Introduction
Family businesses are among the oldest forms of business.Footnote 1 From small businesses to listed companies, family businesses are dominant in terms of their presence and impact. Globally, family businesses account for approximately 70%–90% of annual gross domestic product and provide approximately 50%–80% of employment in most countries.Footnote 2 According to the International Finance Corporation (IFC), family businesses hold a significant sway in countries like Spain, where they constitute approximately 75% of all businesses,Footnote 3 as well as in the US.Footnote 4 This phenomenon is even more entrenched in the Gulf Cooperation Council (GCC) economies.Footnote 5 For instance, family businesses in Saudi Arabia represent approximately 90% of all private enterprises.Footnote 6 This is also reflected in the listed companies, with approximately 45% of all listed companies in Saudi Arabia being family businesses.Footnote 7 Some studies have highlighted that 90% of all businesses in the Middle East are family-owned. The economic importance of family businesses is also reflected in the region's wealth, with an estimated one trillion USD expected to change hands in the Middle East this decade.Footnote 8 A study by the Dubai International Financial Centre estimates that family businesses in the GCC alone hold around one trillion USD.Footnote 9
Despite the economic importance of family businesses both globally and in the GCC, it is well established that compared with regular businesses, family businesses are susceptible to more challenges and conflicts that usually have detrimental effects on their productivity and continuity. Family dominance and presence in family businesses, inter alia, play a critical role in exacerbating these challenges.Footnote 10 Studies show that approximately 95% of family businesses fail before they get passed down to the third generation.Footnote 11 This is reflected in the old proverb ‘shirtsleeves to shirtsleeves in three generations’ attributed to Andrew Carnegie, which illustrates the inherent difficulties faced by family businesses.Footnote 12 One would assume that with this dismal reality of success and continuity, policymakers and lawmakers would have introduced an appropriate regulatory framework to govern family businesses. However, the reality is that most existing national legal frameworks do not account for family businesses in relation to governing rules.Footnote 13
This reality has led some scholars to state that there is no such thing as family business law.Footnote 14 Family businesses are neglected in both the legal and, to a lesser extent, the economic research literature. Listed companies and capital markets have dominated the interest of business law professors at the expense of private companies and family businesses.Footnote 15 This oversight extends to policymakers even in developed markets such as the EU.Footnote 16 Law school curricula follow the same trend, as it is difficult, if not impossible, to find courses devoted to family businesses.Footnote 17
Family businesses face numerous unique structural and institutional challenges.Footnote 18 At the national level in the Arab world, both the relative lack of corporate law flexibility and the limited recognition of private ordering through shareholder agreements and other contractual arrangements among shareholders represent formidable obstacles to effective family business governance structures that ensure longevity.Footnote 19 Furthermore, family law can play either a positive or a negative role in governing family businessesFootnote 20, as illustrated in this article. At the institutional level, the efficiency of the judiciary and alternative dispute resolution mechanisms also play a critical role in supporting family businesses. Finally, the social values within a society can either exacerbate conflicts among family business members or reduce the potential for such conflicts.
The current study analyses recent developments in the legal frameworks governing family businesses in the GCC. In particular, it focuses on the United Arab Emirates’ (UAE) new family company law that was introduced in 2022 at both the federal level (Federal Decree-Law No. 37 of 2022) and the local emirates level in Dubai (Law No. 9 of 2020 Concerning Family Ownership) and Abu Dhabi (Law No. 10 of 2021 Concerning Governance of Family Companies).Footnote 21 These laws are unprecedented both regionally and internationally, except for Malta, which passed a family business act in 2017.
The introduction of a legislative framework for family businesses in the UAE is considered a departure from the historical approach to governing family businesses, which is largely contractual in nature, through, inter alia, family constitutions and shareholders’ agreements. This state intervention marks a shift away from a market-based strategy and introduces a hybrid model to govern family companies.
This article aims to contribute to existing scholarship in the field of family business law in the context of corporate law in two ways. First, I offer an overview of recent developments in the UAE. I argue that the UAE experience can serve as a model for other countries, especially in emerging markets, and that it is an effective strategy for addressing the intrinsic challenges that family businesses often encounter. Having said that, it should be noted that there are interesting differences within the UAE at emirates level, eg, Dubai excludes publicly listed companies from the definition of a family business under article 4 of the Family Ownership Law, while Abu Dhabi is open to consider such companies to be treated as family businesses to fall within the definition of a family business under article 2 of the Governance of Family Companies Law. In doing so, I hope this contribution will stimulate discussion on the need for legislative intervention in family company law.
The second contribution is to advocate for a policy proposition to regulate family company law based on an opt-out model for family businesses that would help mitigate the well-documented risks associated with family businesses.Footnote 22 Through exploring relevant legal uncertainties associated with common governance practices that are used in family businesses, such as family constitutions, the paper aims at identifying needed reforms to achieve an optimal family business governance framework. This would include a two-pronged legislative strategy that aims at adopting a designated legislative framework for family businesses, and, at the same time, reforms relevant rules in other laws, such as company laws, that can have an impact on family businesses.
Given the limited scholarship in the area of family company law in the context of corporate law, this article aims to fill a considerable gap in the current literatureFootnote 23 by building on recent legislative developments in the UAE to introduce a framework for other legislative initiatives in the area of corporate law relating to family businesses.
The second part of the article highlights the fragmented historical trajectory of family business regulation, and the non-legal nature of family businesses, which is critical to consider when regulating and governing them. The article provides the reader with different approaches to identifying what constitutes a family business, ie the legal definition of a family business. Subsequently, it addresses the relevant legal rules in the context of company laws for family businesses. In the Arab world, the legal positions on shareholder agreements, family constitutions, and articles of association are relevant to the governance of family businesses. The article then explores the impact of family laws and inheritance rules, in particular, on family businesses, and how the UAE model has sought to address these in this context. The final section details the proposed optimal regulatory model and framework for addressing family business challenges.
Emergence of a new trend
Historically, countries have addressed family businesses through targeted legislative interventions rather than adopting a comprehensive legislative framework to govern them. For instance, in Austria, family businesses are given preferential treatment regarding opening hours to help them compete with large corporations. In the context of inheritance law, France has accommodated inheritance agreements among family members that were historically forbidden.Footnote 24
This fragmented policy approach falls short of providing a comprehensive legislative framework that addresses the fundamental challenges inherent to family businesses. Furthermore, the internal governance tools relevant to family businesses have historically been based on a ‘soft/self-regulation’ strategy. Governments introduce governance codes tailored to family businesses, but these codes are non-compulsory and merely offer guidance.Footnote 25
Notably, there is currently no internationally adopted legal business form specifically designed for family businesses. Historically, there have been attempts to create such a legal form; for instance, in Germany in the 1930s, a proposal to introduce the ‘family company’ as a legal form was discussed but rejected due to the lack of an agreed definition of what constitutes a family business.Footnote 26
The recent legislative developments in the UAE aimed at regulating and establishing a new legislative framework for family companies, undoubtedly signal a new trend internationally. Prior to that, Malta was the only other country to pass a designated law for family businesses in 2017. Furthermore, the UAE’s recent legislative developments include the aim to introduce appropriate dispute resolution mechanisms for family business conflicts, as outlined in article 19 of Law No. 37/2022. This initiative to designate a specialised law for family businesses could be a major factor in reducing the intrinsic risks associated with family businesses. An interesting additional objective can also be found in article 3 of Dubai’s Law No. 9/2020 governing family business ownership, which states that the law aims, inter alia, to preserve social cohesion and mitigate factors that could contribute to family agitation. These non-business objectives are truly unique and aim to address one of the main factors contributing to the demise and failure of family businesses: internal family disputes.
Non-legal nature of family businesses
It is critical, before engaging in the legal analysis of the best rules or models to govern family businesses, to have a proper understanding of their non-legal nature, as this will affect the formulation of the most effective rules to govern them. Families tend to have a social dimension that naturally spills over into businesses.Footnote 27 In particular, family relationships are intimate and irrational, whereas business relationships are considered more rational.Footnote 28 Families and businesses are two separate spheres, namely, economic and social spheres, and the family business legal framework and mechanics aim at bridging the differences and conflicts existing between these two spheres.
This distinction between families and businesses can be found in both academic definitions and analyses of family businesses and policy papers. For instance, an EU report has stated that what distinguishes family businesses from non-family businesses is ‘the element of families or family culture.’Footnote 29 In other words, family values must co-exist with marketplace values.Footnote 30 Some scholars have applied social theories to understand the root cause of ‘family conflicts’ in the context of family businesses. Others have employed social identity theory to explain family businesses’ susceptibility to internal family conflicts. Social identity theory stipulates that ‘people use social roles to categorise themselves and others as a means of ordering the social environment and locating themselves and others within it.’Footnote 31 Questions relating to the role of family businesses in creating employment opportunities for family members, dividend distribution policy, and other aspects of family businesses will naturally affect family relations. Social disputes within families will also have a negative spillover on business, albeit in the absence of any direct relations between the two.
The history of each family also plays a critical role, directly impacting each family’s business. It is assumed that the ‘shared vicarious memories define the family as a distinct social entity with coherence and continuity over time and space.’Footnote 32 Recently, scholars and researchers have started to appreciate the perspective of assessing and evaluating family businesses through what is known as ‘family history and memory’.Footnote 33 In fact, in 2023, the Family Business Review dedicated a special issue to ‘history-informed family business research,’ focusing on how families remember and forget, and the related impact of this reality on family businesses. This reality contributes to the creation of a set of formal and informal standards rooted in family history and values. In essence, norms are usually incorporated informally into the family’s business operations.Footnote 34
One additional non-legal characteristic is that family members usually serve as managers. For instance, in Austria, 77% of family businesses have family members serving as managers, and similar situations are found in France, Finland, and Cyprus.Footnote 35 This reality creates what is known as the entrenchment effect by some scholars, ie family officers usually end up being entrenched in their positions regardless of whether they are performing or not, just because they are a ‘family’ member.Footnote 36
In other words, accountability and efficiency are diminished because of the entrenchment effect. This fact should be assessed in the context of directors’ fiduciary duties, as any potential director liability claim will cause irreparable damage to family relationships. Unlike situations in non-family businesses where such disputes rarely have an impact on the business or shareholder relationship, in the context of family businesses, a legal action taken against a family member in his or her capacity as a director could bring down the business as it could lead to irreparable friction within the family. Unlike in non-family businesses, the close emotional bonds that are usually associated with family businesses become ‘obstacles to rational action.’Footnote 37
Hence, family business disputes tend to be emotional and more difficult to rectify due to the involvement of non-business emotions.Footnote 38 Nepotism is also more common in family businesses than in non-family businesses. Nepotism includes the hiring of relatives in family businesses.Footnote 39 As in many cases, family businesses are considered the main employers of family members. In other words, family members perceive the family business as a given right of employment regardless of their qualifications.
This reality can also be a major source of conflict, as one can imagine the ramifications within the family if the business decides to terminate a family member’s employment due to their incompetence. Therefore, management experts recommend that family businesses minimise the employment of family members within the business and have the family play a role at the board level rather than in management.Footnote 40
This non-legal element and feature of family businesses has been historically neglected in the drafting and design of governing laws and rules applicable to family businesses. It is understandable that this soft element of family businesses is not subject to regulation due to its nature. However, the absolute negligence of this element, ie leaving it to market forces in the form of self-regulation, can have harmful effects on the longevity and survival of family businesses. A proper understanding of the non-legal nature of family businesses will help introduce more effective policies and regulations.
For instance, legal intervention that mandates mediation and reconciliation can delay and minimise potential disputes among family members.Footnote 41 In addition, the level of information asymmetry is higher in family businesses,Footnote 42 especially in family businesses that adopt an autocratic leadership style.Footnote 43 Hence, a more tailored and comprehensive disclosure requirement for family businesses might be a good legal intervention by the state to minimise potential family disputes.
In conclusion, the main distinction between family-owned businesses and non-family businesses is non-legal in nature, ie the familial aspect of family businesses. Policy makers and legislators must consider this reality to reach an optimal design for regulating family businesses. The reality is that these differences are yet to be seen reflected in the global regulatory and legislative framework for family businesses
Legal definition of a family business
This section will explore the definition of a family business, as it is a critical element for identifying the applicability of family business law. The legislative approach in the UAE in defining family businesses reflects the challenges and variations in determining the scope of such laws.
It is well established that defining family businesses or companies is challenging. To date, there is no widely agreed-upon definition of family businesses.Footnote 44 The theoretical contention regarding the definition of family businesses is beyond the scope of this article.Footnote 45 The focus will remain on the definition from a legal perspective rather than from a functional perspective.
In the GCC context, in Saudi Arabia, family businesses are defined as businesses fully owned or controlled by a family. Footnote 48 In the UAE, the recent legislative framework for family businesses labels a family business as including any company that the owners decide to register and designate as a family business under the Family Businesses Act No 37/2022, in which the majority of the shares are owned by members from the same familyFootnote 49. What constitutes a family is yet to be regulated, and this task has been delegated to the Emirati Council of Ministers.Footnote 50
The UAE approach to defining family businesses is based on an opt-in model, allowing businesses to choose whether to be considered family businesses and be subjected to the new legislative framework. The law establishes a designated Family Business Registry for those who want to be considered family businesses.Footnote 51 Finally, Dubai law excludes public companies and unlimited liability companies from its scope, ie these two forms of companies cannot be designated as family businesses, and it defines a family as comprising spouses and relatives up to the fourth degree of consanguinity.Footnote 52 Conversely, Abu Dhabi law sets a 40% threshold for defining family businesses. The law stipulates that if more than 40% of the company is owned by non-family members, then it will no longer be deemed a family business.Footnote 53 Furthermore, Abu Dhabi law does not exclude any business form from the definition of a family business. This means, public companies can be considered a family business if they satisfy the definition’s requirements.Footnote 54 Control is the ultimate criterion in Abu Dhabi. This approach acknowledges the fact that a number of listed companies can still be considered controlled by a family, and, hence, benefit from the legislative framework that governs family businesses.
Conversely, the Malta Family Business Act 2017 defines a family business as eligible for registration if it is controlled by two owners who are family members.Footnote 55 Additionally, the Maltese law established a Family Business Regulator that oversees, inter alia, the registration of family businesses.Footnote 56 Eligible family businesses receive a unique registration number that is preceded by the letter ‘FB’. The regulator oversees the compliance of registered family businesses with these conditions and is granted the power to cancel the registration of any family business.Footnote 57
These family business definitions at the policy and legislative levels revolve around family-owned and family-managed enterprises. It appears that they are more inclined to exclude only family-managed businesses from the broad definition of family businesses. Yilmazer and Schrank identified three elements that distinguish family businesses: first, a firm owned by a family with 50% or more ownership; second, emotional attachments between the firm and the family; and third, a management structure mirroring that of the family, with family members appointed to managerial positions.Footnote 58
Many scholars are more inclined to consider a business a family business, provided it is associated with family control and the ability to appoint management. The rationale is that family values and behaviour can only affect the business when the family controls it.Footnote 59
Family businesses and legal intervention
The reality is that, in general, family businesses are neglected both by policy-makers and legal scholars. One legal commentator observed that ‘corporate law casebooks are astonishingly devoid of any systematic consideration of family dynamics’.Footnote 60 The reasons for this neglect and the apparent immunity of family businesses from policy and scholarly attention remain unclear. According to an EU report, ‘family businesses are rarely mentioned in official public documents’.Footnote 61
The need for legal intervention to regulate and govern family businesses is critical, and it should encompass corporate law, alternative dispute resolution, and family law.
The assumption of both policy-makers and academics is that family businesses, because of their unique nature, are best suited for governance and regulation through contracts,Footnote 62 eg family constitutions and family councils.Footnote 63 The reality is that many family businesses do not opt for such private arrangements for numerous reasons.Footnote 64 This includes transaction costs associated with such arrangements, a lack of awareness of how these arrangements operate and are structured, the absence of an enabling legal environment in the relevant jurisdiction, and social restrictions and obstacles within the family.
Any legal intervention should consider businesses and families as distinct institutions and aim to facilitate ‘cooperative relationships designed, in important part, to achieve economic objectives’.Footnote 65 However, the social dimension that overwhelms families is dominant and could thus influence the economic output associated with family businesses. This social dimension complicates family businesses and adds an extra element that regular businesses do not usually encounter. The familial perspective in family businesses has been acknowledged by some US courts, particularly the Delaware Court of Chancery, which has applied equitable principles to address non-economic and socially tense situations.Footnote 66 Taking these familial and social aspects into account in developing an optimal model to regulate family businesses is not unprecedented. For example, such considerations have been applied in practice by Delaware courts, which occasionally adopt family law rules governing the division of property and assets within families and apply them in the context of family businesses. Further, in US family law, judges may consider a family member’s misconduct if it negatively affects the value of assets/businesses.Footnote 67 The same can also be found in the context of corporate law, as shareholders’ withdrawal can be based on the fault of other members in the corporation, in what is known as fault-based withdrawal.Footnote 68
Hence, despite the abovementioned discussions, a significant reliance on the voluntary governance of family businesses through contracts remains the dominant policy strategy in many parts of the world. The reality is that this contractarian and self-regulation approach is yet to be widely adopted by family businesses.Footnote 69 An additional dilemma with the current position adopted by most countries is that, at times, the existing general legal framework does not support or acknowledge the contractarian approach that is well established in family businesses, such as family constitutions. This is especially true in developing countries in the Arab world, where corporate laws are mandatory, in contrast to the enabling nature of corporate laws in the West.Footnote 70 For instance, until recently, most company laws in the Arab world required state decrees to incorporate public companies. Some studies show that 80% of the rules in corporate law across the Arab world are mandatory and cannot be departed from by incorporators.Footnote 71 Having said that, recent developments in company laws in Saudi Arabia, the UAE and Kuwait can be seen as a partial departure from this trend.Footnote 72
The following sub-sections will explore the main areas of relevant legal rules that are considered critical to accommodating family business governance structures. The objective is to identify relevant laws that may affect family businesses and to examine how the region has addressed them or failed to do so.
Articles of association and family businesses
Relevant legal instruments for family businesses are diverse, and articles of association are commonly used as a governance tool, especially for those that adopt a partnership or closed corporation legal form. Modern company laws have moved toward an extremely flexible model, in which shareholders can tailor and design articles of association to meet their needs.Footnote 73 However, company laws in most Arab jurisdictions have yet to follow this lead, as articles of association remain relatively rigid in many countries.Footnote 74 The recent legislative development of family businesses in the UAE has addressed this issue, as the new law acknowledges the need for tailored articles of association to accommodate the unique nature of these companies and their governance structures, such as family constitutions and councils.Footnote 75 Furthermore, the new law adopts an interpretative mechanism for articles of association for family businesses. Article 22 of Law No. 37/2022 stipulates that, in the absence of explicit rules or in the event of ambiguity in the wording of the articles of association, the articles of association shall be interpreted in the context of the family founders of the business to ensure the smooth transition across business generations. This policy approach can be seen as a quasi-family stewardship approach in the UAE, it does not go as far as the Singaporean experience that explicitly adopted ‘Stewardship Principles for Family Businesses’ in 2018.Footnote 76 The main difference is that the UAE does not adopt a comprehensive code that fully embraces shareholder stewardship, rather it partially acknowledges the importance of taking into consideration the context of the business founders in interpreting the company articles of association.
The UAE has also adopted an articles of association model that is tailored to the needs of family businesses. As the new legislative framework for family businesses mandates the Ministry of Economy to introduce such an articles of association model, it should be noted that this model is non-binding and serves as guidance rather than a requirement.Footnote 77 This practice is well established in other jurisdictions such as England.Footnote 78 However, the UAE’s recent development introduces specialised model articles for family businesses rather than relying on the standard model articles that are usually applicable to all companies. The differences have yet to be identified, and it will be interesting to analyse the departures tailored toward family businesses. For the first time in the region, the new legislative framework in the UAE has introduced and officially acknowledged the concept of family constitutions.Footnote 79
Shareholder agreements and family businesses
In this sub-section, the importance of having an effective legal framework for shareholder agreements and its relevance to family businesses will be discussed. It is well established that shareholder agreements play a significant role as a governance tool in the context of family businesses, as they address voting rights, peremptory rights, transfer restrictions, and the composition of corporate organs, such as boards of directors and supervisory boards.Footnote 80 The lack of legal certainty regarding the enforceability of shareholders’ agreements can undermine their effectiveness as a governance tool in family businesses. Hence, to ensure an effective legal environment for family businesses, the legal status of shareholders’ agreements must be addressed.
In the context of the Arab world, some scholars argue that shareholder agreements are neither adequately recognised nor widely popular.Footnote 81 Only recently have corporate laws in the Arab world begun to recognise shareholder agreements, which are considered not only the cornerstone of family business governance but also an effective tool for estate planning.Footnote 82 The absence of effective regulations governing shareholder agreements is not exclusive to the Arab world but can also be found in some European jurisdictions.Footnote 83
The biggest challenge to shareholder agreements in the Arab world is that they have not been subjected to legal scrutiny by the courts, as there are very few, if any, disputes involving shareholder agreements that have reached courts.Footnote 84 Hence, this uncertainty must be addressed either through comprehensive legislative intervention regulating shareholder agreements or through court decisions resolving such ambiguity.
The criticality of shareholder agreements in the context of family business governance depends heavily on the sophistication of the relevant legal systems. Less developed jurisdictions exacerbate the risk of family business failure because such businesses are thus deprived of shareholder agreements as an effective governance tool.
The enforceability of a shareholder agreement is a fundamental requirement in any optimal legal system for family businesses, especially in the context of corporate law. For instance, some jurisdictions treat shareholder agreements as separate from the corporation. Because the corporation is not a party to a shareholder agreement, the agreement will not bind the corporation. However, in some US states that have adopted the Model Business Corporation Act, such as Florida, shareholder agreements have binding effect on corporations, provided the corporation is notified.Footnote 85
In the context of recent developments in the UAE, in Dubai, article 6 of Law No. 9/2020 concerning the Regulation of Family Ownership acknowledges and recognises, for the first time in the region, the concept of a family ownership contract, which is another form of shareholder agreement. However, a family ownership contract is limited to family members only and is not available to non-family member owners. This law requires that the ownership percentage be stipulated in the contract and certified by a notary public officer. Finally, a family ownership contract should not contradict public policy. The same can also be found in the latest version of the Saudi Arabian company law. Article 11 of the Saudi Company Law 2022 stipulates that shareholders can conclude a family charter or any agreement that regulates family ownership, the governance of the management, dividend distributions, transfer of shares, and any other matter deemed essential by the owners. The law explicitly allows the agreement to be included in the articles of incorporation. Note that, in both the UAE and Saudi Arabia, such agreements cannot conflict with the law or the articles of incorporation.
Family constitutions and legal uncertainty
In the context of family businesses, family constitutionsFootnote 86 or charters are considered 'a tool intended to help the family stay together and to stay wealthy for more than three generations'.Footnote 87 They are also commonly used in family businesses. However, they are voluntary mechanisms and privately negotiated. They are used as governance tools distinct from articles of association and shareholder agreements, as they encapsulate the values and commercial goals of the family business and are usually not legally binding, ie they reflect only a moral obligation.Footnote 88 In this section, the legal status and relevant regulatory rules of family constitutions in the context of the Arab world will be discussed and analysed.
Historically, family constitutions have been the subject of research by management scholars and have been neglected by legal scholars. John Ward pioneered the use of family constitutions as a governance tool.Footnote 89 Management scholars have emphasised that family constitutions are moral contracts. However, from a legal perspective, such agreements usually fall within the remit of contract law. The enforceability and mandatory nature of family constitutions depend heavily on their drafting. Even if a family constitution is a social/moral contract – ie lacks binding force – such documents can serve as interpretative tools for articles of association.Footnote 90 Albeit, the fact that family constitutions’ signatories can extend beyond the shareholders of the company to include family membersFootnote 91 Courts in France, for instance, used such a non-binding document to reach the underlying intent, values and motives of the shareholders.Footnote 92
Whether implemented through state or private ordering, legal regulation plays a role in the governance of family businesses regarding family constitutions. One aim is to replace informal, trust-based relationships commonly found in family businesses with more structured, formal ones, which are necessary for optimal business governance.
The relevance and legal status of family constitutions vary considerably from one jurisdiction to another. Hence, it is critical to identify the legal impact of family constitutions on existing legal rules, such as directors’ fiduciary duties or their relevance to the interpretation of articles of association, and these recent legislative developments in the UAE fail to address this issue. In the Arab world, family constitutions are still considered a relatively limited practice. It has only been recently that we have begun to witness the emergence of family business governance structures.Footnote 93 This reality is not peculiar to the Arab world. A study in Germany showed that only a quarter of German family businesses adopt a family constitution in various forms.Footnote 94
Having said that, it is critical to have a favourable legal regime that addresses any legal uncertainty regarding family businesses’ family constitutions. The recent legislative intervention in the UAE presents a new model for family business governance in the Arab world and aims to ensure legal certainty in this context. For instance, the binding nature of family constitutions, which extends to new owners of the business, has historically posed a challenge that can undermine their efficiency. However, in the UAE, this issue has been addressed. According to the new Family Business Act, all new owners/shareholders in the family business are bound by the existing family constitution.Footnote 95 It goes even further by acknowledging that the owners of family businesses can adopt transfer restrictions of shares within the articles of incorporation to any individual who is not a family member.Footnote 96
Exit rights in company law and family businesses
Exit rules in company laws play a critical role in the governance of closed corporations and serve as a critical remedy for shareholders.Footnote 97 Depending on the definition adopted, family businesses usually take the form of closed corporations and are therefore directly affected if company law does not include robust exit rules.
The first relevant set of rules concerns the transfer of shares between the company’s owners in the context of withdrawal rules.Footnote 98 The absence of rules governing the mechanics of such transfers and the identification of fair value will exacerbate potential conflicts among business owners, particularly family members, and entrench deadlocks among shareholders. In other words, company laws can play a critical role in reducing and resolving potential disputes in family businesses by adopting remedies that address common causes of disputes, such as exit and valuation issues.
Failure to distribute dividends can also lead to potential conflicts and disputes among family members. Hence, an optimal legal intervention recognises an exit right for minority shareholders.Footnote 99 This exit right is usually considered a qualified right for minority shareholders and is thus not an absolute right. For instance, in Spain, such a reform was introduced in 2011 but is only available in the context of abusive retention of profits.Footnote 100 Although such reforms are aimed at private companies in general rather than family businesses specifically, they can serve as a powerful mechanism for reducing potential disputes in family businesses. The distribution of dividends often sparks disputes, particularly when the family business retains profits for expansion and other purposes, potentially to the detriment of minority shareholders. These policies are usually approved and sanctioned by the majority shareholders.
In the Arab world, some reforms are crucial for existing company laws to address these issues. For a start, squeeze-outsFootnote 101 are unpopular and are not recognised in many company laws in the Arab world. The absence of effective squeeze-out regimes prolongs unwanted partnerships within family members, as members who wish to exit will not be able to force themselves out of the company via squeeze-outs and the same applies to consolidating majority ownership, as they will not be able to squeeze the minority out of the company and cannot force them to sell their shares. The recent company laws in the UAEFootnote 102 and Saudi ArabiaFootnote 103 recognise the concept of squeeze-out, but only in the context of public companies. In a departure from this trend, the UAE has introduced the concept of squeeze-out in the latest family business law.Footnote 104
Majority shareholders’ fiduciary duty
Additionally, any optimal legal framework should aim to enhance minority shareholder protection in family businesses by imposing a fiduciary duty on majority shareholders, which could enhance the effectiveness of any regulatory framework applicable to family businesses. This approach is critical because the usual trend in company law is not to recognise shareholders’ fiduciary duties in governing shareholder relationships. As such, fiduciary duties usually apply in the relationship between directors and the company.Footnote 105 This is especially true in the Arab world but can also be found in some European jurisdictions, such as Spain.Footnote 106 As most family businesses take the form of private companies, introducing the concept of shareholders’ fiduciary duties as a mechanism to protect minority shareholders from potential abuse by majority shareholders can be an effective way to balance shareholders’ interests.Footnote 107 The concept of imposing fiduciary duties on controlling shareholders has been advocated to combat the extraction of private benefits by controlling shareholders, as existing legal tools are ineffective and there is no conflict-of-interest rule governing controlling shareholders and the company.Footnote 108 The introduction of the notion of shareholders’ fiduciary duty in the context of family businesses, in particular the duty of loyalty, will contribute towards achieving general fairness in the operation of the company. The US model, which recognises shareholders’ fiduciary duty to the corporation and to minority shareholders, can serve as a model in the Arab world. This will be an alternative to the existing tool in a number of Arab world company lawsFootnote 109 that are based on the concept of unfair prejudice.Footnote 110 This unfair prejudice notion is considered to be a fact-based fiduciary type, ie shareholders, as Justice Dixon explained, 'are not trustees for one another, and, unlike directors, they occupy no fiduciary position and are under no fiduciary duties'.Footnote 111 In other words, the majority shareholders in the majority of company laws in the Arab world are not considered as fiduciaries, but their actions are subjected to the general principles of law, such as the duty of good faith and the duty not to abuse their powers. Therefore, adopting the fiduciary duty of majority shareholders in the Arab world as an alternative to unfair prejudice can contribute positively to the governance framework of family businesses.
Piercing the corporate veil and family businesses
Piercing the corporate veil can have an impact on family businesses in terms of addressing potential commingling of the family business assets along with the family members. In this context, some scholars have advocated for strengthening judicial review and examining the extent of commingling between family affairs and the family business’ own operations.Footnote 112 This could also help strengthen governance and combat the potential abuse of family members and the potential informal dealings of company assets and resources by family members. The threat of piercing the corporate veil as a result of the lack of proper separation between the business assets and family members personal assets can be an effective external policy tool to encourage family businesses to achieve such segregation and absence of commingling of the business assets along with the family members' assets.Footnote 113
The legal foundation of piercing the corporate veil varies depending on the relevant jurisdiction. However, it usually includes fraud as the legal foundation behind piercing the corporate veil, and, in some jurisdictions, also abuse.Footnote 114 The relevant doctrine in the context of piercing the corporate veil of family businesses is the alter ego doctrine. The need to follow and comply with minimum corporate formalities in order to enjoy the benefits of limited liability, and avoid piercing the corporate veil, will enforce better governance in family businesses.Footnote 115 The importance of this element emanates from the fact that family business operations tend to be less formal due to the shareholders being members of the same family. To put it simply, family businesses are more susceptible to be managed in a less formal setting (in the family context), hence, the threat/risk of piercing the corporate veil and holding individuals liable can potentially contribute to imposing a more stringent governance structure. In other words, adopting an effective piercing the corporate veil legal framework can potentially act as an external force that bolsters the governance framework of family businesses.
Family laws and family businesses: Foes or allies?
Family law and inheritance rules aim at achieving the opposite objective of company law. While the former aim at ensuring the transfer of the estate, company law aims at achieving longevity.Footnote 116 Inheritance laws have a significant impact on survival prospects and longevity.Footnote 117 Some studies have shown a relationship between inheritance laws and what is known as the 'dead money' phenomenon, which refers to the division and misallocation of family firm assets as a result of inheritance lawsFootnote 118.
Further, family laws undeniably influence family businesses, particularly in terms of direct ownership in the case of succession and estate planning. Wills and trusts are integral in Western jurisdictions, where family law offers extensive flexibility for structuring and addressing questions of ownership allocation and distribution.Footnote 119 Although estate and succession planning in many cases is driven by tax considerations, such as minimising and avoiding estate taxes,Footnote 120 it is a critical element in designing and governing family businesses.Footnote 121
In common law jurisdictions, such as the US and the UK, family law impacts individuals through legal instruments such as prenuptial agreements,Footnote 122 family trust agreements, and inheritance contracts.Footnote 123 Testamentary freedom is a well-established concept and is considered a bedrock of inheritance law in the West, particularly in common law jurisdictions.Footnote 124 Conversely, family laws in the Arab world are Shari'a-based, and rooted in the concept of natural inheritance rights.Footnote 125 Hence, they do not enjoy the same freedoms as are usually available in Western secular family laws, but they do overlap to some extent with some civil law jurisdictions, which tend to have more restricted inheritance rules than common law jurisdictions. For instance, under French law, there is an obligation requiring a portion of the estate to be divided equally among the heirs.Footnote 126 Inheritance laws in the Arab world adopt forced heirship, which guarantees heirs a portion of their parents’ estate.Footnote 127 The definition of what constitutes a family is also restricted to spouses and blood relatives, thereby excluding in-laws.Footnote 128 Hence, heirs are a predefined group of people. In addition, wills are restricted to one-third of the estate under Shari’a law.Footnote 129 The discretion of the testator is limited, as in addition to the one-third restriction, a testator cannot bequeath to an individual who is already inheriting according to inheritance rules.Footnote 130 Having said that, it should be noted that under Islamic law, the testator can engage in inter vivos transactions during her lifetime. This rule is usually used to circumvent the mandatory nature of inheritance rules under Shari’a, as no restrictions apply to inter vivos transactions.Footnote 131 In other words, premortem estate planning is the only way to enjoy the full freedom of structuring estate planning.
However, in reality, most family businesses fail to adopt private ordering to govern the 'family aspect' of the business. For instance, in France and Greece, approximately 80% of family businesses have not adopted such arrangements.Footnote 132 This reality subjects family businesses to inheritance laws as a default rule and therefore directly affects them.
In Italy, legislative reform was introduced in 2006 to accommodate family constitutions as a tool for estate planning and to overcome the lack of recognition of inheritance agreements. This reform allows a family business owner to transfer all, or part of their ownership, provided that all heirs sign the arrangement in a public document. Failure to obtain the consensus of all heirs imposes an obligation to compensate them for their portion in the estate, and any dispute will be heard by a specialised board.Footnote 133
In the UAE, article 24 of the new Family Business Act No. 37/2022 adopts a relatively effective approach to address inheritance laws that are Shari’a-based. It stipulates explicitly that any arrangement made during the life of an owner is valid and shall not be considered in violation of family law in the UAE provided that the legal transaction by the founder was concluded during his or her lifetime.Footnote 134 The rule aims to ensure legal certainty for transactions and legal actions concluded during the life of the owner of a family business. The usual objective of such legal challenges is to invalidate the action taken by the integrator, such as gifts granted to a family member.
Another way to engage in Shari’a-compliant estate planning is the use of private Awqaf, or waqf thari, which is equivalent to private trusts in Western jurisdictions. It is a Shari’a-based legal form that is established during the lifetime of the founder of the waqf. It is akin to charitable foundations and can be designed for public benefits or it can be a private waqf, whereas the beneficiaries are family members and hence makes it akin to private trusts.Footnote 135 It has recently been recognised as a tool in estate planning in the Arab region, particularly in the GCC. In 2018, the UAE issued Endowment Law No. 5/2018, which addressed family businesses in the context of endowments (Awqaf). This meant that private endowments can be used as part of estate planning in family businesses. Founders can now transfer ownership into a private family endowment during their lifetime. One of the main benefits that this new law offers is that it ensures that after the founder passes away, his/her interest in the company will not be divided among his/her heirs, as the law restricts the ability of any beneficiary to demand that his/her share in the business be transferred to them directly.Footnote 136 In other words, these arrangements can minimise the risk of wealth transfer upon death and avoid wealth fragmentation.Footnote 137
Family business private trusts/waqf can be either perpetual (ie, dynasty trusts) or set for a given period of time. In the case of term-limited private trusts, the term may be extended with the approval of three quarter of the beneficiaries, and the extension will be limited to two equivalent time periods initially stipulated in the private trust deed.Footnote 138
The introduction of more comprehensive regulations governing private trusts and endowments in the Arab world can play a critical role in governing family businesses and facilitating more effective estate planning regimes.
Toward an optimal regulation for family businesses
Both in light of the economic importance of family businesses and their unique survival challenges, there is a need to adopt holistic regulatory and state intervention policies to preserve family businesses.Footnote 139 In the previous sections, various areas of legal reform were identified as critical to achieving an effective legal framework for family businesses. The question is whether these reforms should be designed as an opt-in or opt-out model. The assessment of either model should take into account non-legal factors unique to family businesses.
The social characteristics of family businesses are a critical element to consider when designing family business laws. The relationship between family business owners is not merely transactional; they are relatives before partners. Hence, the social dimension can be an obstacle to openly and freely discussing the imposition of governance tools, as it could be perceived as a sign of mistrust toward other family members. This is especially true in hierarchical collective societies, such as those in the Arab world.Footnote 140 Hence, I suggest that the rules adopted in any proposed family business regulations should be default rule-based. In other words, the distinctive nature and values of each family business make the default rule-based approach more suitable. Families can opt out of such regulations and rules versus opting in, thereby respecting the nature and values of each family.
This approach would help address a common problem in family businesses that evolve around the social reluctance in many families to discuss the need to introduce family constitutions, councils, and other contractual arrangements that would govern and regulate the family aspect of the business, as it might be interpreted as a sign of mistrust. Trust is fundamental in family relationships. However, its informal nature poses challenges when family members seek to formalise it, potentially signalling mistrust and social stigma.Footnote 141 The opt-out model mitigates this problem, as all family businesses would be subjected to a minimum set of rules promulgated in family business regulations, and they can opt out if they decide to do so. In this way, the awkward discussion of the need to introduce a more formal structure for the family business is avoided.
Furthermore, the opt-out model addresses the widespread lack of knowledge among numerous family businesses regarding the importance of adopting governing rules and frameworks that enhance the longevity of the business and minimise family-oriented conflicts. This would include a reflection on best governance practices, such as family constitutions and shareholder agreements. Buy-sell arrangements, ie, exit mechanisms for family members who do not wish to continue in the business, are also considered crucial for preventing potential and continuous conflicts in family businesses.Footnote 142
In addition, the opt-out model addresses human limitations, as individuals are affected by bounded rationality: their capacity and cognitive abilities are limited in addressing complex problems.Footnote 143 Further, the overconfidence and optimism of shareholders undermine their ability to be risk-averse and create potential and future conflicts. Hence, there is no need to introduce legal strategies at the outset to address them.Footnote 144 These human realities underscore the need for an opt-out model to minimise the risks arising from the absence of relevant legal strategies in family businesses.
The proposed opt-out model also helps the courts address potential conflicts, especially regarding gaps in general corporate law and related laws governing family businesses.
Some experts argue that an opt-in model is more appropriate, as some family businesses may not intend to continue in the long term.Footnote 145 In these cases, an opt-in model will avoid all rules that might add compliance costs. Although this proposition is understandable, I truly believe the proposed opt-out can still achieve the stated objective of the opt-in advocates. Family businesses that do not wish to be subject to the law can opt out and avoid unnecessary costs and compliance requirements.
The emphasis on alternative dispute resolution can also be an effective tool in governing and regulating family businesses, as it minimises associated risks with court-based litigation, such as media exposure and the prolonged nature of litigation that will negatively impact the business. The UAE has introduced a hybrid system by introducing specialised quasi-judicial tribunals with the right to appeal the decision to the court of appeal as a final arbiter. This rule kicks in in the absence of alternative dispute resolutions, such as arbitration.Footnote 146
Conclusion
On the side of legal scholarship, corporate law scholars should pay more attention to family businesses as a speciality within mainstream scholarship. Particular attention should be paid to the influence of social relationships, ie, the familial nature of family businesses, and to its potential impact on the rules of engagement and the directions of the policy framework.
The peculiar nature of family businesses mandates that legal scholarship depart from the traditional rational actor presumption that dominates corporate law and economic scholarship. If anything, family relationships are anything but rational, which naturally spills over into family businesses. The emergence of a subdiscipline of business law, designated to the study of family businesses from a legal perspective, is critical and will have a positive impact on family businesses.
In the regulatory framework governing family businesses , the historical trend of neglecting regulations specifically addressing family businesses persists. However, it appears that the GCC can play a leading role in pioneering and advancing family business regulations by presenting a model that can influence policymakers globally. This is especially true given the introduction of the UAE’s Family Business Act in 2022, Abu Dhabi’s 2021 initiative, and Dubai’s 2020 initiative to regulate family business ownership through legal interventions. The effectiveness of such regulatory intervention has yet to be assessed on the ground. However, the fact that states are acknowledging the need to regulate and govern family businesses is a unique evolution in family business regulations globally.
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