The Buy-Sell Agreement Check-Up
Volume 4 • Issue 7 • September 2014
The Counselor is a monthly newsletter of Hallock & Hallock dedicated to providing useful information on estate planning, business succession planning and charitable planning issues. This month's issue will discuss the buy-sell agreement. If you are interested in learning more about the ideas and processes discussed in this newsletter please contact us for an initial consultation.
For owners of a closely held business such as an LLC, Partnership, or Corporation, there are few things more important than the buy-sell agreement among the owners. The buy-sell agreement is an agreement among the owners designed to establish a predetermined and agreed-upon business value (or method of arriving at the value) at the occurrence of certain trigger events such as the death, disability, divorce, deadlock, voluntary or involuntary termination of an owner, retirement of an owner or the attempted sale to a third-party.
The School of Hard Knocks
Unfortunately, like many planning documents, once the buy-sell agreement is signed it is often put on a shelf, never to be looked at again until it is needed. At that point it may be too late to make the necessary adjustments in the agreement to ensure it meets the current needs of the owners. A case from 2011, Estate of Claudia L. Cohen, is illustrative.
In the Cohen case, Booth Computers was a partnership created by Claudia Cohen’s father when she was 27. She was given a partnership agreement to sign and did so without legal counsel. The agreement mandated the sale of a partner’s interest upon death. In determining the value of that interest, the agreement provided: “. . . the full and true value of the Partnership is equal to its net worth plus the sum of FIFTY THOUSAND ($50,000.00) DOLLARS. The term 'net worth' has been determined to be net book value as shown on the most recent Partnership financial statement at the end of the month ending with or immediately preceding the date of valuation.” Claudia died some thirty years later, and the agreement had never been updated.
Based upon this formula, Claudia’s heirs received $178,000.00 for her interest in Booth Computers. Had the fair market value been used, Claudia’s family would have received approximately $11 million. Parenthetically it should be noted that Claudia had benefited from a similar windfall when her brother had passed away ten years prior. The court wrote of its reasoning: “. . . where the terms of the contract are clear, it is not the court’s function to make a better contract for either of the parties.” The reasoning used by the New Jersey court is consistent with how most courts around the country will interpret a contract.
A Review Checklist
In order to avoid ending up like the Cohen family, this brief review checklist will help assess potential deficiencies in a current buy-sell agreement and identify those areas that should be updated. If a buy-sell agreement doesn’t exist, this checklist can be used to ensure any new agreement includes important provisions. While it is not meant to be comprehensive or replace important advisors, the checklist should provide a jump start to the process.
Does the agreement bind all owners and the business entity?
Have the spouses agreed to accept the terms of the agreement with regard to community property/marital interest?
Are there any provisions conditioning ownership or acquisition based on family relations or other factors?
Did you address non-competition, non-solicitation, and confidentiality?
Is there a provision for how the purchase price is determined (valuation)?
Is there a provision for how the purchase price will be paid?
Is your agreement adequately funded – i.e. how will a buy-out be paid?
Will the purchase be funded by life insurance?
Has life insurance been purchased?
Are appraiser qualifications specified?
Is the appraiser selection method specified?
Did you address the death of an owner?
Did you address the disability of an owner?
Did you address the divorce of an owner?
Did you address the bankruptcy of an owner?
Did you address the failure of an owner to perform expected duties?
Did you address the retirement or other voluntary withdrawal of an owner?
Did you address the right to sell to a third-party purchaser?
Did you specify the method of resolving disputes?
Did you address expulsion of an owner?
Did you address dissolution of the company?
Regardless of what stage your company is at, if there are multiple owners, the failure to have a buy-sell agreement and the failure to keep a buy-sell agreement up to date can be devastating. A review meeting with your attorney and other advisors should take place each year to ensure the buy-sell agreement continues to meet the needs and expectations of the owners. Additionally, a valuation of the business should be undertaken periodically to ensure the parties are operating with a full understanding of the impact of any valuation decision. So remember these points:Conclusion
Work with quality advisors who understand these issues;
Have a buy-sell agreement for your business;
Have a regular review meeting, at least annually, to discuss the buy-sell agreement; and
Act timely in making revisions to the agreement.
Please contact our offices if you would like us to review your Company’s buy-sell agreement.
This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.