Abstract

There is less literature available on the subject of the Family Constitution/ Family Charter; even lesser from an Indian perspective. In this article, an attempt has been made to discuss the basics of a Family Constitution and how it can help in estate planning. As there is no law governing Family Constitution, this article draws minimal references to statutory provisions or case laws. This article will be helpful for family businesses, and advocates, chartered accountants and consultants who advise family businesses.

Abstract

1. Introduction
2. Understanding a Family Constitution
   1. 2.1   What is a Family Constitution?
   2. 2.2   Why is a Family Constitution necessary?
   3. 2.3   What are the contents of a Family Constitution?
   4. 2.4   How is it implemented?
   5. 2.5   What are the pitfalls?
3. Family Offices
4. Dénouement

1. 1. IntroductionThere is an English proverb ‘Blood runs thicker than water’, which means family bonds are stronger than other relationships. In India, save and except the new era of start-ups, the majority

      of the businesses are family-run. And as we have studied, one of the three fundamental accounting assumptions is ‘going concern’. Most businesses are run with this assumption. The family business is succeeded by the next generation and so on.

      However, with each step in the next generation, the ownership of the family business gets divided. Taking an inference from Maslow’s hierarchy of needs, money and share in profit is not the sole criterion of successor generations. The issues are rather dynamic and there is no straight-jacket formula to resolve the same. The Indian Judiciary system has witnessed countless family disputes even among the biggest industrial families in India. These disputes hamper the future growth of the business and also the growth of the Nation. Empirically speaking, the disputes appear to be concerning the division of businesses, management of businesses, vision for the future, the status of each owner et cetera. Entering into a Family Constitution/ Charter could be one of the solutions to avoid any unintended future differences among the members of the family.

   2. Understanding a Family Constitution/CharterThis part of the article will deal with the basics of a Family Constitution. This part is divided into six sub-parts, viz. what is a family constitution, its necessity, its contents, types of such agreements, methods for successful implementation and its pitfalls.

      A Family Constitution is an important component of a family’s governance structure. It is a document or set of documents that a family can use to help them with their building guideposts and decision-making rules and help codify a family’s values, mission, and vision. Family Constitutions can also help define the relationship between critical resources of a family such as the family office. There are several key areas that families should consider when developing a Family Constitution.

      1. 2.1   What is a Family Constitution?
         Every family and every family business has a Charter or a set of values. Most remain unspoken and uncodified. These values influence how the family interacts with the business and how the business progresses through its life cycles.

         A Family Constitution is a written document that serves as a record of a family’s heritage, culture, vision, and mission. It codifies interest in businesses, a conflict resolution guide, and family values. It sets out the duties, conduct and responsibilities of the next generation who will succeed in the family business. It can also set out principles for governance management, the use of family assets, investments, education and philanthropy.

         A Family Constitution is a living document as opposed to a legal one. The armchair rule should be applied to understand a family constitution rather than resorting to legal interpretations. The terms and conditions set out in a Family Constitution should be construed according to the understanding between the parties.

         A reference can be drawn to a Family arrangement or a Family settlement, where Courts have time and again advocatedalternative dispute mechanisms to settle domestic disputes as they preserve peace and unity in the family.1 In India, Courts have made every attempt to sustain a family arrangement rather than to avoid it, having regard to the broadest considerations of family peace and security.

      2. 2.2  Why is a Family Constitution necessary?Wealth is transferred from generation to generation. Distribution of such wealth sometimes results in an unprepared transition of power. There could also be a scenario where the ethos and values of the founder are inconsistent with the third generation. Or a situation where the successor generation does not wish to participate in the day-to-day management of the company but does wish to continue to be entitled to the estate and its returns. The possibilities are endless.

         In such situations, to preserve peace and harmony, it is advisable to execute a Family Constitution. The Family Constitution sets out all the terms that the family should abide by.

         It would set out the vision and mission which will serve as a road map. For example, an orthodox Indian Family that believes against the consumption of alcohol and meat could state in the charter that the family will never invest or engage in a business that involves alcohol or meat.

         A family could impose conditions such as, on achieving a certain level of profitability every year, a percentage of the profits would be donated to a particular charity.

         As seen in the famous 2009 Bollywood film, Wake Up Sid, there could be a scenario where the next generation is not interested in continuing with the family business. A Family Constitution can explicitly elaborate the terms and conditions for a pay-out to the family members who will not participate in the day-to- day affairs of the business.

         A mediator, neutral to all the family members, could be specifically named in the Family Constitution, who would try to resolve any domestic conflicts or interpretations in the Family Constitution. This reduces the exposure to Courts which not only drains time and money but also brings shame to the family members.

         All these are necessary for keeping the business a ‘going concern’. The document serves as an aid to avoid disputes in the family and helps the business focus on growth.

      3. 2.3   What are the contents of a Family Constitution?By its very nature, a Family Constitution is a bespoke document. But while there is no template or specimen, there are certainly some common themes that will emerge organically as members of the family and business engage in dialogue among themselves and with the advisors. Some of the important clauses are listed as under:

         Mission statement: A mission statement defines what line of business it is in, why it exists or what purpose it serves, the goal of its operations: what kind of product or service it provides, its primary customers or market, and its geographical region of operation.

         Vision statement: A vision statement provides a brief description of a business’s long-term goals. It’s typically ambitious and communicates how the business plans to make a difference in the world. Think of it as a roadmap for making decisions that align with your company’s philosophy and objectives.

         Family tree: A Family tree also called a genealogy or a pedigree chart, is a chart representing family relationships in a conventional tree structure. The Family tree chalks out all the members of the family and their share of interest in the business. It can also project the future size of the family and what the ownership structure will look like in the subsequent generations on account of death, birth marriages and divorces.

         Protocol for Family Governance: This will set out how the family will run the business. Whether the ownership will be separated from the management, completely or partially. It can also set out the number of the minimum meetings between the members of the family, this would help improve communication and exchange of thought processes.

         Allocation of duties and responsibilities: This will set out the expectations from the members of the family members and the responsibilities they require to shoulder. For example, horizontal or vertical distribution of business responsibilities.

         Remuneration/Profit distribution model: This clause will set out the share of profits to be paid out to a family member not actively participating in the family business and the additional remuneration to the member who is.

         Philanthropy: This clause will set out the type of charity or religious activities the family wishes to donate to. This is an important clause to preserve family culture and heritage, as the same appears to be diluted with subsequent generations.

         Dispute resolution policies: This clause acts as a safeguard by providing an alternate dispute mechanism to family disputes. The dispute can be amicably settled behind closed doors and thus protect the family’s reputation.

         The above list of clauses/contents of a Family Constitution is not exhaustive and can address many other important issues.

      4. 2.4  How is it implemented?It is advisable to include professionals and advisors while drafting a Family Constitution. It is also advisable to draft the Constitution when the founder is alive or before triggering a particular event which can cause chaos.

         A meaningful discussion should be undertaken with each member of the family who is an owner or a potential owner of the business. Their vision for the business and personal goals have to be understood. Their relationship with other members of the family is also to be looked into.

         Usually, the possible structures and hierarchies should be transparently discussed with all the members of the family. The profit- sharing policies, personal aspirations, vision for the future, business policies, rights and responsibilities should be communicated.

         A consensus should be reached by the members of the Family. No member of the family should be influenced to enter into a Family Constitution or agree to its terms. It should be out of their own free will.

         A clause for an annual or semi-annual review of the Family Constitution is a must to ensure that the document stays relevant.

      5. 2.5   What are the pitfalls?On most occasions, the conversation on the need for a Family Constitution is never initiated by the founder or the patriarch/matriarch of the family. It is not a comfortable subject of discussion as it reminds people of their mortality. This results in a delay or not having a Family Constitution/Charter.

         Further, family members do not wish to express their sensitive thoughts as the same could result in conflicts. There is a tendency to avoid awkward or conflicting situations.

   3. Family OfficesA Family Office is a wealth management and advisory firm that usually serves anUltra High Net Worth Individual or an affluent family. They provide all kinds of services such as investing, tax management, philanthropy, insurance and succession planning. This helps maintain confidentiality, alignment of interest, protection of family assets from the business, et cetera. The team involves professionals and advisors such as lawyers, chartered accountants, investment bankers, et cetera.

      There are several family offices set up by Ultra High net worth Indians and the details are in the public domain. Singapore and Dubai are some of the favourable destinations for Indians to set up Family Offices on account of the low tax prevalent in these jurisdictions, their proximity to India, the robust judicial system and infrastructure.

      India reportedly has 250-300 family offices, with average assets under management of $100 million each. In 2022, the Reserve Bank of India (RBI) permitted profitable non-financial entities to set up financial services entities outside India and invest up to 400 per cent of the net worth of the investing entity. However, whether financial services activities include investing activity was not clarified. Recently the RBI expressed its reservation that the liberalization scheme wasn’t intended to cater to the formation of Family Offices outside India.

   4. Dénouement
      

In practice, less than 10 per cent of the family businesses have a Constitution/ Charter albeit there are several benefits to the same. It can promote cohesion – both at home and at work. The Charter is a private document, which will not be in the public domain, enhancing the discretion that many family businesses value so highly. Drafting a Family Constitution is an integral step to protecting the legacy of the family.

1. Kale & Others v. Deputy Director Of Consolidation 1976 AIR 807
2. Maturi Pullaiah and anr v. Maturi Narasimham and ors AIR 1966 SC 1836