Death of a Salesman

When it comes to the unexpected death of a shareholder who works in the business he owns, whether as a salesman or in any other key role, a little disaster planning beforehand can make dealing with this sort of situation a whole lot easier for everyone.

Such a death will create a number of difficulties for the firm. Setting aside the grief and upset other shareholders and  colleagues will inevitably feel, at a practical level the company will need to think about:

• Appointing a replacement to carry out the deceased’s role within the business.
• Calling on any keyman insurance taken out against such an eventuality.
• If the shareholder was also a director, you will need to consider appointing a new one. In some circumstances you may have no option, if you wish to keep the company operating.
• Working out what is going to happen to the deceased shareholder’s shares?

Inheritance issues

Inheritance issues are incredibly important, both from the perspective of the company and from the perspective of the shareholder’s beneficiaries.

If the company is a big PLC with many thousands of investors, each with relatively small shareholdings, the shares will generally pass to the shareholder’s estate, to be transferred to a beneficiary or sold, with no impact on the company at all. If however your company is a private limited company and the deceased shareholder was working in the business, the position is very different.

If no planning has been done, the risk is that the shareholding will be transferred to the deceased’s family under the terms of his will. That may be to someone who is not appropriate to work in the business, someone who lacks business experience, and/or someone who has a different vision for the future of the company. None of this is good news for the business and the remaining shareholders.

From the beneficiary’s point of view, being stuck with a shareholding in a private company that he doesn’t want to work in, has no interest in, and cannot sell, may not be ideal either. Often beneficiaries would much prefer to sell the shares for cash instead. But what if they can’t because neither the company or its shareholders can afford to buy them out? 

The solution is to make sure, in advance, that:

• The other surviving shareholders can, if they want, exercise a right to purchase the shares from the deceased’s estate;
• The deceased’s executors or beneficiaries can, if they want, exercise a right to sell the shares back to the Company or the surviving shareholders; and
• The shareholder/Company have the funds to buy back the shares if required.

This is best achieved by way of a cross option agreement backed up by an insurance policy.

Cross option agreement

A cross option agreement is, in general terms, an agreement signed between all the shareholders that will entitle them to retain control of the shares of any deceased shareholder. Effectively it gives them – and the representatives of the deceased shareholder – the power to trigger the purchase/sale of the shares.

To ensure that there is sufficient money to pay for the shares, each shareholder usually then takes out a life insurance policy, in trust for the other shareholders, for the value of their shares.

It is essential that care is taken when drafting the cross option agreement, to make sure that it does not conflict with the company articles, any shareholders agreement and, indeed, the Wills of the individual shareholders.

The wording used in the cross option agreement can also impact on the inheritance tax liabilities of those concerned. If it implies that the option to buy/sell is an obligation, rather than a right, then the shares may no longer be eligible for Business Property Relief, which currently stands at 100% of the business property being transferred. Careful drafting can avoid that.

The message here is that it pays to be prepared. When the worst happens, having agreements and funds in place to deal with the situation is in everyone’s interests – the shareholders, the Company and the bereaved family. Don’t leave it to chance.

Disclaimer 
The matter in this publication is based on our current understanding of the law.  The information provides only an overview of the law in force at the date hereof and has been produced for general information purposes only. Professional advice should always be sought before taking any action in reliance of the information. Accordingly, Davidson Chalmers Stewart LLP does not take any responsibility for losses incurred by any person through acting or failing to act on the basis of anything contained in this publication.