Family Owned Businesses and Estate Litigation

In this course, we will discuss problems that arise with family-owned businesses. 

Lesson 1: The Facts – Family-Owned Businesses

Under Probate Code Section 6401, where a married person dies and has no Will or Trust, all their community property passes to the surviving spouse. The surviving spouse is also entitled to either one-third or one-half of the deceased spouse’s separate property. This allocation is officially termed an intestate distribution scheme. This intestate distribution scheme can be changed by using a Will, Trust, Joint Titling such as joint tenants, or Beneficiary Designation as used in life insurance policies. 

Let’s consider a hypothetical situation to demonstrate the problems that arise and the options you have when confronted with a California intestate distribution of community property and several properties. After the hypothetical, we will discuss the inheritance of assets between married couples in more detail. 

A Hypothetical Family-Owned Business Estate Scenario

Walter and Patty married in January 1998, they each had previously been married, and Walter has two sons from his prior marriage, Simon and Todd. A year after marrying Patty, Walter created a business and both sons worked in that business for the last 18 years. In February 2017, Walter died. The business grew over time and was worth 3 Million dollars at the time of Walter’s death. Both sons helped grow the business substantially and Walter considered his sons to be equal partners in the business.

Walter said many times that the business would pass to Simon and Todd and he told them both that they were equal owners. Unfortunately, the business was legally owned 100% by Walter at the time of his death. Walter never created a Will or a Trust. He owned a home with Patty that was titled in their names as joint tenants with right of survivorship, the home is worth 1 Million dollars.  He also had a bank account held jointly with Patty and an investment portfolio worth $500,000.

After Walter’s death, Simon and Todd tried to change the authorized signers on the business checking account from Walter to Simon and Todd, but the bank refused to do so because Simon and Todd were not legal owners of the business. Simon and Todd then consulted an attorney who told them the business had to pass through probate to be transferred, meaning, there had to be a court-supervised transfer of the assets from the probate court. Meanwhile, Patty also consulted a lawyer, the lawyer helped Patty secure her home, bank account, and the investment portfolio in Patty’s sole name since she was a joint owner.

Who Get’s The Business?

Patty then asked who would receive the business? Patty’s lawyer pointed out that the business was not held in a Trust or governed by a Will. Under California intestacy laws, all of the community property would pass to Patty alone even if the business were considered separate property, Patty would be entitled to one-third of the business, but Patty had a claim to the business or a portion of the business either way. After Simon and Todd filed a Petition for Probate, Patty files a competing Petition for Probate claiming sole ownership of the business. Simon and Todd became understandably upset, it appears that Patty had a good argument that she should receive the entire business from Walter’s estate.

What Can Be Done to Protect their Rights if any to the Family Business? 

Here are the options. Option 1, contract to make a Will. Simon and Todd file to enforce the agreement their father made to leave them the business. Option number 2, find a Holographic Will. Search through Walter’s files to see if he ever wrote down his intentions in his own handwriting. This is what’s called a Holographic Will. Option number 3, file a creditor’s claim. Simon and Todd assert that they had a general partnership with their father and they are entitled to the business as general partners. Option 4, negotiate with Patty. Somin and Todd can negotiate with Patty in an attempt to settle a matter with her voluntarily. 

Lesson 2: The Law – Family Owned Businesses

Now, let’s listen to the approach that Keith Davidson would take to fight for your inheritance. 

Hi, this is Keith Davidson at Albertson and Davidson. So we have a problem here with Simon and Todd because they found out that a substantial amount of the business that they’ve been working with their father that they probably are not going to receive or that somehow is going to pass to their stepmother, Patty. And the problem really comes about because Walter didn’t do any planning, and so it’s an intestate estate, and under our California Intestate laws, Patty is entitled to a hundred percent of anything that’s community property, and at least one-third of anything that’s separate property because there are two children that Walter had. So that means that at a minimum, Patty’s probably going to get anywhere from a third to one hundred percent of this business, and that really put Simon and Todd in a bad position.

Finding a Holographic Will

Of those options that we presented, certainly, the first thing I would do is ask Simon and Todd to see if they could find any type of Holographic Will. So they know that their dad died without a formal Will, so there wasn’t a Will that you normally would see that’s typed up by a lawyer and signed and witnessed and all that. But there’s a lot of different types of handwriting that people can do during their lifetime and some of these handwritings can be considered a Will. And we refer to that as a Holographic Will, and a Holographic Will is anything that’s in the testator’s handwriting that they sign. And so if dad sent them a note for example that says, when I die I want you two to have my business and he signed that note, that could suffice to be a Holographic Will and that would be a big difference here because at least then, Simon and Todd would have some rights to that business. Now, a lot of this is going to come down to is the business community property or separate property, because if it’s community property, even if they do find a Holographic Will, only half of that community property can be given away from the spouse, that other half has to go to Patty. If it’s separate property, then Walter could give a hundred percent of it to the kids and exclude Patty. So there’s always going to be that argument that going to have to be worked out, we don’t have enough facts here to really get to the bottom of that argument but that’s going to be a big part of this case as to how the assets go.

Negotiation

If they can’t find a Holographic Will and chances are they can’t, then they have a lot of choices here that they need to make. Obviously, negotiating with Patty would be a great way to start to see if Patty is open to a discussion as to the ownership of the business. It could be that maybe Patty doesn’t want to run the business or she doesn’t know how to run the business, or she wants some money in exchange for the business. If that’s the case, then Simon and Todd might be able to negotiate with her. Simon and Todd do need to be a little realistic here because they are going to lose something to Patty, so they’re going to have to come up with something to but Patty out if they’re going to successfully negotiate.

If that doesn’t work, then they either can bring a contract to make a Will and say that their father had a contract with them or they can file what we call a creditor’s claim. Either way, there’s a potential that they might be triggering a no-contest clause if Walter has a Trust in place for other assets. Now if Walter just has no Trust or Will whatsoever, then they don’t have to worry about a no-contest clause. But if there’s a Trust over the home for example, and Simon and Todd were going to get something from that, then filing a claim with the Probate Court could put that gift in jeopardy. But let’s assume that that’s not happening here, they just want to secure the business, that’s the only thing that they want, that’s the only thing that they’re going to get, then they have two approaches.  With the contract to make a Will, that’s a claim where you say that you gave up something in exchange for the receipt of gifts of death. So here, Simon and Todd would have to say that they gave up pay, they gave up benefits, they gave up pursuing other opportunities in exchange for getting the business. But they would have to prove that by clear and convincing evidence because they don’t have anything in writing, and if you don’t have anything in writing, you have to prove by clear and convincing evidence that there was an actual agreement, a meeting of the minds between dad and Simon and Todd. If Simon and Todd chose to just give up other opportunities to help dad out because they want to be nice to dad and help him, that wouldn’t be enough to base a contract to make a Will, you have to have an actual contract or an actual agreement between the parties for that to work.

Filing a Creditor’s Claim

And finally, Simon and Todd could file a creditor’s claim, the creditor’s claim would have to be based on something, so perhaps they could say that they bought into the business or they earn some of the business with sweat equity, or they can say that dad said that they were joint owners of the business, and they want is to at least get their joint ownership out, and they’re each entitled to a third under joint ownership. The problem with that, of course, is that they don’t have anything in writing to establish their joint ownership, so they’re going to have to somehow prove up that they were joint owners of this business. It’s a very very tricky situation that Simon and Todd find themselves in. But it’s not uncommon, a lot of times families don’t document these sorts of things.

So to recap our options. Number 1, definitely look around, see if there’s any evidence of a Holographic will, any writing at all that dad signed that would give Simon and Todd some rights to the business. Number 2, see if you could negotiate with Patty. And the third and fourth option is to file a contract to make a Will claim or a creditor’s claim and see if you can get something using either one of those avenues. 

Lesson 3: The Talk – Family Owned Businesses

Let’s listen to Stewart R. Albertson and Keith A. Davidson discuss the options and their recommended approach to this difficult problem.

Our View of the Legal Options

This is Keith Davidson. We just heard my opinion of what’s going on here with Simon and Todd and this family business and the mess that they find themselves in. I think it is a pretty big mess that is going to be difficult to unwind. There will be a resolution eventually, but who knows what it will be? What are your thoughts, Stewart?

The Importance of Selecting a Qualified Lawyer

It really matters who the wife, Patty, ends up hiring as a lawyer. What’s their background? Does the lawyer know and understand this area of California law? If Patty hires a law firm like Albertson & Davidson that practices in this area of law, we are going to be pretty effective in supporting her rights. From the facts, it sounds like the business was started after the marriage.  If we were representing Patty, there is a very strong claim to be made that the business is going to be an asset that goes entirely to Patty.

The Steps Simon and Todd Should Take

The second piece we need to know is how is the case going to be rolled out by Simon and Todd. What Simon and Todd need to do is they need to hire a law firm that will file what is required if they can’t get a negotiation with Patty. The no-contest clause is a concern because this looks like an intestate estate. A lawyer might file something quickly and immediately move to doing written discovery showing how much time and effort Simon and Todd put into the business.

Using Legal Action to Jumpstart Settlement Negotiations

A deposition of Patty could be used to show that she doesn’t know anything about the business and that she understood this was a three-way partnership or at least that her husband treated Simon and Todd as equal partners. Make her lie. Catch her in a lie. Option number four—of negotiating with Patty—will come to life. Both sides need a little bit of a bloody nose before a good settlement can happen.

If Patty gets the right lawyer, Simon and Todd are going to be in trouble. But if they themselves were to prosecute the case properly, they will be able to work something out. If Patty can’t run the business, the only way the business is valuable is if Simon and Todd are running it and making it more valuable for her.

Exploiting the Facts that Weaken Patty’s Claim

Setting aside the legal theories for a moment, what is really the weak point for Patty in a case like this?

You have to make Patty and her lawyers concerned about the idea that she may not get anything. Sometimes, the opposing lawyer in these cases is our best advocate. Lawyers tend to draft letters to their clients that they would never share publicly. Those letters generally tend to outline the worst-case scenario. We want to continue to touch the lawyer with pleadings and discovery and depositions and whatever else we need to do in the case.

You always get some good facts out of every deposition, no matter how bad the facts of your case appear. When you find those good facts, you want to make sure you highlight those to the opposing attorney. Then the negotiation or a mediation will take place.

Seeking a Creative Resolution to a Family Business Dispute

If a negotiation or mediation takes place, the chances are Patty will secure something and Simon and Todd will secure something. The lawyer for Simon and Todd could make the argument to Patty that they will make the business profitable over the next 20 years. Simon and Todd can agree to make regular payments to Patty over the next 20 years from the proceeds or earnings from the business. That’s a win-win for everybody. It keeps the boys employed and gives Patty a nice paycheck every month or every quarter over the 20-year period.

This case is going to take 12 to 24 months to move through the court system. It’s going to cost Patty a substantial amount of money to pay her lawyer. Simon and Todd are going to have to pay money, too. The point is that there is a financial cost. There’s a time cost. There is an emotional cost. At some point, there has to be a break where the two sides negotiate.

The reason that negotiation is so interesting is that with a family business like this, you can be very creative. You can do payments over time versus lump sum payments. You can base it on profitability. There are protections you can build in so if they don’t make the payments, then this happens. You can get highly creative with these situations.

If you could be creative as a lawyer and find that settlement that allows them to continue on and ultimately own the business down the road, that is very satisfying.

That’s an odd thing that Patty has the stronger rights given the fact that Simon and Todd were the ones that worked in the business. They helped build it up. They made the sacrifices. Maybe Patty did, too. In our factual scenario she didn’t, but that’s not always the case. Let’s say Patty had nothing to do with the business, doesn’t know anything about it. But Simon and Todd worked 80 hours to 100 hours a week building it up and yet they are the ones with the weaker claim.

Importance of Planning for the Future of Family Business

This difficult situation goes back to Walter. Walter probably was a good guy. He probably didn’t think he was going to die. Most people don’t think they are going to die. But you’ve got to do the estate planning, especially when there’s a valuable asset like this. If he left a will, at least, we would be clear on what Walter intended because we have documents to consult. But he didn’t do that. So the lawyers all got better off on this transaction and hopefully Simon, Todd and Patty found a way to split this up to where they all could survive.