Newsletter
Family Business Succession Planning and Company Act Series-Close company and holding shares through a trust
I. Introduction
In the amendment to the Company Act on 6 July 2018, the numerous new and experimental institutions designed for a close company were adapted for a typical/general company limited by shares. For instance, it used to be mandatory to hold an in-person shareholders’ meeting; after the amendment, video conferencing becomes a viable alternative. Additionally, there is the application of special shares giving multiple voting rights and the possibility of increasing the number of times earnings are distributed. However, the 2018 amendment did not make contribution by service and restrictions on transfer of shares applicable to a company limited by shares. These two features make a close company distinct from a typical/general company limited by shares, providing SMEs with an advantage in strengthening their equity structure and the relative ease with which they can raise funds, and helping SMEs stay flexible in implementing tactics in response to industry shifts.
I II. Either a close company or holding shares through a trust
Establishing a close company to facilitate family business succession offers the advantages of restricting transfer of shares and having a limited number of shareholders. However, when opting for this approach to achieve family succession, it should be noted that a close company is still subject to Taiwan's Company Act. Though a close company is designed with such features as limits to transfer of shares, special shares giving multiple voting right and those giving veto power, in essence it is formed with an emphasis on the amount of capital, with each shareholder owning a part of the company in proportion to the capital contributed. Such is the inherent limitation under the Company Act, which might prove to be in conflict with the goal of family business owners planning to make their businesses sustainable by designating the family's holding company as the core mechanism to bond the family and ensure that the business, besides being sustainable, will not be divided up.
Apart from setting up a close company, establishing a trust to hold shares is another way to ensure that the family business is sustainable and the control of the business does not fall into the hands of outsiders. Abroad, setting up a trust to hold shares has long been standard practice among family businesses seeking to pass down the family business' wealth. The object of the trust can be ownership of shares, dividends, or even voting power, thus achieving the goal of centralizing management and benefiting each party involved. Specifically, this approach involves placing the business’ shares into a trust (a financial institution is often designated as the trustee), restricting purchase and sale of shares, and setting up a committee or family office for family members to express their opinions via internal channels. Decisions are made on behalf of the entire family. In this way, family members can reach a consensus on choosing the appropriate business manager while benefiting from the business' profits proportionately.
The trust framework within which a trust's holding of the family business' shares is arranged is essentially based on a trust agreement. The substance of the legal relationship is formed by the settlor and trustee with free will. With consideration of the autonomy of private law and freedom of contract, judicial authorities will respect the contents of a trust agreement made by the parties to it with free will, even when jurisdiction clauses of other countries or judiciaries and foreign governing laws are involved. The trust agreement so made will not be easily changed by the beneficiary's own will. Arrangements for shares to be held by a trust can, relatively speaking, overcome the natural limit of the business owner's lifespan, the gradual decline of the owner's cognitive ability, and the limit of the company's institution being inherently focused on the amount of capital. If the object of a trust's shareholding is the stock of a close company, it will be of even greater help in consolidating the sustainability of the family business' operations.
III. Practical Issues
Establishing a close company, or a trust to hold shares, or both, may run into certain recurring issues in practice. For example,
When the sole company designated for trust purposes has a higher equity ratio (e.g. over 50%), does the trustee have to bear risks of the company's operations? If the trust agreement explicitly provides that the trustee shall vote in the shareholders' meeting and election of directors according to the voting wishes of the settlor and beneficiary, but they for some reason fail to inform the trustee as to their voting wishes despite having agreed to do so, is the trustee liable to additional responsibility because it is obliged to exercise the due care of a good administrator?
The authors are in agreement with Articles 22 and 23 of Taiwan's Trust Law, which state that a trustee shall administer the trust affairs with the care of a prudent administrator; and that a settlor, beneficiary or other trustees may request the trustee to pay pecuniary compensation for damage caused to the trust property or to restore the damaged property to its original condition if the damage is incurred due to the trustee's improper administration of the trust property, or if the trustee disposes of the trust property in violation of the stated purpose of the trust. In addition, reduction of the remuneration payable to the trustee may also be sought. Articles 34 and 35 of the same Law provide that the trustee is obliged to maintain faithfulness. In addition to the Trust Law, Articles 535 and 544 of the Civil Code provide that the mandatory who receives remuneration for the affair commissioned shall be in accordance with the instructions of the principal and exercise the care of a good administrator; and that the mandatory shall be liable to the principal for any injury resulting from his negligence in the execution of the affairs commissioned or from such acts as are beyond his authority.
Accordingly, the trustee shall observe the obligations of faithfulness and of exercising the care of a good administrator in performing the trust agreement. If the trust agreement explicitly provides that the trustee shall vote in the shareholders' meeting and election of directors according to the voting wishes of the settlor and beneficiary, but they for some reason fail to inform the trustee as to their voting wishes despite having agreed to do so, it is recommended that the trustee, to prevent future disputes, inform the settlor and beneficiary of the foregoing in writing and specifically the method of disposal to be taken when the settlor and beneficiary are late in giving notice (e.g. voting for the same director/supervisor candidate previously designated) so as to minimize the legal risk to the trustee.
I IV. Conclusion
While the development of SMEs in Taiwan is vibrant, many SME owners are under pressure to bring about succession. Whether it's a case in which the second generation does not wish to inherit, or one in which the owner seeks to have the hard-earned family business jointly run by the family, Taiwan's current legal institutions provide the framework of a close company to help achieve family succession by way of restricting transfer of shares, and that of a typical company limited by shares enabling the issue of special shares as a tool to make plans for family-owned shares. Further complementary measures are also available, such as formulation of a trust agreement on holding equity to structure a trust framework in which ownership and the right to benefit are separated. This will provide further assistance to family business owners aiming to achieve a sustainable family succession.
Regarding the application of complementary measures of holding shares through a trust, in a case where no explicit instructions on exercising rights to shares have been given, the trustee should, in the authors' opinion, exercise the due care of a good administrator, take the initiative in consulting the person with the right to give instructions on how to exercise said rights to shares, and specifically give notice as to how said rights will be exercised when no instructions have been given, in order to minimize legal risks.