Looking to the Future - Business Continuity

Now, more than ever, companies need to consider and put in place a business continuity strategy. Leaving a business rudderless or having to deal with complex continuity issues will, at best, take up management time and cause distress at a time when emotions may be running high and at worst, could result in the failure of the business.

The coronavirus pandemic continues to present difficulties for businesses across the UK. Many are having to deal with multiple challenges, ranging from managing revenue streams and contractual performance obligations, to deciphering guidance on employment and health and safety obligations.

However, the recent case of (1) Martin Williams (2) Gareth Williams (3) Wendy McCreath v Russell Price Farm Services Ltd (2020) highlights that business continuity issues can also be created by a company's own constitution. The case serves as a useful reminder that companies need to keep their constitutions under frequent review to ensure that they are fit for purpose and actually work, especially during the current turbulent times.

Background to the case

Russell Price Farm Services Ltd (the Company) had a sole shareholder who was also the sole director. When he passed away, he left 90% of the shares in the Company (the Shares) to his two children under his will. The Shares passed by operation of law to the three executors of his will. Under the Company's articles of association, a director could only be appointed by its members. Due to the complexities of the probate process, the Shares had not yet vested in the children, and the executors were not themselves members. This left the Company without a director, and unable to undertake certain activities, including, critically, accessing its bank account to settle expenses needed to run the underlying business.

An application was made for an order under section 125 of the Companies Act 2006 to rectify the register of members of the Company to record the executors as members of the Company and entitled to appoint a director.

The judgment

For the rectification order to be granted, it had to be demonstrated that there was an ‘unnecessary delay’ in registering the fact that a person had ceased to be a member. Given the anticipated duration of the probate process and surrounding circumstances, the application was granted, although the executors were required to provide undertakings relating to their handling of the probate application – essentially to ensure there were no further delays. The judgment noted that the ‘the Company [was] completely directionless with no officer capable of acting on its behalf’ – an obvious, yet damning statement of fact.

Implications for governance and succession

The rectification order requested in the application was granted by reference to the particular facts of the case. The key question however is, how many more cases like this may the Courts find themselves dealing with over the next few months and at what cost to the underlying business?

The application in the present case was made because, without an ability to operate its bank account and pay creditors, there was a very real risk that the business might fail. When one considers the numerous challenges which companies face every day – market competition, onerous legislation, changes in demand and supply – it is quite extraordinary that the downfall of a business could potentially be started because its constitution does not adequately make provision for the death of its founder.

The case highlights the importance of companies ensuring that their articles of association allow for continued and effective operation in the event of a member’s or director’s death or incapacity. This, in turn, leads to broader succession considerations.

General constitutional reviews tend to be prompted by specific events in the life cycle of a company, such as the admission of new shareholders or the sale of the business. This can mean that provisions dealing with decision making, exit arrangements or succession are often generally outdated, or no longer reflect the specific nuances of the underlying business and its ownership structure. It is important that business owners review their organisation’s constitution regularly to ensure that it remains fit for purpose and actually works in practice. Questions to be considered include:

1. How are decisions currently made and is this consistent with the operational reality of the business?
2. How will decisions be made and how will the business be run in the event of my incapacity or death?
3. Does the company's constitution ensure that the key visions of the business can be maintained?
4. How and when do I wish to exit the business? Who will be my successors? Should there be a distinction between future managers and future owners?

It is often sensible to consider these questions in the broader context of a company's general strategy to ensure that there is clarity on key issues, such as visions and goals for the business. A company's ‘mission statement’ is a strong foundation around which general governance and succession issues can be shaped.

Family businesses

Family businesses can present particular issues. Incumbent owners may not have fully considered when and how to start the transition to the next generation, and there may be concerns as to whether the younger generation has the willingness or experience to continue running the business. Members of the same family often have distinct interests, which do not necessarily align with other participants in the business or its broader culture and values. As businesses expand, it's fairly common for more family members to become involved but the constitution may not effectively support that ownership or management model, or contemplate the future in an appropriate manner.

Issues such as these can often be emotionally charged, and are sadly often highlighted in difficult circumstances such as ill health or death.

Although the transition of the business from one generation to the next is often assumed, key individuals should discuss what the future looks like, and what each person's role is likely to be. Control in some businesses is often tightly held, but the coronavirus pandemic has demonstrated how businesses may find themselves subject to economic or operational challenges that test even the most experienced owners. Businesses should consider whether the current team is sufficient for the business' requirements, or whether external advisors or additional officers should be brought on board to share particular expertise or experience they might have. If a business does choose to explore this route, in addition to selecting the right person, they will need to consider how best to incentivise such individuals in the long term, and how this can be done in the most prudent and tax efficient manner.

Now could also be the time to properly document informal arrangements with family members. If founders want to encourage transition of the business to the next generation, this will provide an opportunity to consider incentivisation. If there is potential for a third party exit, it will also provide additional protection for individual members and help to frame the financial and other terms of any exit.

Conclusion

Companies should keep their constitutional arrangements under regular review. Many businesses are already facing an existential crisis, and founders and owners should ensure that these challenges are not exacerbated or increased as a result of outdated governance arrangements and a failure to consider succession issues in a timely manner.

Forsters has extensive experience in drafting, reviewing and advising on all forms of constitutional documents, from articles of association to bespoke governance documents for family businesses. We can also assist with all legal aspects of broader succession arrangements, from wills and estate planning to negotiating business sales and exits.

Disclaimer

This note reflects our opinion and views as of 26 May 2020 and is a general summary of the legal position. It does not constitute legal advice.

The Life Cycle of Family Wealth

From growing a business to starting a family or handing over control of that business to the next generation, every individual has their own goals to aspire to. Our Private Wealth lawyers advise our clients throughout this family life cycle, providing the legal advice required for specific transactions such as purchasing a home or selling a business, whilst also advising on the long-term opportunities for succession and estate planning.