In this article, we explore the situations that can affect a family business in the event of the death of the “head of the family,” who holds the greatest responsibility for running the business.
Usually, family businesses will only start to deal with the realities of managing the business after the death of the founder when everyone is aware of the aforementioned founder’s impending death due to old age or serious illness. However, death can occur suddenly and unexpectedly, complicating the running of the family business and causing significant economic damage.
Large family businesses are often structured as trading companies, separate legal entities from the founder. Here, we focus on situations wherein the family business operates as a limited liability or joint-stock company, the two most common legal forms of business corporations in Slovakia.
After the founder’s death, shares are typically divided into a larger number, posing challenges in operating the family business. Each heir may have differing opinions on the business’s direction, and over time, the succession of shares by other heirs may create distance among co-owners.
The Period Before the Founder’s Death
If everyone in the family knows that the founder’s death is imminent, a practical solution is to elect a successor and make the necessary corporate changes. However, if the founder’s death is unexpected, mechanisms set up in advance should activate and eliminate constraints on running the family business during succession proceedings.
Upon the founder’s death, their assets, including shares and stock, become subject to inheritance proceedings. It’s essential to consider the value of shares acquired during marriage, which typically belong to an undivided co-ownership (“UCO”). Therefore, in inheritance proceedings, the UCO must be settled first. According to the UCO, under normal circumstances, the surviving spouse is entitled to 50% of the deceased’s estate, while the remaining 50% will be subject to inheritance proceedings. One option to reduce the other spouse’s share is to narrow the UCO or cancel it during the marriage.
For this reason, it is necessary to consider how to ensure the operation of the family business in the event of the death of its founder at the very beginning of the family business. The founder must consider whether they want the majority shareholding to go to their spouse or their children, as well as which of the children specifically, in the event of their death.
If one of the founder’s children is to participate in the running of the family business after their death to a greater extent than the others, the creation of a will is appropriate but not sufficient. However, in the case of a will, it is essential to bear in mind the claims of the intestate heirs, which are composed of all of the founder’s children (even illegitimate). It should also be borne in mind that a will cannot impose conditions on the heirs as to how they are to dispose of the inherited property.
It is thus clear that in the event of the founder’s death, a potentially large number of persons are entitled to participate in the continuation of the family business. However, while founders generally want to eliminate the fragmentation of the family business assets in subsequent generations as much as possible, they also do not want to completely “exclude” close family members from profiting from the family assets.
Therefore, these issues should be comprehensively resolved before the founder’s death by narrowing the UCO and a will and preparing a sophisticated corporate structure to optimize the tax burden on the estate and the potential costs associated with succession proceedings.
The Period Between Death and the End of Succession Proceedings
After the founder’s death, the inheritance proceedings are initiated; a notary public conducts them in the Slovak Republic. First, the founder’s property and value, which will be the subject of the inheritance, are determined. The inheritance proceedings also include the aforementioned settlement of the UCO. The notary then ascertains whether the founder has left a will; if not, the inheritance is divided according to the statutory definition. The basic rule is that every heir’s shares are equal. The surviving spouse and the founder’s children are usually the lawful heirs in family businesses. If one of the children is no longer alive but has left other descendants (grandchildren and great-grandchildren of the founder), these descendants will also be heirs.
A common complication arises when the founder is the sole authorized body to act on behalf of the family company and holds majority voting rights. This may restrict the overall functioning of the business until the succession proceedings are completed. In such a case, the notary appoints a so-called administrator of the succession. The law stipulates that such an administrator must have business experience. One of the heirs may also be the administrator of the succession. However, choosing an administrator is entirely within the competence of the notary, and the founder cannot determine in advance who is to be the administrator in the succession proceedings.
The notary also defines the scope of the property to be administered. The main task of the administrator of the succession is to preserve the value of the inheritance and, at the same time, to be liable for damages in performing their duties. Therefore, the acts of the administrator of the succession may be limited, and it will not be possible for the family business to make serious decisions that could carry some risk. The operation of the family business through the administrator is optimal for a very short period; however, in the event of a lengthy succession procedure, such a method of running the family business can be problematic.
When setting up the optimal mechanisms in a limited liability company, it is also necessary to bear in mind that the possibility of inheriting the founder’s business share can be excluded. The condition for excluding the inheritance of the business share is that the shareholder in the company is another person besides the founder. The exclusion of the succession of a business share must be approached with great caution if the other partners are close persons who spend time together, as a frequent cause of sudden death can be a car accident in which more than one member of the family is killed.
Intestate Heirs and Gifts
Slovak legislation includes only the testator’s children among the intestate heirs (the spouse may be omitted). This means that the intestate heir must, even if the founder established a will, receive at least the statutory value from the inheritance.
Minor children must receive the same value from the estate as if they had inherited a statutory share. Adult children must receive at least half of the estate’s value as if they had inherited a statutory share. If this condition is not met in the case of intestate succession, the descendant who received less may seek partial annulment of the will, which can prolong the succession proceedings for several years.
Another provision often overlooked in practice is the need to set off unusual or extraordinary gifts received by any of the heirs during the testator’s lifetime against the inheritance share. If no will has been established, the notary must always consider the value of the unusual or extraordinary gifts. If a will has been established, the offset of unusual or extraordinary gifts shall be conducted only if the settlor provided in the will or if the heir to the gift would be considered “unreasonably favored” over the intestate heir.
In practice, the founder often transfers part of the business shares to the heirs, who will continue to run the family business during his lifetime, free of charge. At the same time, however, they do not compensate the other heirs for what they have been deprived of by acquiring the business shares. This will make it possible for heirs who have not acquired business shares to claim, during the succession proceedings, that their share of the inheritance be increased by the part of which the founder’s conduct has deprived them. However, pursuing these claims prolongs the overall duration of the succession
proceedings and, thus, the duration of the administrator of the succession, which can paralyze the process of making important decisions for the family business for a long time.
Conclusion
It is evident that without careful consideration, a founder’s death can lead to varying complications for the family business. The absence of mechanisms for the business’s continuity post-founder death can trigger a cascade of inheritance litigation. Even in the founder’s absence, planning for the family business’s operation requires addressing multiple factors, including establishing a substitute statutory body, defining the limits of the founder’s heirs’ omission, and optimizing tax distribution within the family assets.
This article has been brought to you by Falath & Partners.
Authors of the article:
Ján Falath, Managing Partner
Vladimír Sedliak, Associate
