Retaining Control: What happens on the death of a shareholder?
In this article, Olly Davidson explores the different considerations for owner-managers from both a corporate and an estate administration perspective.
Owner-managers of a business are generally keen to retain control of their company’s shares. This allows for continuity of ownership, rather than allowing the shares (often a significant proportion of the total equity) to pass to unconnected third parties. This is why it is important for owner-managers to consider what will happen to their company’s shares on the death of its shareholders and for appropriate provisions to be put in place as a precaution, to ensure that the remaining owner-managers retain control of their company.
Articles of association of the company
Sometimes, the articles of association will include provisions for what will happen to a shareholder’s shares when he dies. For example, the current model articles of association (as prescribed by the Companies Act 2006) provide a mechanism to enable a person entitled to a deceased shareholder’s share to either become a shareholder of the company himself or to transfer his shares to another person.
This however does not provide sufficient protection to owner-managers that would like to limit the control of the company to themselves, without the involvement of any third parties. A more appropriate protection therefore is for a cross option agreement to be entered between all the owner-managers from the outset.
Cross option agreements
In the event of the death of any of the shareholders in a company, the other owner-managers/shareholders can ensure, by putting in place a cross option agreement, that not only the surviving shareholders have a right to purchase the deceased shareholder’s shares from his personal representatives, but that they also have the funds to pay for them.
Having the funds to pay for the shares is crucial and in order to support the provisions set out in the cross option each owner-manager may need to insure his/her life under a life assurance policy. The value of this policy should reflect the value of the shares registered in the shareholder’s own name and the policies must be written in trust for the other shareholders, to enable them to fund the purchase of the deceased shareholder’s shares. Often insurance providers will supply their own paperwork for putting the life assurance policy into trust, however if this is not the case then a separate trust document will need to be drafted. If insurance policies are being put in place it is also important to ensure these are periodically reviewed, with the help of an insurance broker if appropriate, to ensure that the value they are insuring reflects any fluctuation, by way of increased or decrease, in the value of the shareholder’s shares.
These corporate mechanisms can provide good protection for owner-managers looking to retain full control of their company, but for their intentions to be given full effect, one needs to look beyond these transactional safeguards and make sure that the Will of the deceased shareholder also reflects the owner-managers’ intentions.
It is important that any Will complements, not conflicts with, the corporate mechanisms outlined above, otherwise, it will not only frustrate the owner-managers’ intentions but also complicate the ongoing management of both the company and the deceased’s estate.
Although it sounds obvious, the starting point is to ensure that each owner-manager actually has a Will in place. In the absence of a Will, the default position is that the intestacy rules apply, which set out who is entitled to inherit the estate of the deceased shareholder and may differ significantly from what such shareholder intends.
In a Will, there are various mechanisms for harmonising the position with any corporate mechanisms already in place. Often the simplest approach is for the Will to remain silent on the company so that the owner-manager’s interest is not explicitly mentioned. This means that any corporate mechanism (e.g. cross-option agreement etc) would apply unless it has been cancelled or usurped. Depending on the circumstances however, it could be advantageous to include a discretionary trust over business assets, which may attract preferential treatment for IHT purposes (under what is known as “Business Property Relief”). This is usually preferable to a legacy of an owner-manager’s shares, which runs the risk of contradicting any corporate planning.
In short, a joined-up approach between corporate and personal planning is essential, ensuring that any disruption from the death of an owner-manager/shareholder is minimised and avoiding any complications from contradictory documents. If you require assistance or advice on any of the issues raised in this article, Olly Davidson in our Wills, Tax & Trusts team would be happy to help.