Cross-options - what they are and what do they protect?

04 Jun

04Jun

Introduction / Reasons for a Cross-Option in a Shareholders' Agreement / Ensuring continuity of the business / Preserving Business Property Relief for Inheritance Tax purposes / Providing liquidity for the deceased shareholder's estate / Main Features of a Cross-Option in a Shareholders' Agreement / Shareholder Insurance / How are shareholder insurance policy proceeds are dealt with in cross-options / Conclusion

Let us know if you need a cross-option agreement included in your shareholders' agreement.

Introduction:

Shareholders' Agreements play a crucial role in protecting the interests of shareholders and ensuring the smooth operation of a company.

One important provision that is often included in these agreements is the cross-option.

This article explores the reasons for having a cross-option in a shareholders' agreement, its main features, and how shareholder insurance operates to facilitate its implementation.

Reasons for a Cross-Option in a Shareholders' Agreement:

Dealing with a shareholder's death: One of the primary reasons for including a cross-option in a shareholders' agreement is to address the potential impact of a shareholder's death.
A cross-option agreement provides a mechanism for the surviving shareholders to have the option to buy the deceased shareholder's shares at market value upon their death. This ensures that the value of the deceased shareholder's shareholding will be received by their family, without the need to leave the shares themselves to relatives who may not actually want them or may not be in the best interests of the company.

Ensuring continuity of the business:

Another key reason for a cross-option agreement is to maintain the continuity of the business.

By allowing the surviving shareholders to purchase the deceased shareholder's shares, a cross-option agreement helps to prevent the shares from passing to beneficiaries who may have no business experience or may not wish to be involved with the business.

This could potentially cause tension between family members and other shareholders and disrupt the smooth operation of the company.

Preserving Business Property Relief for Inheritance Tax purposes:

Cross-option agreements should be considered in conjunction with the provisions of the shareholder's Will to ensure that the shares will still qualify for Business Property Relief for Inheritance Tax purposes. This is important for tax planning purposes and to minimise the tax liability on the deceased shareholder's estate.

Providing liquidity for the deceased shareholder's estate:

By having a cross-option agreement in place, the surviving shareholders can use the proceeds from the life insurance policies held in trust to pay for the deceased shareholder's shares. This provides liquidity for the deceased shareholder's estate and ensures that the beneficiaries receive a fair market value for the shares.

Main Features of a Cross-Option in a Shareholders' Agreement:

Mutual options: Each shareholder has the option to buy the shares of the other shareholders in the event of their death. This ensures fairness and equal treatment among the shareholders.
Trigger event: The trigger event for the exercise of the cross-option is typically the death of a shareholder, but it can also include other events such as incapacitation or a lasting power of attorney being registered. This allows for flexibility in addressing various scenarios that may impact the ownership structure of the company.
Market value determination: The purchase price for the shares is usually set at the fair market value of the shares at the time of the trigger event. This ensures that the transaction is based on the true worth of the shares and protects the interests of both the selling and purchasing shareholders.
Funding arrangements: Shareholders may agree on funding arrangements, such as using life insurance policies held in trust, to provide the necessary funds to buy the shares from the deceased shareholder's estate. This ensures that the surviving shareholders have the financial resources to acquire the shares and maintain control of the company.
Continuity of the business: The purpose of a cross-option agreement is to ensure the continuity of the business by allowing surviving shareholders to acquire the shares of the deceased shareholder. This helps to avoid disruptions and conflicts that may arise if the shares were to pass to inexperienced or uninterested beneficiaries.

Shareholder Insurance:

Shareholder Protection Insurance: Shareholder Protection Insurance, also known as Share Purchase Insurance, is a type of life insurance policy taken out by the shareholders of a company. Each shareholder is insured for a sum of money that represents the value of their shares in the company.
Funding the Purchase: The insurance proceeds received from the Shareholder Protection Insurance policy can be used to fund the purchase of the deceased shareholder's shares. This ensures that the surviving shareholders have the necessary financial resources to acquire the shares and maintain control of the company.
Fair Valuation: The insurance policy is typically structured to provide a sum assured that reflects the fair market value of the shares. This ensures that the purchase price for the shares is fair and based on their actual worth.
Estate Liquidity: Shareholder Protection Insurance provides liquidity to the deceased shareholder's estate. Instead of inheriting illiquid shares in the company, the estate receives a cash payout from the insurance policy. This can be particularly beneficial if the estate requires immediate funds to settle any outstanding debts, taxes, or other financial obligations.
Tax Efficiency: The insurance payout received by the deceased shareholder's estate is generally free from inheritance tax. This can provide tax advantages and help mitigate the potential tax burden on the estate.

How are shareholder insurance policy proceeds are dealt with in cross-options:

In a cross-option agreement, shareholder insurance policy proceeds play a crucial role in facilitating the purchase of shares in the event of a shareholder's death.

Here's how the insurance policy proceeds are typically dealt with:

Placing policies in trust: The shareholder insurance policies are usually placed in trust. This means that the insurance proceeds are held separately from the deceased shareholder's estate and are managed by a trustee. Placing the policies in trust ensures that the funds are used in accordance with the terms of the cross-option agreement and provides clarity and protection for the surviving shareholders.

Trustee's role: The trustee is responsible for managing the insurance proceeds and ensuring that they are used to facilitate the purchase of the deceased shareholder's shares. The trustee acts as a neutral party, overseeing the distribution of funds and ensuring compliance with the terms of the cross-option agreement.

Purchase of shares: Upon the death of a shareholder, the surviving shareholders have the option to purchase the deceased shareholder's shares using the insurance proceeds. The trustee will coordinate the transfer of funds from the trust to the selling shareholders or the deceased shareholder's estate, depending on the specific terms of the agreement.

Fair valuation: The purchase price for the shares is typically determined based on the fair market value at the time of the trigger event. The trustee may engage an independent valuer or accountant to assess the value of the shares and ensure that the purchase price is fair and reflects their true worth.

Allocation of funds: The insurance proceeds are used to provide the necessary financial resources for the surviving shareholders to acquire the shares. The funds are typically distributed to the selling shareholders or the deceased shareholder's estate in exchange for the transfer of the shares. This ensures that the surviving shareholders can maintain control and ownership of the company.

Tax considerations: The use of insurance policy proceeds in a cross-option agreement can have tax advantages. The insurance payout received by the deceased shareholder's estate is generally free from inheritance tax. However, it is important to consult with tax advisors to ensure compliance with relevant tax laws and regulations.

Legal enforceability: The distribution and use of the insurance proceeds are governed by the terms of the cross-option agreement and the trust arrangement. This provides a legally binding framework for the allocation of funds and ensures that the rights and obligations of all parties involved are protected and enforceable.

It is important for shareholders to carefully consider the insurance coverage needed to adequately protect the value of their shares and the financial stability of the company.

Consulting with insurance professionals, legal advisors, and trustees is crucial to determine the appropriate insurance policy, trust structure, and distribution process that aligns with the specific requirements of the cross-option agreement and the shareholders' objectives.

Conclusion:

In conclusion, a cross-option in a shareholders' agreement is a vital provision that ensures business continuity and protects the interests of shareholders.

By addressing the potential impact of a shareholder's death and providing a mechanism for the purchase of shares, a cross-option agreement helps maintain stability and control within the company.

The use of shareholder insurance further facilitates the implementation of a cross-option by providing the necessary financial resources to fund the purchase of shares. It is important for shareholders to seek independent legal and financial advice to tailor the cross-option and insurance arrangements to their specific circumstances and objectives.

Legal Notice: Publisher: Atkins-Shield Ltd: Company No. 11638521
Registered Office: 71-75, Shelton Street, Covent Garden, London, WC2H 9JQ

Note: This publication does not necessarily deal with every important topic nor cover every aspect of the topics with which it deals. It is not designed to provide legal or other advice. The information contained in this document is intended to be for informational purposes and general interest only.

E&OE

Comments