Lesson learned from “Queen of Tears”: A reflection on Family Governance and M&A

【May 29, 2024】Effectiveness of family governance and M&A is the cornerstones of a sustainable family business operation.  The recent popular K-drama “Queen of Tears” has captivated such spirit; should the leaders of the family owned business can break away from the mindset of traditional blood lineage and refer to the Japanese practice of Muko Yōshi, i.e., the adoption of son-in-law, prioritizing the continuity of the family business, the storyline could unfold quite differently.  Ingrid Chen, partner of Deloitte Legal, uses this narrative to delve into the critical issues of family succession and the various legal instruments, aiming to shed light on strategies for better planning for family business leaders to ensure enduring legacy of their enterprises.

I. Thinking ahead as well as behind: Trusts and Voluntary Guardianships before Death in addition to Wills

In the drama, the management team of the Queen Group falls for a high-reward investment scheme devised by the hostile acquirer.  They underestimate the risks and invest by pledging their shares as collateral for loans.  Furthermore, the chairman of the board, deceived by the hostile acquirer, signs an investment agreement with terms allowing the conversion of the investment into equity and a power of attorney granting a proxy to the ally of the hostile acquirer to exercise the chairman’s voting rights and seize control of the Queen Group when he becomes incapacitated.  Despite the family members having pre-written wills, they did not foresee losing control during the chairman's lifetime, rendering the will's restrictions on distributing assets to non-family members completely futile.

Ingrid Chen reminds that when doing transactions, the parties shall be cautious of investments that, rather than loans, without interest payments or repayment pressure, might have potential risk of dilution via share conversion or new share issuance.  Employee stock ownership trust or family trust to appropriately separate ownership from management of the company may be helpful mitigating such risk.  It also may be prudent to hand over part of the business to the next generation in advance, with measures of safeguarding the company seals with power of attorney or entering into advance voluntary guardianship agreements, so as to ensure that the designated successors can obtain the authority to manage assets in a timely manner to avoid the predicament of losing control when faced with a hostile acquirer.

II. Equal Distribution of Shares: Right or Wrong?

Ingrid Chen also explains that in pursuit of fairness, the first generation often distributes the shares of the family business equally among the second generation.  However, this practice, continued through successive generations, gradually dilutes individual shareholdings, resulting in none of the descendants having a controlling stake.  If family members cannot remain united, or if an ambitious individual among the family members seeks to seize power by allying with outsiders for a takeover, this could lead to a violent takeover and the eventual demise of the family business.

III. People-Oriented: Building Consensus through a Family Charter and Strengthening Understanding with Regular Gatherings

Laws alone cannot carry themselves into practice.  To foster a shared value among family members and maintain harmonious and trusting relationships, Ingrid Chen suggests regular gatherings for mutual understanding, formulating a family charter, and establishing family committees.  These measures can help create a rigorous, institutionalized training and succession mechanism, and oversee the operation strategies and overall interests of the family business.  Proper arrangements shall also be made for family members who wish to withdraw from the family business or not participate in its management but still retain their beneficiary rights, ensuring that parting ways can still be a graceful transition.

IV. Close Companies Fortifying Control

Taiwan Company Act provides a framework for close companies, allowing family businesses to apply restrictions on share transfer to outsiders through statutory and contractual mechanisms including specific provisions of the company’s articles of association, golden veto rights, and multiple voting rights.  These measures help solidify control and are highly recommended for family businesses to make greater use of.