By: Antoine Del Sordo Véliz
In general terms, the family protocol is an agreement among various members of the same family that seeks to regulate family relationships and the management of a company or companies of which they are common shareholders, protecting thereby the right development and subsistence of both family relationships and family business(es).
In the context of a stock corporation in which family members partially own the capital stock of a corporation, the family protocol has two key objectives. First, it seeks to form a cohesive voting block among the family members, and second, to establish rules and dispute resolution mechanisms within the family that are respected by all its members. This aims that purely family or personal matters do not affect business decisions related to the management of the company, and at the time, maintain at all times a unified vote in the Shareholders' Meetings.
In terms of the above, as part of this protocol, in cases in which family members are partial owners of the capital stock of a corporation, granting preemptive rights among the family members, non-sale agreements and regulation to determine the direction of voting at Shareholders' Meetings are usually agreements that are included, which are explained with more detail below:
1. Preemptive rights:
It is a right granted to family members to acquire shares offered for sale by another family member. In this case it will be important to establish: (i) a prior written notice by which the family member who wishes to sell shares informs the price at which plans to sell them together with the supporting calculation, as well as other essential terms of the sale so that the other family members can exercise, where appropriate, their preemptive right; and (ii) establish regulations to solve any controversy in the event that several family members want to exercise their right.
Likewise, within the regulation of the preemptive right and taking into account the characteristics of the relevant company, it can be regulated that the selling shareholder be bound to: (i) submit to the non-selling shareholders who signed the family protocol information that allows to determine that third party offer to buy is in good faith, (ii) providing the identity of the controlling beneficiary of the potential acquirer non family member, (iii) make the potential third party buyer being bound to acquire at the agreed upon price in case the shareholders who subscribed the family protocol do not exercise their preemptive right, foreseeing on the contrary for a liquidated damages clause payable by the seller (is common that the penalty amounts at least a 50% of the purchase price), and/or (iv) a preferential price in percentage below the third party’s offer, at all times within the market value of the shares, to favor the acquisition by the shareholders who signed the protocol and discourage third parties from acquiring shares of the company.
2. Non-sale agreements::
By these non-sale agreements, it is undertaken that none of the family members may sell their shares to any shareholder or to any third party directly or indirectly related to a current shareholder who has not signed the family protocol, seeking that shareholders who are not members of the family increase their shareholding to obtain control of the company. It is important that in order for the non-sale agreement not to be void, it is thoroughly determined which person or group of persons cannot acquire the shares since, if it is stipulated that the shares cannot be sold except to members of the family, said obligation could be null, particularly in the case in which the family members do not want or are able to acquire the shares that are sought to be sold.
Moreover, it is important to mention that considering the family ties between the protocol's signatory members, it may be convenient to regulate issues that, although they could be null/non-enforceable from a legal perspective, may have an important ethical and moral weight within the family, thus inducing the behavior sought as a moral obligation.
3. Agreements on voting at Shareholders' Meetings:
A fundamental part of family protocols that include regulations on stock corporations involve determining in advance the direction of the vote at Shareholders' Meetings so that all family members vote in the direction previously determined by the majority of its members. Depending on the degree of control aimed to achieve, there are various mechanisms that can be implemented.
One mechanism would be to establish holding meetings among the signatory members of the family protocol to determine in advance the direction of the vote in the Shareholders' Meeting, same determination that should be binding even for family members who may have not been able to attend the family meeting prior to the Shareholders' Meeting, providing for a liquidated damages clause in the case in which a family member votes against to what was agreed upon. The effectiveness of this mechanism will depend mainly on the penalty amount since, in the end, each family member would individually and personally exercise their vote in the Shareholders' Meeting.
Another alternative would be to establish a syndication of shares appointing a director of the syndicate, who is granted with irrevocable powers of attorney to vote the shares in the direction determined by the majority of the family members in their capacity as syndicated shareholders, prior to the holding the relevant Shareholders' Meeting. The advantage of this mechanism which implies a broad degree of control is that it shields the company from potential takeovers by another group of shareholders who are not part of the family protocol, ensures power over other shareholders who may be in a feud, and helps to maintain control of the company, since through the exercise of the irrevocable power it is ensured that the voting of family members is casted in the same direction.
Although in Mexico, unlike other countries such as Spain, the family protocol is not yet explicitly regulated, it can legally operate as an atypical contract or a shareholder’s agreement with respect to a stock company. Furthermore, it should be noted that although the regulation regarding a corporation is an essential element of the family protocol, its objectives and regulation are much broader than a mere agreement among shareholders, since it also may comprise clear and precise rules regarding intimate aspects of the family independent from the company, such as methods to solve family conflicts, orders of incapacity of its members, forms and methods to obtain resources, philanthropic aspects, public image of the family and its members, etc.
Hence, depending on the extent of the assets and regulations outlined in the family protocol, various family governance bodies may be established, such as (a) family council, serving as the executive and governing body of the family, and although it does not have decision-making authority, it usually executes the decisions adopted by the family assembly and acts as a bridge between the family assembly and the family businesses, (b) family assembly, which comprises all family members and makes the decisions; the main objective of this body is to achieve family cohesion and maintain a unified front, and (c) external advisors, who must be impartial experts advising on decision-making and helping resolve conflicts that may arise among family members.
In conclusion, a family protocol can result an appealing tool for families seeking to maintain control of a family business. This is particularly relevant in the case of a stock corporation partially controlled by a family since; by establishing clear rules for decision-making within the company, the protocol can prevent the gradual dilution of control over the family business due to conflicts or divergent interests over time. Simultaneously, it enables the regulation of intimate family matters, potentially avoiding protracted and costly legal disputes (which generally end up permeating the family company). For instance, the protocol may provide guidance in situations such as a member’s incapacity or significant conflicts between siblings or parents and children. The above, through the establishment of action and dispute resolution mechanisms that help strengthen family values and, at the same time, the subsistence of the family and family businesses.
In case you are interested in implementing a family protocol tailored to your family’s needs, do not hesitate to contact our Firm.
Pablo Gómez Sainz
Antoine Del Sordo Véliz
