What Should Managers Design with Family Governance? A Detailed Explanation of Construction and Operational Management Methods

Many business leaders may be aware of the growing conversation around the benefits of “Family Governance” and are seriously considering its design and implementation.

Family Governance refers to the comprehensive set of rules established to aim for the prosperity of the family. Especially for business owners, Family Governance is crucial as it is closely linked to the future of the company. The effectiveness of Family Governance for business owners is discussed in detail in the following article.

Related Article: The Rising Focus on Business Owners’ Family Governance: Explaining Its Effectiveness by Type[ja]

If you feel the need to establish governance, the next step is to understand what kind of rules you should design specifically.

This article provides a detailed explanation of the steps to design Family Governance and the content of the rules that should be created. It also covers important points to consider during the design phase and the management of operations after construction, so please use it as a reference.

Overview of Family Governance Design

Many may find themselves uncertain about the steps and creations necessary when constructing family governance. Here, we will explain the outline of the process for designing and building family governance.

The Purpose and Current State of Family Governance

The construction of family governance is carried out to clarify the family’s values and policies and to ensure that these are permeated and adhered to by the entire family.

Creating governance is not an end in itself but a means to protect assets and aim for the family’s prosperity over the future. First, let’s set the family’s ideal goals and objectives as concretely as possible.

Next, we will review the implicit rule systems that currently exist among the family members. By organizing the current state in this way, we can identify the gaps between the current situation and the goals and objectives we are aiming for.

Then, based on the strengths of the family that have become apparent in the current state, we begin to build governance to enhance these strengths and compensate for any deficiencies.

Implementing Effective Communication

For family governance to take root, it is crucial to establish an environment that facilitates smooth communication. If the values and perspectives that should be unified within the family become disjointed, even a well-constructed family governance system will not function effectively.

Furthermore, a lack of communication leading to a diluted relationship can itself become a governance risk.

To ensure that the established governance is utilized cohesively, it is essential to closely align understandings from the stage of creation.

Drafting Written Agreements for Family Governance

In creating the ‘rules of the game’ for family governance, we prepare the following types of documents:

• Family Charter
• Family Rules
• Spousal Property Agreements, Prenuptial Agreements
• Voluntary Guardianship Contracts, Trust Agreements, Property Management Mandates, etc.
• Wills, Deeds of Gift on Death, etc.
• Shareholders’ Agreements

Since the legal validity of family-related documents is often contested, the drafting process must be conducted with caution. Involve experts in the creation of these documents and ensure that all contracting parties understand the contents correctly.

Furthermore, it is advisable to notarize important documents. This can enhance the validity of the content and also prevent the risks of loss or tampering.

Refinement

It is crucial to construct family governance without the assumption that it will frequently require refinement. Typically, business rules are refined in accordance with the PDCA (Plan-Do-Check-Act) cycle, adapting to changing circumstances.

However, in the case of family governance, many aspects do not lend themselves well to refinement using the PDCA cycle. For example, prenuptial agreements are made before marriage, and even if improvements are identified after submitting the marriage registration, it is often impossible to make revisions.

Furthermore, family relationships are emotional rather than purely economic, as found in business settings. Imposing rules on a family, which is already a challenge to discipline, and frequently changing them irregularly, will make it difficult for governance to take root.

To avoid the need for short-term and irregular changes after establishment, the initial crafting of family rules is of paramount importance.

Essential Documents for Business Owners to Create When Designing Family Governance

There is a wide range of rules and procedures to be established when designing family governance. In this section, we will explain the critical documents that business owners must create and have in place.

Family Charter

A Family Charter is a document that articulates a family’s philosophy, values, behavioral guidelines, and decision-making criteria, serving as the supreme norm for the family. Also known as family precepts or family constitutions, it establishes the following:

• Core values to be emphasized
• Standards of behavior
• The head of the family
• Members of the family management council
• Systems and guidelines for business operations
• Systems and guidelines for asset management and succession
• Basic rules for family governance
• Methods for resolving disputes
• Education

Once established, a Family Charter is generally not subject to change. It clearly defines the universal aspects for the family and aims to create a common understanding of the direction to be followed.

While the Family Charter itself does not have legal binding force, as the family’s highest norm, it influences legally binding documents. It may also exert de facto coercive power through mutual monitoring. When designing a Family Charter, it is crucial to proceed with the establishment through thorough consultation to ensure consensus within the family.

Family Rules

Family Rules serve to concretize the contents of the Family Charter. To ensure that the rules, starting with the Family Charter, are accepted across generations, we recommend including the family’s developmental history and the thoughts of its leaders.

Since Family Rules specifically define the discipline within the family, they are subject to updates as time progresses and circumstances change. Therefore, it is advisable to set opportunities for reviewing the content at predetermined intervals.

Regarding legal binding force, Family Rules, like the Family Charter, do not possess it. However, based on the content established in the Family Rules and the Family Charter, they will guide the specific legal relationships.

Marital Property Agreements & Prenuptial Contracts

A marital property agreement is a contract that a couple intending to marry enters into before their wedding. It outlines the division of household and childcare responsibilities, property management, and the distribution of assets in the event of a divorce.

For a detailed explanation of marital property agreements in the context of family governance, please refer to the related article below.

Related article: To be published soon

When someone who is not the head of the family is getting married, particularly careful judgment is required. It is crucial to prioritize ensuring that the new spouse does not inadvertently cause disruptions to the family, and to establish a contract accordingly. Depending on the position of the person within the family business who is getting married, the content and focus points to include in the marital property agreement will vary.

Voluntary Guardianship Contracts, Trust Agreements, and Property Management Mandate Contracts

It is crucial to establish voluntary guardianship contracts and trust agreements in preparation for situations where one’s decision-making capacity may decline. Additionally, considering the use of property management mandate contracts is necessary for when one’s physical autonomy becomes limited.

If a business owner becomes incapable of performing legal actions, it can have a significant impact on the company’s stakeholders and family. It is essential to have predetermined measures in place for when one’s decision-making abilities diminish.

Furthermore, not only for family heads but also for those with substantial assets or those deeply involved in business, it is beneficial to utilize the aforementioned contracts in anticipation of a potential decline in decision-making capacity.

Wills

To prevent disputes over asset succession, creating a will is essential. For business owners, the issue of business succession also arises, making the will even more crucial.

For a detailed explanation of wills in the context of family governance, please refer to the related article below.

Related article: To be published soon

Not only the head of the family but all family members should create a will. Since a will can be rewritten any number of times, it is advisable for everyone to draft one initially and then periodically review and revise it as circumstances change. Depending on one’s position in a family business, the content and focus of the will may vary.

Regarding children, they are eligible to create a will once they reach the age of 15. Since a will must be made by the person themselves, it is recommended to draft a will upon reaching the age of 15.

Shareholder Agreements, Class Shares, and Personal Provisions

When operating a family business, shareholder agreements are utilized to define the handling of shares. The role of a shareholder agreement is to prevent the dispersion of shares and the potential for operational recklessness when involving multiple individuals as shareholders in the family business.

Provisions for the compulsory acquisition of shares, rules for transfer restrictions, and limitations on voting rights are among the arrangements made between shareholders to manage and dispose of shares.

Beyond shareholder agreements, class shares and personal provisions in the articles of incorporation are also employed to enforce discipline.

Key Features and Considerations of Shareholder Agreements in Family Governance

In family businesses, it is common for family members and relatives to hold shares, making the design of shareholder agreements a crucial point for asset protection. Therefore, when entrepreneurs design family governance, it is essential to deepen their understanding of shareholder agreements.

Here, we will explain the personalityistics of shareholder agreements and the points to consider when creating them.

Key Provisions in Shareholder Agreements for Family Governance

In designing shareholder agreements for family governance, we establish rules for the following matters:

• Transfer Restrictions
• Provision of Information
• Stipulations on Board of Directors’ Resolutions
• Right of Refusal
• Rights to Nominate and Dismiss Officers
• Dividend Policy
• Mandatory Buy-Out
• Non-Compete Obligations
• Predetermined Compensation Amounts
• Provisions for Inheritance
• Causes for Termination

When operating a family business, the succession and handling of shares involve more complex risks than usual. Therefore, it is essential to anticipate all potential troubles and establish rules tailored to your family’s specific needs.

Design and Operational Features

One of the key features of shareholder agreements is their flexibility in terms of content and the procedures for amendments, compared to the issuance of class shares or personal provisions. For instance, class shares can only be issued within the statutory scope. The matters that can be regulated by personal provisions in the articles of incorporation are also limited.

On the other hand, shareholder agreements are the result of free negotiations between equal parties. As long as the content does not violate mandatory laws or is not egregiously unfair, its validity is recognized.

Furthermore, changes to the articles of incorporation or the terms of class shares require procedures under the Japanese Companies Act (会社法). In contrast, amendments to shareholder agreements can be made without any special procedures, provided there is consensus among the contracting parties.

Thus, shareholder agreements offer a user-friendly system with flexibility in design and operation.

Characteristics of Enforceability in Case of Violations

One disadvantage of shareholder agreements is that, in the event of a breach, they have weaker enforcement power to hold parties accountable compared to preferred shares or personal provisions.

Actions taken by a company in violation of its articles of incorporation or the procedures of a class shareholders’ meeting can cast doubt on the validity of those actions. Directors who violate their duties of care may be held responsible for breach of their fiduciary duties, and in some cases, their actions can be enjoined.

On the other hand, since a shareholder agreement is merely a contract, it cannot challenge the validity or responsibility of the company’s actions. While it is possible to hold parties liable for damages due to non-performance of contractual obligations, it is impossible to claim any further responsibility or seek an injunction. Therefore, from the perspective of providing relief to the aggrieved party or preventing harm, a design using the articles of incorporation or preferred shares may be more effective.

However, it is possible to seek remedies for breaches by predefining penalties for contract violations within the agreement itself.

Key Points When Designating a Minor as an Heir

When designating a minor as an heir and the minor enters into a shareholders’ agreement, it is crucial to be aware of the right to rescind contracts related to the legal actions of minors (Article 5 of the Japanese Civil Code).

Transferring shares to a minor is feasible without any legal issues. However, when it comes to entering into a shareholders’ agreement, legal obligations arise. If a contract is made without proper authority, there is a risk that the right to rescind could be exercised.

Of course, if the contract is made by a legal representative, such as a parent with parental authority, it will be valid and effectively binding on the minor without the risk of cancellation. However, if the parent with parental authority is also a party to the shareholders’ agreement, they may end up acting without authority. In such cases, it is necessary to have a special representative appointed by the family court.

Key Considerations Involving Spouses

When transferring shares to a spouse, it is crucial to ensure that the right of rescission under the Japanese Civil Code (Article 754) is not exercised against the shareholder agreement made at that time. Careful attention is needed to prevent the annulment of agreements between spouses.

If involvement in a family business is anticipated before marriage, the details of such involvement should be stipulated in a prenuptial agreement (spousal property contract). If arrangements are made after marriage, it is important to clearly establish that the agreement concerning the shares is not a spousal contract.

Methods of Operating and Managing Family Governance for Executives

To maintain the effectiveness of established family governance, smooth operation and management are required. Here, we will provide an overview of methods for operating and managing family governance.

Management of Governing Bodies

To ensure the permeation of established family governance, communication between family members is crucial. As an effective means to consciously facilitate communication, setting up and managing governing bodies is recommended. Depending on the size of the family and the presence of a family business, consider the following forms for these governing bodies:

• Whether to select members for the governing body
• Whether the body will make decisions
• Whether the body will not bind decisions but provide advisory opinions

Initially, events such as New Year gatherings can be sufficiently utilized as meetings for family governance. Gradually, it is advisable to incorporate measures that convey the importance of the meeting and instill a sense of urgency.

Family Office

To make established family governance and family governing bodies function as effective systems, organizing a family office is beneficial. The family office is expected to perform functions such as:

• Management, operation, and succession of assets
• Tax strategies
• Investment strategies
• Conflict prevention and resolution

Including professionals in the above areas as members of the family office allows for comprehensive solutions to all problems surrounding executives. It is an extremely effective method for ensuring the operation and management of family governance.

Conclusion: Consult a Lawyer for Your Family Governance Concerns

Designing family governance begins with setting the goals of the family and then constructing the specific content to realize those ideals. Frequent changes after construction can make it difficult to permeate governance throughout the family. Therefore, it is crucial to meticulously craft the design at the planning stage while facilitating communication.

However, designing family governance requires establishing detailed arrangements across a wide range of areas, while simulating future developments. Moreover, it is necessary to define these arrangements in writing so that their significance is fully understood within the context of the document.

To ensure that family governance is effectively completed and operational, we recommend seeking advice from lawyers who are well-versed in a broad spectrum of legal fields.

Guidance on Measures by Our Firm

Monolith Law Office is a law firm with high expertise in both IT, particularly the internet, and legal matters. In advancing family governance, there are times when it becomes necessary to create contracts. Our firm handles the creation and review of contracts for a wide range of cases, from Japanese Tokyo Stock Exchange Prime-listed companies to venture businesses. If you are having trouble with contracts, please refer to the article below.

Areas of practice at Monolith Law Office: Contract Creation & Review, etc.[ja]