September 4, 2013

Trustees Holding Interests in the Family Business: Intersection of Shareholder and Member Rights and Fiduciary Duties

Holland & Knight Shareholder Rights Blog
Michael J. Zdeb

Trustees holding interests in family enterprises may have conflicting duties to the beneficiaries as well as unrelated shareholders and members of the business. 

It would appear that over the last three years, a substantial shift in ownership of family held enterprises has occurred. This belief is based on the observation of two phenomena.  First, the aging of the post WWII generation of business founders has created pressure to consider and implement succession of management and ownership. Second, the flux and uncertainties with the federal transfer tax effective dates, rates and exemption amounts created incentives to transfer interests rather than wait.

Use of long term "dynasty trusts"

Frequently the transfer of interests in the enterprise has been to trusts, in particular so called “dynasty trusts.” Dynasty trusts are trusts intended to last for several generations of a family. The use of such trusts in this context is designed to avoid Federal and State transfer and death taxes on the value of the family enterprise for indefinite generations of family members.

From a tax planning perspective, the use of trusts in this manner is a very effective and beneficial technique. Avoiding transfer taxes, particularly over generations of a family can have an enormous economic impact on the accumulation of wealth for a family. In addition, it mitigates against the potential of the business having to fund a large estate tax liability.

Planning to accomplish the objective of accumulating such wealth with a family enterprise also involves a whole series of important non-transfer tax related considerations. Such considerations include:

  • Who are to be the beneficiaries? Those active in the business or those inactive or both?
  • How to define the rights of the various generations of beneficiaries?
  • What expectations do the grantor, trustee, beneficiaries and other family members have regarding the economic benefits of the family business?
  • Who are to be the trustees (and successors)? Are there to be advisors to the trustee?
  • What participation in governance and management will be expected of or allowed by the trustees? The beneficiaries?
  • How will the trust be able to respond to changing fortunes and circumstances of the business over time?
  • What will be the relationship of the trustee and trust interests to other participants in the enterprise who may or may not be beneficiaries?

Shareholders duties to each other

The transfer of interests in family enterprises has been occurring contemporaneous with the development of intra-shareholder/member duties. In most jurisdictions, the courts and legislatures have created duties running directly from those in control of the family enterprise to those with minority interests. These duties include the common law duty of good faith and loyalty as well as the statutory development of the concept of oppression of the minority by those in control.


The use of trusts to hold interests in family businesses and the development of intra shareholder duties has created situations in which a fiduciary holding interests in the enterprise may simultaneously have duties running to the beneficiaries as well as duties to other participants in the enterprise. This is especially true if the holdings of the trust are able to control the governance and management of the enterprise.

While the conflict between a trustee's duties to the beneficiaries and involvement in the governance may well have been created by the grantor that will offer little comfort to a trustee that finds the need to make decisions at the entity level and at the trust level which may be in conflict.

A trustee with the ability to influence decisions at the enterprise (as a director, manager or officer) may exercise that ability in such a way as to impact the economic interests of one class of beneficiaries over another. At the same time, the decision could be in conflict with the desires or expectations of minority shareholders-unrelated to the beneficiaries. For example, a decision to withhold distributions from the business and present a newline of business can create a conflict with other participants in the enterprise as well as current income beneficiaries. 

A decision to dissent on a corporate action might not be appreciated by the other shareholders or even some of the beneficiaries. A dissent would allow for the prospect of an appraisal and buyout of the trust's interest at "fair value." In particular when it is realized that the interest is otherwise illiquid and heavily discounted under the fair market value standard of value, (and the likely carrying value as part of the principal of the trust), the trustee might feel compelled to dissent and capture the "fair value" and liquidity.  

When the intra-shareholder rights and duties come into conflict with the duties of a fiduciary in this manner, I refer to it as the 'intersection' of fiduciary duties with shareholder rights.

At this intersection, a number of questions will arise, in particular, will the trustee/director's conduct be evaluated from the point of view of rigorous fiduciary duty standards or the potentially more favorable "business judgment" rule? It can make a substantial difference.

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