You are currently viewing Arbitration and its Role in Family-Businesses

Arbitration and its Role in Family-Businesses

Family businesses contribute significantly to the GDP of Saudi Arabia, albeit the dynamics of the family business continue to evolve as the second and third generation enter the corporate world.

While family businesses leverage cooperation, disputes may arise which threaten the health of the enterprise. Alternative dispute resolution offers a mechanism family members can use to resolve differences privately and cost effectively.

Common Disputes in Family Businesses

Disputes over succession following the demise of a founding member are common and can take the business on a downward spiral if no succession planning or dispute mechanisms exist.

Often, family and business values will overlap but not necessarily align. Family values will insist on the unity of the members, which sometimes conflicts with the objective of optimizing the economic return of the family business. There may be a reluctance to disassociate a family member whose actions harm the company.

Furthermore, in the event a formal succession plan is not in place, the voting in of a temporary leader may cause unharmony between family members, which brings into question their position and future within the business.

Such rapid changes may lead family members to cash in on their stake, which may give rise to potential liquidation or divestment of stakes, again compromising the family business, brand reputation and future growth plans.

Avoiding Disputes

Families that decide to go into business should plan on ways to resolve conflicts in advance, usually at the outset of drafting company laws.

There are various pre-emptive measures at the disposal of family businesses to prevent disputes. These measures include legal governance structures providing for dispute resolution.

Families must establish a dispute resolution mechanism in their constitution, appointing an arbitrator or mediator.

The constitutional documents should have provisions for family members that want to cash in on their share, allocation of voting rights, processes of operating charities, and a dispute resolution mechanism.

Family businesses should prioritize succession planning in the event the founder expires.

In a nutshell, precautions that family members can take before they decide to go into business together include:

  • Preparation for conflicts: conflicts are always possible when business and family inter-twin. A careful analysis of the potential pitfalls and interests can preempt conflicts to establish sound mechanisms for resolution.
  • Focus on transparency: conversations about issues and challenges should come before negotiations on business matters. In addition, discussions on the norms and procedures in conflict resolution should also occur.
  • Appoint an arbitrator: parties should agree on a competent arbitrator in case of a dispute.

Alternative Dispute Resolution (ADR)

The Saudi government has taken steps to modernize the countries legal system to align with global standards. This includes provisions for mediation and arbitration. Unlike in the past, the parties can choose the foreign law they wish to apply in the ADR process. The provision is practical where one or more parties to the dispute are non-Saudis.

Usually, mediation and arbitration are the two major forms of ADR available to family businesses in KSA. Other variations such as expert determination, conciliation, neutral evaluation, and adjudication may exist, but they are still sub-branches of mediation and arbitration.

Mediation should typically come before arbitration and only move to arbitration when mediation fails. When the government established the Taradhi platform for virtual mediation, the primary objective was to accelerate dispute resolution, which is the overall goal of ADR.

The 2020 Commercial Courts Law introduced various changes to encourage arbitration and mediation in conflict resolution.

The benefit of ADR is control of the process. It is more flexible and inexpensive and provides a faster way to resolve differences between parties.

Arbitration as a Legal Resolution Channel for Family Businesses

With arbitration, dispute resolution between the family members usually involves one or more hearings. The arbitrator is a neutral third party, mutually or contractually engaged by the parties, or the arbitral tribunal based on the arbitration law.

Before the arbitration process, parties to the dispute agree to be bound by the arbitrator’s final decision.

Considering that the arbitration process is private, the public does not access information on disputes or resolutions. However, the parties must sign a non-disclosure agreement to keep all the dispute details confidential.

The process is also preferable when subject matter expertise is necessary. Some arbitrators specialize in particular areas such as construction and real estate law, and the process can leverage this expertise for quick and fair resolutions.

Drawbacks of the arbitration process can include the relaxed evidentiary and discovery rules. The arbitrator may use materials that an actual court may not have to make final decisions, and the result may be an unfavorable outcome that does little to resolve the dispute in the long run.

Normally, the arbitration law in KSA requires the supervision of the process by a court that typically has jurisdiction. Parties can appeal the arbitration decisions through that court, which can lengthen the process. The absence of finality can water down the benefits of the arbitration process, such as swiftness and cost-effectiveness.

The Saudi legal regime is undergoing significant changes, and challenges such as compliance will be apparent. However, the new modifications benefit the overall dispute resolution mechanism and provide greater certainty and clarity.

The decision to include a binding arbitration clause in the governance structure of a family business is up to the members. Nevertheless, the family business should consider drafting a process for arbitration for effectiveness and to avoid wasted time through appeals. Attention to the KSA arbitration law provisions is vital to making informed decisions.

Hammad & Al-Mehdar Law Firm has experience in all legal matters involving businesses and can help with arbitration agreements. Contact us to discuss your requirements further.