The value, validity and enforceability of a Family Constitution in the UAELexisNexis Middle East - 2018

1. Overview;

  • The key to long-term success for families in business is keeping the family committed to the Business and securing their capability to carry on as responsible Owners.

  • Owners as opposed to shareholders have a long-term approach. They are driven by an underlying sense of purpose beyond financial results though of course profitability is also important.

  • Attaining the right balance between family values and economic profitability relies upon various factors including, inter alia:

    • A defined shareholding (ownership of financial interests) structure that allows effective control (decision-making) of the business; coupled with

    • Harmonious relations within the family and a collective understand of how it should be involved with the business, and

    • A robust governance framework for the family and the business

  • These attainables are often met through the creation of a Family Constitution, also commonly referred to as a Family Protocol or Family Charter.

  • A Constitution can however include provisions that are included in more commonly recognized forms of legal agreements such as a Shareholders Agreement and to this end the provisions of a constitution can be legally binding and enforceable.          

  • This Practice Note covers the enforceability of a Constitution in the UAE.

2. Definitions;

  • Active Family Members: Family Members who are neither part of the ownership system or business system yet remain integral to the fundamental operation of the family business as a whole. Those individuals who, by virtue of their familial relationship with the business contribute to the identity and operation of the family and business. This may be in an individual capacity, or as a member of the Family Council, Family Assembly etc. dependant on the governance framework adopted.

  • Deed of Adherence: The agreement pursuant to which a new shareholder / Family Member (including any permitted transferee) agrees and adheres to the terms and conditions of a Shareholders Agreement / Family Constitution that is already in place.

  • Engaged Family Owners: Family Members who are part of the ownership system and family system, and are actively involved in the operation/oversight of the business either in an individual capacity, or as a member of the Board of Directors, Shareholders Assembly etc. dependant on the governance framework adopted.

  • Family Constitution: A formal document which sets out a Family’s values, rights, obligations and rules applying to stakeholders in the Family Business while also providing a framework and systems and policies to deal with situations that arise during the course of operation of both the family and the business.

3. Practical Guidance;

Family Constitution Prerequisites

  • The provisions of a Constitution cannot contradict the legal codes or public policy of the country where the agreement would be executed, nor should it violate the public policy of the relevant jurisdictions it would be implemented. In the UAE, the legal system is founded upon civil law principles and Islamic Shari’ah, the latter constituting the guiding principles and source of law.

  • A Constitution, provided it follows the basic principles of contract law, is legally binding. The formation of a contract generally requires an offer, acceptance, consideration and a mutual intent to be bound.

  • A Constitution that is voluntarily signed by members of a business owning family having come together to make a set of promises to each other and reaching mutual assent is therefore a legally binding and enforceable bilateral contract. The UAE Civil Code confirms this in Article 257 “The principle in contracts is the assent of the parties and the contractual obligations they are bound to perform.”

  • The mutual assent and voluntary signature of the Constitution is a key component which contributes to the validity of the contract. As such, a participatory process is key when drafting a Constitution - a Constitution cannot be prepared by one or two members of the family and imposed on the majority. In such instances it would be void of the assent that should be voluntarily given by all parties to the Constitution.

  • Under the UAE legal system, the general rule is that the court is not permitted to interfere in what parties have agreed under a contract; hence, it presents some assurance that the terms agreed are enforceable.

  • While the morally guiding provisions of a Constitution may be difficult to enforce or make binding, remaining provisions can be effectively imposed and made binding. For example, restriction on the transfer of shares of the family business to non-family members, while contained in the Constitution, can also be included in a shareholder’s agreement to supplement the Constitution. The other guiding principles (commonly referred to as soft issues) will be taken into consideration to reinforce the spirit of the understanding among the parties, and the intent of the signatories.

  • The soft issues are however pertinent when it comes to the law of contract, the primary rule of the UAE Civil Code is that contracts should be interpreted based on the parties’ intentions which should be apparent in the construct and language of the agreement.

  • As the next-generation of family members or in-laws enter the family business, they can also be asked to sign a deed of adherence consenting to being a member, and to being bound by the Constitution, so long as it is willingly and voluntarily done so. 

  • While many will draw comparisons between a Family Constitution and Shareholders Agreement, these are not mutually exclusive. From a practical perspective, a Constitution is the overall framework for the Family Business based on the rule of law.

 

Why have a Family Constitution?

The Family Business is an interactive system comprising of 1) family, 2) business, and 3) ownership systems presenting complex relationships, both between and among family members and executives. Managing these relationships requires a delicate balancing act to combine family and work relationships.

In a Family Business, the interests of Family Members as owners are multi-faceted, and go beyond those of a shareholder who is solely a financial interest holder. By virtue of being owners, every family member has an interest in, and an element of responsibility towards the business, even if they choose not to be involved in the business.

While not every conceivable situation can be adequately planned for, a good Constitution is one which:

  • creates a certain element of certainty

  • puts in place systems and policies to address events and circumstances that could potentially paralyse the operations of the business or threaten family unity and harmony is of paramount value.

 

When should a Family Constitution be created?

A Family Constitution may be drafted and entered into any time throughout the life of a Family Business. However, it is advisable to enter into a constitution as early as possible in the lifecycle of the business to pre-empt matters and events that it is intended to regulate prior to the said issues arising – this applies to both expected events such as succession and unexpected events such as family feuds.

Rights and obligations of Family Members part of a Business Owning Family

Engaged Family owners:

  • Enjoy the benefits and rewards (beyond the financial rewards) afforded by being part of a business owning family, and have an obligation to give something in return. For example, a Family Member benefiting from the social status afforded to them by virtue of being a member of a particular business owning family, is obliged to respect and uphold the family’s values, and its reputation in society.

  • Have a responsibility to communicate with non-active owners about the business and to recognise them as partners in a common enterprise, thereby illustrating the distinct difference between an owner and shareholder.

 

Purpose of a Family Constitution

A Family Constitution establishes a framework for how the Family and Owners behind the business will make joint decisions together:

  • clarification of roles and responsibilities

  • examination of the boundaries between family, ownership and business

  • defining communication platforms and channels and decision-making bodies.

 

Law sets minimum standards of ethical behaviour, and while it embodies ethical principles, it does not prohibit acts that may be perceived by others as unethical (i.e. Article 92 of the UAE Companies Law states that only shareholders holding at minimum of 25% of the share capital of a limited liability company can request a meeting of a general assembly). In a Family Business where all owners are Family Members, this may lead to family members feeling that they are being treated unfairly or unethically. As such a Business Owning Family may choose to allow any shareholder to request a meeting of a general Assembly.

Under UAE Companies Law, there are no explicit statutory protections that are specifically granted to minority shareholders, however such minority rights may be protected through the incorporation of protections in a Family Constitution.

This is a pertinent area in Family business because beyond the law, there exists a human relationship and family bond among and between family members, and society, and thus the relationship between law and ethics is an important one.

Family values and philosophy will influence the operation of the business and will likely lead to a different mix between what is ‘legal’ and what is right for the Family Business, the Family Constitution serves as a beneficial tool to address such an overlap. To this end, the Family Constitution connects the dots between law and family ethics and values, often building on the minimum legal requirements stipulated by the law.

Due to the construct of a Family Constitution and its all-encompassing nature it is a more enduring contract. A shareholder’s agreement in absence of addressing the soft nature of a family business is in many cases redundant.

Components of a Family Constitution

Mission and Purpose

  • Objectives and long-term goals including the vision of the founder(s) and the family members and a broad strategy for achieving the Family’s mission

  1. Family Values and Expectations

    • What are the key values on which the family and business are run?

    • Does the Family come first or the business come first?

  2. Ownership Rights and Obligations

    • Who can own shares?

    • Are in-laws permitted to hold shares?

    • What matters are reserved for the decision of shareholders?

    • What matters require majority consent (beyond those stipulated by law)?

  3. Governance Framework

    • Decision-making Platforms – who will exercise key powers?

    • How is voting conducted?

    • Methods of Communication and Reporting

    • What is the role of a Board (if any), composition of the board?

    • How is succession to the board managed?

    • Can Family Members be Board Members?

    • Family Employment Policy: Can Family Members be employed in the Business, if so what are the prerequisites? Do they receive special benefits as a Family Member?

  4. Financial Matters

    • Dividend Policy and Payment of Dividends

    • Allocation of a reserve such as a contingency Fund

    • What are the sources of finance for the Business

  5. Conflict Resolution

    • What dispute resolution mechanisms are to be employed by the family?

    • How are decisions to be made?

    • What are family members’ rights and obligations in relation to the business

  6. Exit Strategy

    • How can Family Members dispose of their shares?

    • Are non-Family Members allowed to hold shares, if so, in what circumstances?

  7. Revision and Amendment

    • The Family Constitution should be an evolving document, as such the process and timings for review and amendment should be defined as well as a procedure for family members to raise concerns and queries.

    • Given the broad scope, and somewhat personal nature of the provisions in a Family Constitution, a key feature is its malleability.

    • There is no standard form to a Family Constitution. The Family Constitution is specifically tailored to fit each family’s needs after thoughtful input and deliberation. It can be short or long, general or specific, and can adapt to meet the evolving needs of the Family and their business.

4. Comparison with Common Law

  • Contacts, under common law, allow one party to terminate a contract “without cause”, in essence permitting one party to terminate a contract if it no longer wishes to contract with the other for any reason.

  • “Without cause” terminations are contrary to Shari’ah law and as such “without cause” terminations are not permitted in the UAE.

  • Misrepresentation in Common Law is a concept that refers to a false statement of fact made by one party to another party, which has the effect of inducing that party into a contract. For example, a Family Member may be invited to sign a Family Constitution based on misrepresentations regarding the prospects and management of the Family Business. In Common Law it is possible to make a misrepresentation either by words, conduct or omission, be it innocently or negligently.

  • However, Article 185 of the UAE Civil Code holds that misrepresentation occurs when a party "deceives the other by means of fraud, by word or deed, which leads the other to consent to what he would not otherwise have consented to". Unlike in Common Law, actions under the UAE Civil Code may only constitute misrepresentation where they are deliberate, as such it does not capture actions or statements that may be made innocently or negligently.

5. Related Content

Legislation

  • Federal Law No. 5/1985 on the Civil Transactions Law of the United Arab Emirates (UAE Civil Code)

  • Federal Law No. 2/2015 on the new UAE Commercial Companies Law (UAE Commercial Law)

 

 

This article was adapted to address the legal considerations in the Kingdom of Saudi Arabia and in Qatar.

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NOTA: The opinions, the views, and the thoughts expressed herein belong solely to the author.

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