Failing to plan for death of a company shareholder or director – legal and practical risks
Failing to plan for death of a company shareholder or director – legal and practical risks
Though death is one of the only certainties, some companies are still failing to put succession plans in place to counter the serious and adverse consequences, which can arise on the unexpected death of one of its shareholders who is also a director (a key employee). On the death such shareholder-director the following issues can arise and will need to be dealt with in order to best deal with the situation for both the company and the deceased’s family:
Director’s loans made to the company?
In private companies it is common for shareholders to make directors loans to the company. These loans are not always documented which can cause disagreement over repayment as well as the rate of interest to be charged until repayment. Repayment of company’s bank overdraft and/or loans?
The directors, in respect of the company’s borrowing facilities, may have given personal guarantees. Death of a guarantor may trigger a repayment obligation. If the company is unable to renegotiate the borrowing facilities and cannot repay the bank, then the guarantees might be recalled. In these circumstances the deceased’s guarantee is payable by his/her estate and could add hardship to next of kin.
Loss of profit
The death or diagnosis of a serious illness of a director who has effectively been a “key” employee can lead to a loss of profit. The deceased may have had a large client base, and on his death his clients might decide not to stay with the company. The likely result would be an immediate drop in sales and consequently a drop in profits. This could lead to a significant amount of stress on other members of the workforce and damage to confidence and service delivery. All this could a dramatic effect on the company’s bottom line.
Recruitment
The loss of a key person will need time and effort to fill the void. There will also be a time lag having found a replacement to ensure he is fully up to speed and as effective as the person they have replaced; there can also be considerable recruitment fees involved.
Deceased’s shareholding?
In the absence of any agreement providing otherwise any, shares held by the deceased will pass under the terms of his will (assuming he has a will) to his named beneficiaries. This could mean the surviving shareholders find themselves with the deceased’s spouse holding a significant shareholding in the company, entitled to equal dividends – despite not playing a part in the running of the business. One way to deal with this would be to offer to buy the shares from the deceased’s spouse at market value. However, it is worth remembering that in the absence of any agreement to the contrary, if the shares are a minority holding, the value of the shareholding will be materially discounted.
In the absence of any agreement providing otherwise any, shares held by the deceased will pass under the terms of his will (assuming he has a will) to his named beneficiaries. This could mean the surviving shareholders find themselves with the deceased’s spouse holding a significant shareholding in the company, entitled to equal dividends – despite not playing a part in the running of the business. One way to deal with this would be to offer to buy the shares from the deceased’s spouse at market value. However, it is worth remembering that in the absence of any agreement to the contrary, if the shares are a minority holding, the value of the shareholding will be materially discounted.
All of these issues can be planned for to ensure that both the company and the bereaved family are shielded from adverse financial consequences. Succession planning will involve putting in place business protection insurance (Key Man and Shareholder Protection; Business Loan Protection; Life Insurance) as well as a shareholders’ agreement.
Insurance
The company can take out Key Man life insurance on the lives of its shareholders for a sum assured sufficient to cover: possible liabilities to the bank; the likely loss of profit; costs of recruiting a replacement. The surviving shareholders can also take out Life Cover along with the beneficiaries. In the event of death of a shareholder the surviving shareholders will be put in funds to pay full value to the heirs of the deceased shareholder for their shares in the company. It will also be worthwhile obtaining critical illness cover, which will allow the business to continue to pay a director or shareholders should they be unable to work due to a serious illness.
Shareholders’ agreements
The shareholders should enter into a shareholders agreement, which should address what will happen in the event of death. Provision should be made in the agreement for beneficiaries to have the option of selling their shares to the surviving shareholders who will be obligated to buy the shares from the beneficiaries; provision should also be made for the surviving shareholders the option to request the beneficiaries to sell their shares to the surviving shareholders. These options should be carefully drafted to ensure that minimal tax is payable.
The shareholders agreement should also provide that that there is no discounting the value of a minority shareholding. Prior to entering into a shareholders agreement, the company’s articles of association should be reviewed to ensure there are no conflicting provisions.
Review
Once in place the arrangements should be reviewed regularly to ensure they are still adequate. For those who have such arrangements already in place now is the time to re-visit what may have been in place for a number of years.
Contact our corporate and commercial law experts today
To speak to one of our corporate or commercial solicitors please call us today on 01895 207973 or email corporate@ibblaw.co.uk. Alternatively please visit www.ibblaw.co.uk/service/corporate-and-commercial for more information on how we can help you with succession planning for your business.
