Cross-option agreements and business continuity
6 August 2024
Putting in place cross-option agreements and shareholder protection policies provides peace of mind that the future of the business is secured on the death of a shareholder.
Background
On the death of a shareholder, the beneficiary under his/her Will, often the widow, may have no interest in taking over the deceased’s role in the business and no relevant experience. Worse still, the beneficiary may wish to be involved in the running of the business, which the other shareholders may not appreciate.
The surviving shareholders may wish to buy the shares of the deceased shareholder, but the beneficiary may not wish to sell the shares. Conversely, the beneficiary may wish to sell the shares and have the cash proceeds of sale instead. However, the surviving shareholders may refuse to buy the shares, in which case the beneficiary may be left holding illiquid shares that cannot readily be sold.
On the other hand, the surviving shareholders may wish to buy the shares, but they may not have the resources to do so. This is when cross-option agreements, backed by shareholder protection life insurance policies, come into play.
Cross-option agreements
The purpose of a cross-option agreement is to ensure that, on a shareholder’s death, shares are returned to the business and remaining shareholders with as little disruption as possible.
A cross-option agreement grants the surviving shareholders a ‘call option’, which is an option (so not a mandatory obligation) to buy the deceased’s shares at market value, while also granting the deceased’s executors a ‘put option’, which is an option (so again not a mandatory obligation) to sell the shares to the surviving shareholders at market value.
These corresponding or crossing ‘options’ give the cross-option agreement its name. Alternatively, the company may have an option to buy back the shares of the deceased shareholder.
Shareholder protection
A life insurance policy, written in trust for the benefit of the other shareholders (or the company) should be put in place, which ensures the sum required to purchase the shares is available to the surviving shareholders (or the company) at the time of death. The level of cover should be reviewed periodically to check that it is sufficient. By writing the policy in trust, the proceeds will fall outside inheritance tax on death.
Business Relief
Business Relief is a 100% relief that applies to trading companies if the relevant conditions are met. The relief is lost if there is a ‘binding contract’ for sale of shares, for example if a cross-option agreement states that the surviving shareholders or the company ‘must’ buy the shares of the deceased shareholder ‘on death, rather than there being an ‘option’ to do so. Careful drafting of the cross-option agreement is therefore required in order to preserve this valuable tax relief, in addition to a review of the constitutional documents and in particular the Articles of Association.
Conclusion
The death of a shareholder can lead to concerns and uncertainty about the company’s future. Cross-option agreements and shareholder protection policies provide business continuity, removing doubts about succession and providing a clear way forward.
The Birketts view
Insufficient planning about what happens on a shareholder’s death may lead to a beneficiary who has no interest or corporate acumen inheriting an interest in the business. This can lead to conflict between the beneficiary and surviving shareholders about how the company should be run. Putting in place cross-option agreements and shareholder protection policies offers business continuity and peace of mind.
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Katherine Forster
Services
The content of this article is for general information only. It is not, and should not be taken as, legal advice. If you require any further information in relation to this article please contact the author in the first instance. Law covered as at August 2024.