Risky Business: Family Business Succession and the Rules of Professional Conduct

• Jurisdiction: California,United States
• Citation: Vol. 12 No. 2
• Publication year: 2006
• Author: By John W. Ambrecht, Esq. and Elyce Pike, Ph.D.
• topic: Business of Law

RISKY BUSINESS: FAMILY BUSINESS SUCCESSION AND THE RULES OF PROFESSIONAL CONDUCT

By John W. Ambrecht, Esq.^* and Elyce Pike, Ph.D.^**

I. INTRODUCTION

Ironically, the California Rules of Professional Conduct¹ ("CRPC" or "Rules") actually tend to hinder rather than help the transfer of a family business from one generation to the next. This becomes apparent if you compare conduct under those Rules to the "best practices" developed by other professionals in the family business succession field. Of course, hindering rather than assisting the succession process is hardly the purpose of the Rules, but it is often the effect.

To frame this discussion we begin with the fact that Rule 1-100 (A) provides in part as follows:

"Rule 1-100.² Rules of Professional Conduct in General
"(A) Purpose and Function.
"The following rules are intended to regulate professional conduct of members of the State Bar through discipline. They have been adopted by the Board of Governors of the State Bar of California and approved by the Supreme Court of California pursuant to Business and Professions Code sections 6076 and 6077 to protect the public and to promote respect and confidence in the legal profession."

Do the Rules "protect" the public, or do they hurt the public and generate risks for the public when the lawyers work on the family business succession process? Is it possible that Rules designed to protect the public actually contribute to the generally accepted statistics³ that only 34% of family businesses succeed to the second generation and only about 14% to the third generation?

This article explores these questions and related issues. Specifically, the authors:

• examine possible root causes of the family business failure rates cited above to understand better why the best practice approach of other family business succession professionals may make sense for attorneys;
• discuss a best practice approach that has been developed by practitioners in other professional fields (e.g., organizational development consultants,⁴ clinical psychologists,⁵ psychiatrists,⁶ family business consultants,⁷ business management consultants⁸) to help the family business succession process;
• compare that best practice approach to the limitations that our Rules of Professional Conduct impose on estate planning lawyers and suggest how a lawyer might work more effectively with the family business client within the framework of the Rules;
• examine whether our Rules may prevent us from addressing the root causes of the failure rates cited above and thus indirectly contribute to those failures;
• identify what, if anything, attorneys can do to address those causes within the constraints of the Rules.

II. ROOT CAUSES FOR THE FAILURE RATES IN FAMILY BUSINESS SUCCESSION.

Findings from one of the first empirically-based research studies⁹ identifies three factors as those most often leading to succession breakdowns. This study may provide some insight into the unintended consequences of our well intentioned Rules. The research conclusions¹⁰ indicate that the high rates of family business failures are due to three factors:

1. 60% of typical breakdowns arise from relationship issues or "how we get along";
2. 25% of typical breakdowns arise from heirs lacking competence and being unprepared; and
3. 10% of typical breakdowns arise from tax and traditional estate planning issues.

Other issues account for the remaining reasons that family businesses fail.

In light of these findings, we draw your attention to two points related to our estate planning practices. First, estate planners and business owners generally spend their time on activities related to 10% of the causes¹¹ of succession breakdowns rather than on activities related to the factors accounting for 85% of the breakdowns. Second, attorneys' skills and competencies in tax and governance matters are the least¹² effective ways to address family relationship issues (60% of the cause) or the needs of heirs who are unprepared to assume their new duties (25% of the cause).

Assuming that these two points are reasonable, two potential improvements suggest themselves. First, it may be useful for estate planners and business owners to adopt a broader view and more comprehensive approach to the succession planning process (granted, more easily said than done!). Second, estate planners trained exclusively in tax, investment and trust law might seriously consider revising¹³ their current advisory approaches by developing

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knowledge and skills that would enable them to address more effectively the main causes of breakdown in family-business succession. In fact, the Rules may actually "require" attorneys to acquire the appropriate skills or "associate with, or where appropriate, professionally consult another lawyer reasonably believed to be competent" (Rule 3-310(C)¹⁴) in these matters.

However, given the limitations imposed on attorneys by the Rules, it may not be possible for lawyers to broaden the scope of their representation of family businesses. To understand why the lawyer (and even the family business client) may be at risk if the lawyer tries to "do the right thing," we will first review a generally accepted "best practice" approach for family business consultation. This approach has been developed by the other professional fields mentioned above. Then we examine whether the estate planning lawyer can use that approach.

III. "BEST PRACTICE" FOR A FAMILY BUSINESS, SUCCESSION CONSULTATION

There is no shortage of suggested best practices for family business succession consultations. Books, journals, family-business magazines, and websites all provide plenty of guidance. In the following section, we outline a generally accepted, best practice approach for family business succession consultations. However, we first define a family business, and then outline the best practice approach, although it is not the only one developed in the other professional fields.

A. What Is a Family Business?

A family business is a hybrid in that it combines two separate, but interrelated, complex systems: the family system and the business system.¹⁵ Each system contains elements that are related such that a change in any one part of either system will influence, or produce change in one or both parts of the system.¹⁶ The interrelatedness of the elements in a system is exemplified by the idea that a butterfly flapping its wings in South America can change the weather in California.

In a family business, the two systems are linked by their intertwined relationship. Each system is distinguished by its difference from the other, but linked by the underlying unity of the two being connected.¹⁷ In other words, each system has its own elements of rules and expectations, yet is continually influencing and being influenced by the other system, such that when the two systems are combined it produces a family business¹⁸ with its own unique configuration of elements of both family and business.

To understand the applicability of the "best practice" approach described below, let's briefly review the rules, roles, and expectations¹⁹ of each of these two systems.

• A family system involves kinship, relationships, unity, marriage, children, gender,²⁰ brother, sister, sibling rivalries, and the various roles family members play for each other, such as the parent, child, the older, younger and middle sibling, the grandchild, the scapegoat, the victim, the black sheep, the outsider, the hero, the loser, the winner, the favorite, the entrepreneur, the business owner and the power holder, among others. A family consists of a set of stories or plots "some of which are inherited, some created and others are the myths that people live out as part of the family legacy."²¹
• A business system²² consists of the many rules and expectations that center on money, profit, efficiency, capital, markets, sales, competition, performance, and operations.

The unique management and succession challenges in family business stem from the two systems and hybrid nature of the entity. Not incidentally, planning for and implementing succession often intensifies the effect of family dynamics on the business and of business dynamics on the family, and rarely for the better. In response to those challenges, the professionals noted above have generated research, literature and practices designed to help both the family business and the family.

B. The Basic "Best Practice" For Family Business Succession Consultation

There are several models for entering, assessing, intervening, implementing and completing a family business succession consultation, but assessing them all is beyond the scope of this article. Instead, we want to address two underlying characteristics of the various best practices that are most germane to this discussion.

1. Identity of the Client

Upon entering the situation, the first question to address, as in the practice of law, is to identify the client. However, unlike law, in terms of best practices, it is generally accepted that the family business system²³ itself is the client. However, the advisor works with both systems and spans the boundaries of each system. The complex linkages between the family system and the business system dictate that the best practice is to work with both systems.

This means that the consultant must consider the interests, goals, values, actions and other aspects of the two systems. Thus, the consultant "represents" and deals with each individual and each group (including family members who do and do not work in the business), and perhaps with non-family members in the business, as well as the organization itself, which in turn interfaces with the markets, vendors, and political, social and economic environments.²⁴

2. Assessment, Intervention, and Implementation

A generally accepted model for organizing the assessment, intervention and implementation is the "action research model."²⁵ The action research model typically involves fact finding, diagnosis, planning based on the...