Shareholder Protection – Key Considerations For Business Owners
Many business owners have worked hard to establish their business and ensure that the day-to-day running is, for the most part, seamless. However, unforeseen events and circumstances, such as an unexpected death or long-term illness of a significant shareholder, can cause standstills and critical problems. By planning in advance appropriately, these issues can be avoided.
We have previously discussed cross option agreements as a solution to deal with these issues. Such agreements are usually backed by ‘shareholder protection’ insurance policies provided by your business’s insurance broker.
In summary, cross option agreements create a structure whereby the shareholders of the company can buy the shares back from a deceased shareholder’s estate (or from a critically ill shareholder) with monies received from the ‘shareholder protection’ insurance policies, allowing for a quick and orderly transition that benefits both the family of the deceased shareholder and the ongoing business owners.
As the popularity of these types of agreements has increased, the way they operate has shifted. For this reason, business owners should take the time to understand whether existing arrangements are up to date and will function as intended should they ever need to be used. With this in mind, our corporate and commercial team have outlined the most important updates and considerations surrounding shareholder protection in this article.
How Shareholder Protection Policies Work
‘Shareholder protection’ insurance policies provide the funds for a cross-option agreement to operate effectively. At GA Solicitors, our corporate and commercial solicitors have been closely following developments in the insurance market, which have significantly changed how some cross option agreements must be prepared and subsequently function, whilst achieving the same commercial outcome.
Now, ‘shareholder protection’ insurance policies are being put in place for the benefit of the Company rather than the individual shareholders. This is done primarily as the Company is then responsible for the payment and maintenance of the insurance policies.
What Are The Implications Of The Changes To Shareholder Protection Policies?
Whilst the trend towards putting shareholder protection policies in place for the Company rather than individual shareholders may be preferable from the owners’ perspective, it does considerably alter the legal process required to buy the deceased shareholder’s shares. The cash received by the Company from the policies must then be used to perform a share buyback of the deceased shareholder’s shares.
Share buybacks are strictly regulated by the Companies Act, and various requirements must be complied with. If the buyback does not meet the required standards, then the buyback is illegal and considered void. As a result, this structure does have its risks, as you do not know what the financial position of the company will be when the cross option is exercised.
I have highlighted some of the key requirements under the Companies Act below for cross option agreements structured in this way:
- The Company must have sufficient distributable profits when the buyback occurs. If this is not the case (despite the insurance cash payout) any buyback would be illegal and cannot take place. As a result, the financial position of the Company must be carefully considered.
- A resolution of the shareholders (save the holder of the shares in question) must be passed approving the buyback.
- A buyback contract must be completed to evidence that the buyback has taken place. This contract must also be conditional on the shareholder resolution above passing.
Please note that this list is not exhaustive and there are other key aspects, such as payment timings and the Company’s articles of association, that must be considered.
Do You Need Legal Advice On Shareholder Protection?
Given the legal complexities involved and the fact that providers of shareholder protection are increasingly favouring Company-owned policy structures, it is important to ensure that any cross option agreement works alongside your insurance arrangements.
At GA Solicitors, we would strongly recommend that legal advice is taken at the outset so that your cross option agreement aligns with the practical realities of the ‘shareholder protection’ insurance policies you have in place (and that you understand the pros and cons of the different structures and options available).
If you would like to speak to us about preparing a cross-option agreement or if you already have shareholder protection insurance policies in place and would like to ensure your related agreements are valid, please call our corporate and commercial solicitors in Plymouth today on 01752 203500 or email jack.ross@GAsolicitors.com.
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