Are you a shareholder or director in a small or medium-sized company with two or more shareholders or directors? Do you know what will happen to your shares in the company when you die? Failure to make proper arrangements could lead to major problems for both the company and your family.
The likelihood is that you have prepared a will that provides for your personal assets, including company shares, to pass to family members on your death. You may want to ensure that your beneficiaries receive the full financial value of your shares as soon as possible after your death. On the other hand, if your fellow shareholder or director dies, you may want to know that you will be able to retain control of their shares. Otherwise you may find that suddenly you are in business with their family members who have no business experience or interest in the company, or even working for a competitor.
The articles of association of the company and possibly also a shareholders’ agreement are likely to give surviving shareholders some form of pre-emptive rights to acquire the deceased shares. However, these rights might not be exercised and so cannot be relied upon, particularly if the surviving shareholder(s) cannot afford to purchase the deceased’s shares (as is often the case).
One solution is for the shareholders in your company to act now and enter into a ‘cross option agreement’ supported by life assurance policies. This is a legally binding agreement between all the shareholders of the company that if one of the shareholders dies: (1) the surviving shareholder(s) have the option to purchase all of the deceased’s shares from the beneficiaries of the deceased; and (2) the beneficiaries of the deceased have the option to sell all of the deceased’s shares to the surviving shareholder(s).
So both sides have the option to force the sale and purchase of the shares. If neither side wishes to exercise their option then the shares shall remain with the deceased’s beneficiaries.
Life assurance policies are used to fund the purchase of the deceased’s shares. The policies are entered into by each shareholder for the duration of the agreement and upon a shareholder’s death the policies will pay out the funds necessary for the remaining shareholder(s) to purchase the shares. The exact price of the shares can be determined by the amount paid out by the policy, so this avoids the unpleasant and troublesome situation where the deceased’s beneficiaries and the surviving shareholder(s) dispute the value of the deceased’s shares.
The agreement is drafted as two ‘options’, as opposed to ‘obligations’, to purchase or sell the deceased’s shares. Drafting the agreement in this way means the transfer of the shares can qualify for business property relief and therefore no inheritance tax is payable.
Cross option agreements can also be used by partnerships. As with shareholders’ cross option agreements, a partnership cross option agreement will protect surviving partners and the deceased partner’s family in the event of one of them dying.
Fionula Scanlan is a senior associate and a solicitor specialising in corporate law. Particular areas of expertise include business and share sales and acquisitions and commercial contracts. To discuss cross option agreements or other ways in which Raworths can assist your business to plan for the future, please telephone 01423 566 666 or visit our office at Eton House, 89 Station Parade, Harrogate HG1 1HF.