sold.
As the demographic bump of the baby boomer generation heads into retirement, Whitfield family type situations are on the rise. Many baby boomers have benefited from dramatically increased values in property prices in recent decades, quite apart from any other financial achievements such as coffee bean businesses. A lot of them and their now middle aged off-spring are in blended families, multiplying the complexity not only of family dynamics in the here and now, but also the expectations and claims a range of family members may have on a person’s estate.
For all these reasons it is hardly surprising that we’re witnessing the convergence of Family Law and Estate Planning on an unprecedented scale. With Family Court judges able to take into consideration not only what a person earns or owns right now, but what he or she can expect to own in the event of inheriting the family business, farm or other asset, it is also hardly surprising that people are seeking legal protection for all manner of scenarios.
If you have assets, children or a family business, it is vital that you are aware of the legal instruments available, and take timely action. So what are those legal instruments? Can their effectiveness be guaranteed? And what can you do to ensure that the Sharmaynes of this world don’t destroy everything you or your family has worked so hard to achieve?
Family Trusts are created so that an asset is owned not by an individual, but by a separate entity controlled by Trustees on behalf of beneficiaries. Tax planning and asset protection are the main reason why Family Trusts are created. It is a widespread fallacy that these same Trusts can protect the assets of a person in the event of divorce. Part 106B of the Family Law Act makes it clear that assets transferred to a Trust or another person to defeat a claim can be clawed back to be considered as part of the matrimonial pool. And the High Court has ruled conclusively that a Trust such as a Family Trust can be easily penetrated and its assets divided in event of divorce.
In the case of Bev and Dan, putting ownership of Whitfield Coffee into a Family Trust, if Luke was a beneficiary, would not protect the business if Sharmayne was to divorce him and claim her share.
Binding Financial Agreements (BFAs)
BFAs are sometimes known as ‘pre-nups’ because they can serve the purpose of setting out the division of assets, before they get married, in the event of a couple divorcing or for de facto relationships, on the termination of that relationship. BFAs can also be used when a couple who are divorcing or separating are able to come to an agreement about a division of assets as an alternative to court orders. A BFA can even be used during an otherwise happy relationship to set out what happens if the relationship breaks down.
In the case of Whitfield Coffee, Sharmayne could be asked to sign a BFA stating that, in the event of divorce she would not be entitled to any claim on the family business.
While this may provide an elegant solution, there are two possible problems with it. One is asking Sharmayne to sign such an agreement – an area where the law and human relationships do not always sit comfortably. The second and a very important concern is that courts across the country are setting aside BFA’s for a variety of reasons, in particular, where the BFA has been entered into by a young couple starting out on their relationship and especially where there is a significant power imbalance resulting in one of them signing against advice or where the advice was inadequate or incompetent. Even if Sharmayne signed the BFA, she could potentially still apply later on to have it set aside by a Court by asserting that she was ‘bullied’ into signing it.
Our own view is that BFAs, notwithstanding the current attitude of a number of Courts to willingly set them aside, still serve a very useful purpose in creating a legal obstacle and deterrent. Sharmayne may be able to have it overturned, but she would still have to take the matter to Court, run her argument that she was for example, ‘bullied’ and await a decision – the emotional and financial stakes and costs are much higher than if there was no BFA. And while a BFA may not guarantee a complete and irrevocable solution, used in conjunction with other legal protection, it could serve as a powerful deterrent.
These can be structured in many ways, but can be made just like Family Trusts: however they only come into effect when someone dies and their Will is enacted. They provide a most useful way of transferring ownership of an asset from an individual to a Trust that does not yet exist.
Bev and Dan would be well advised to consider a Testamentary Trust as part of their overall legal strategy. In this scenario, they retain Whitfield Coffee as their own company, their kids working as employees only with no ownership or expectation of ownership. Sharmayne could walk out on Luke in seven year’s time, and Luke would posit that she ought have no claim on Whitfield Coffee because he is only an employee and not an owner.
On the death of Bev or Dan, whoever survives the longest, Whitfield Coffee ownership passes to a Trust whose Trustees are required to direct income to specified beneficiaries, such as Luke and his children, or even wider classes of beneficiary such as Luke’s siblings or their spouses, and other of Bev and Dan’s grandchildren.
A testamentary trust in this case can work just like a discretionary family trust and who is going to control that Trust is a key consideration for Bev and Dan. Care must be taken in structuring this sort of trust to make sure that Luke is not both the Trustee and Appointor on the one hand and the Beneficiary on the other, because Sharmayne could then well claim the business is for all intents and purposes, Luke’s and back it comes again into the pool of assets she can claim against on divorce.
A properly drafted Will remains the foundation of estate planning. Even though it is a ‘must have’ document, approximately 40% of Australian’s do not have Wills, and many of those who do have such poorly drafted DIY Wills that they are wide open to challenge if the estate was of any value and there were conflicts in the family.
One option Bev and Dan could consider is that of skipping the next generation and leaving their assets to their grandchildren. This could also raise more problems than it solves: whilst it certainly means Sharmayne will find it very hard indeed to claim the assets that have skipped Luke ought be open for her to claim against in the divorce, it also means Luke does not get a direct benefit from his own parents estate. Children in these cases can often feel deeply aggrieved at their parents for, effectively, disinheriting them. Unless Luke is brought in early on in the strategy and reasons and understands the value in not being a beneficiary of his parents Wills he could end up challenging his own parents Wills in Court- and that means challenging his own children as the intended beneficiaries- a messy result indeed.
In summary, families endowed with assets, in particular family businesses, can have quite complex legal needs. While few guarantees accompany the legal safeguards that can be put into place, these are nevertheless critical in providing protection to the family as a whole if one specific relationship breaks down. Being aware of the legal safeguards available is a useful starting point. More important, if you are a member of a family in this situation, is to consult a good lawyer to devise a strategy specific to your particular needs.
By Damien Bowen and Morgan Solomon of Bowen Buchbinder Vilensky – www.bbvlegal.com.au, 08 9325 9644