Cross Option Agreements
For companies the shares of the deceased or critically ill person can either be purchased by other individual shareholders or by the company itself, whereas for partnerships the shares can only be purchased by individuals.
Companies and Partnerships – Purchase of Business Share by Individuals
By taking out a Cross Option Agreement you will determine what will happen to the shares in the business if one of the owners was to die or become critically ill. It is important that this agreement is not binding regarding sale of the shares because this will prevent you from claiming relief from inheritance tax. You can find out more about this on the taxation page of our website or by contacting one of our helpful Key Man Insurance Advisors on: 0845 680 8495.
A Cross Option Agreement should be drawn up by a solicitor who will ensure that it does not conflict with any existing agreement relating to a business partnership, or to a company’s Articles of Association. When this type of agreement is set up a ‘sell’ option is created for each owner relating to death and/or critical illness, and a ‘buy’ option is created for all owners relating to death only. This means that by exercising the ‘sell’ option, the remaining owners will have to buy the share of the dead or critically ill owner. With the ‘buy’ option representatives of the deceased owner must sell his share to the remaining co-owners.
- Critical Illness Options
If you decide to include critical illness options in the agreement, you need to think about whether an owner who becomes critically ill will have a single option permitting them to sell their share of the company, or whether you also want the co-owners to have an option to buy. If you decide on a single option to sell, this ensures that the critically ill owner cannot be forced out of the business. The advantage with this is that the owner will be able to return to his position in the business if he recovers from his illness. The flip side of this is that if the critically ill owner is unable to return to work, the co-owners will not have the rights to buy that person’s share in the business. In these circumstances the critically ill person would still have a right to a share in the profits of the business even if they are unable to return to work.
- Double Option for Critical Illness
If you decide to include a double option relating to critical illness, this agreement will differ from a cross option on death. With this type of option an owner who becomes critically ill has an option to sell straightaway. If he chooses to exercise that option the co-owners of the business must buy that person’s share. However, they would be unable to force him from the business straightway as there would be a time constraint involved. This means that the option to buy would only apply if the ill owner did not return to work within a specified period. This has advantages both to the ill owner who has the chance to return to work if he recovers, and to the co-owners who are able to remove him from the business if he is unable to return to work after the specified period.
The following diagrams help to demonstrate what would happen regarding an individual purchase on death or critical illness. If you want to discuss Cross Option Agreements in more detail, we will be happy to help. Please call to speak to a Key Man Insurance advisor on: 0845 680 8495 for advice.
Companies Only – Purchase of Shareholding by a Company
In the case of a purchase by the company itself, the deceased or ill person’s shares would be cancelled and would therefore revert to unissued share capital. The remaining shareholders would retain the same number of shares but their proportion of issued share capital would increase as each shareholding would represent a higher value. The Company’s Articles of Association must allow the purchase of shares by the company, and there are a number of conditions attached, which are detailed in full in Part 18 of the Companies Act 2006. We will outline the most important of these, as follows:
- The company’s distributable profits must be used to purchase its own shares or, alternatively, they must be purchased out of the proceeds of a new issue of shares.
- A repurchase of shares using capital reserves may be permitted, but this is subject to strict circumstances being met. These state that all distributable profits must have firstly been exhausted, and the capital payment is made by referral to ‘relevant accounts’. A statement must also be made by the directors, and the auditors will have to report to the directors whether they feel that the financial position of the business makes a purchase from capital a viable option.
- Agreements must be set up relating to the company as a whole and also to each individual shareholder. These agreements will grant the purchase of a person’s shares in the event of their death or critical illness. The company must also take out life or critical illness cover for that person to cover the cost of the share purchase.
The following diagram illustrates what happens if a shareholder dies or becomes critically ill and the company purchases their shares. If you want to find out more about Cross Option Agreements or any other aspect of Business Protection Plans, an adviser will be happy to help. Please contact us for assistance on: 0845 680 8495.