Passing on Wealth

How to prepare for a seamless and hassle-free transfer to the next generation
Shardul Shroff and Divi Dutta    New Delhi     Print Edition: September 24, 2017
Passing on Wealth
Shardul Shroff is Executive Chairman, while Divi Dutta is Partner, Shardul Amarchand Mangaldas (Photo: Vivan Mehra)

With a sharp rise in the number of high net-worth individuals (HNIs) and the growing incidence of disputes among legal heirs, the need for estate planning is growing rapidly. Additionally, expansion of businesses and listings of companies result in the personal assets of promoters becoming more susceptible to claims and challenges. To mitigate this risk and to safeguard the future of promoters and their families, it is important to provide a suitable mechanism to ring-fence their assets.

The most favoured options used by HNIs and promoters for effective estate planning are wills, trusts, family settlement agreements and family constitutions.

Will

A will is a legal document that declares the intention of a person (the testator) and sets out the manner of bequest of the testator's assets upon his/her death. A will is revocable during the lifetime of a testator and can be revoked as many times as the testator decides by either destroying the will or executing a subsequent will or by making a written declaration to revoke the will.

In the event a person dies without a will, or the will is declared invalid, the person is said to have died intestate. In such a case, assets of an individual are distributed among his/her heirs as per the laws of succession, which more often than not lead to disputes among legal heirs that can last for generations. The execution of a will prevents such disputes.

Illustration by Ajay Thakuri

A will ensures that an individual's assets are protected and distributed exactly as desired by the individual. It allows an individual to appoint custodians of assets, create multi-layered conditional bequests, effectively split and distribute assets, etc. Further, a will gives you the freedom to appoint a guardian of your choice for your heirs. It also allows you to appoint an executor, if needed, to manage your property.

Trust

Disputes over wills and often costs associated with the execution of a will have led to an increase in the use of a private trust as a vehicle of succession planning. The robust and flexible nature of trusts allows for bequest of assets as well as creation of structures for the management of assets.

A trust is settled when a person (the settlor) transfers property to another person (the trustee) to hold for the benefit of one or more persons (the beneficiaries). The trust deed defines what the trustees may do with the trust property and outlines the interests of the beneficiaries. There are three types of trusts: Irrevocable determinate (specific) trust - beneficiaries are identifiable and their shares are determinate; irrevocable discretionary trust - beneficiaries are unidentifiable and their share is indeterminate and the trustee has the discretion to distribute the income to the beneficiaries; and revocable trust.

A trust can be settled by any person competent to contract. Any person capable of holding property can be a beneficiary of a trust, including a minor. The settlor can himself be a trustee and can, therefore, exercise various degrees of control over the property. Alternatively, a special purpose company can also be used as a trustee, and a professional administrator can be appointed for the management of the trust.

A trust structure is especially useful in promoter-driven companies as there is often a gap in administration and management of the company after the founder's death. Such private trusts, which end up controlling the companies after the promoter's death, can have well-defined principles to set out its governance. Such trusts can also be used for bequeathing, administering and managing of personal assets in India as well as abroad, and providing for bequest of assets to future generations through an effective and structured mechanism. Additionally, private asset management trusts can be used for segregating and ring-fencing assets from third party claims (creditors, for example).

Combination of Will and Trust

Another popular option for succession planning is the combination of a will and a trust wherein an individual can transfer all his/her existing assets to a trust. Further, all subsequent assets acquired by or bequeathed to him/her in his/her lifetime can be bequeathed to the trust through a will.

Family Settlement Agreement

A family settlement agreement is an enforceable and binding contract entered into between the members of a family through which family members mutually set out the distribution and separation of their business and assets. Family settlement agreements can be used for inter-se transfer and segregation of the family's interests, movable and immovable assets.

Growth of a family business, many times, gives rise to diverse expectations, ambitions and differences among the succeeding generations of a family. Having a family settlement in place facilitates family initiatives, growth and governance of the business, without causing a break-up of relationships.

A family settlement ensures fair and equitable distribution of family assets/business to all family members and, thereby, preserves mutual respect and goodwill. It aids in avoiding bitter and acrimonious disputes that may arise among future generations and is instrumental in maintaining peace and harmony.

Family Constitution

A family constitution is a document which sets out the manner in which a family shall run its family business. It attempts to develop policies and processes, and create a long-term sustainable governance structure that will serve the family's current and future generations.

Illustration by Ajay Thakuri

Often, disputes between family members lead to decline and disintegration of family businesses. A family constitution helps in preventing creation of future disputes by setting out long-term family vision, rights and obligations of family members, employment opportunities and performance evaluation of family members, management of family assets, etc. It also details the manner of functioning of various governance structures created within the family such as family council, family business board and non-business family forum. A family constitution is an effective answer to the long-standing problem of sustainability faced by family businesses across the globe.

While a majority of family businesses decline and disintegrate in three generations, a minority of them has lived and prospered into the fourth generation and beyond. These are family businesses that charter the course for future generations through effective succession planning and formulate sustainable solutions for unforeseen disputes among the future generations. As Warren Buffett rightly said, "Someone is sitting in the shade today because someone planted a tree a long time ago."

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