Shareholder/Partnership Protection

Question 1

Legal Agreements:

Answer 1

BUY AND SELL - the deceased partner/shareholder’s estate must sell and the surviving partners/shareholders must buy. As there is a binding agreement, business relief (BR) is not allowed.

CROSS OPTION or DOUBLE OPTION - works on a similar basis as above but instead of a contractual right to sell/buy, both parties have an option to do so. The agreement is binding only when the option is exercised by either party. BR is usually allowed.

AUTOMATIC ACCRUAL - shareholders/partners leave their share of the business to the surviving directors/partners in their Will. To compensate, the life policy reimburses the estate of the deceased shareholder/partner so they receive the right share of the value of the business.

Question 2

Issues that might arise if either one of the 3 equal Partners were to die without appropriate planning… (9 marks)

Answer 2

• If any of them died, their share of the partnership would go to their spouse/family/beneficiaries.
• There is unlikely to be a ready market for the partnership share / difficult for the beneficiary(ies) to sell it;
• and realising the value of the partnership share will require the surviving partners to purchase the deceased’s partnership share.
• Purchase by the surviving partners is also dependent on them having the available resources / £200,000.
• This could result in the beneficiary(ies) losing out financially.
• Without the beneficiary(ies) having the available money/being able to sell the partnership share, the surviving partners will have to work with the spouse/family/relatives of the deceased partner;
• who are unlikely to have the expertise the business needs.
• As there is no legal agreement in place, they would need to rely on the partnership agreement to determine what happens
• and this might not be what they would like.

Question 3

Explain how a cross option agreement works and how it would work alongside an own life policy on each of their lives written in trust and payable in the event of death. (9 Marks)

Answer 3

• The cross option would state that the surviving partners have the right or option to buy the deceased’s share of the partnership. (1) If they wish to buy, the estate must sell. (1)
• The estate also has the option to sell the deceased’s share of the partnership. (1) If the estate wishes to sell, the surviving partners must buy. (1)
• The own life policy would provide the surviving partners with the means to buy the deceased’s share of the partnership. (1) Each partner should therefore ensure that the cover is maintained (1) and that the level of cover remains suitable. (1)
• The trust would speed up payment of the proceeds to the surviving partners (1) and ensure that the life policy does not form part of the deceased’s estate for Inheritance Tax purposes. (1)

Question 4

Explain to the partners the drawbacks of using life of another policies as part of this arrangement instead.

Answer 4

• Where there are more than two partners, (1) life of another policies can be an inflexible arrangement (1) as they do not readily accommodate any change in circumstances (1) such as a change in the distribution of partnership share or the addition of a new partner. (1)
• In addition, the cost of the premiums may not reflect the benefit to the recipient as there may be an unfair premium cost.
• Insurable interest would also need to be established
• and it would need to be reasonable in the context of the business.

Question 5

Most suitable for CIC is no partners wish to be forced to sell - Single option agreement.

Benefits and Drawbacks

Answer 5

Benefits: • This would give the critically ill partner the right or option to sell, (1) but does not grant the other partners the option to buy. (1)
• This gives him/her the opportunity to continue in the business if he/she recovers and returns to work.

Drawbacks: It could result in the critically ill partner still being entitled to their share of the profits (1) even though they are no longer contributing to the business. (1)

Question 6

Describe when putting in place a purchase agreement why using a business trust may not be Inheritance Tax efficient.

Answer 6

• In order to be IHT efficient the arrangement must be commercial.
• This will not be the case if the trust beneficiaries include anyone other than the business partners subject to the shareholder arrangement.