I recently had a couple of clients ask me about cross-option agreements. What they really needed was a shareholders agreement and its worth reading my articles on why you should have a shareholders agreement. However, cross option agreements are something that are often misunderstood so I figured I should write about them here.
Cross-options are linked to insurance policies. Two or more shareholders in a company will take out life insurance that protects shareholders in the event of the death or incapacity of one of the shareholders. It can be known as shareholder protection or relevant life cover, but in short it is life insurance that each party takes out against the other. It works by providing a mechanism for the surviving shareholder(s) to purchase the shares of the deceased or incapacitated shareholder at a predetermined price. Insurance is taken out at that price (say £1m) and the cross-option agreement gives the surviving shareholder the option (and sometimes the requirement) to buy the shares at the set price. The right to buy option is usually called a Call Option. The right to force the sale is called a Put Option.
A cross-option agreement solicitor will create a trust arrangement over the life policy, directing that the proceeds be paid out to the surviving shareholders which guarantees that they will have cash available in the form of the life policy proceeds to buy the shares. In the event of the death of any of the shareholders in a company, cross options give the surviving shareholders the right to buy the deceased shareholder’s shares and give their personal representatives the right to require the survivors to buy those shares.
Most insurance companies provide their own cross-option deeds, which are basic ‘tick box’ exercises. I always urge caution against using these if at all possible, and if you do not want to go to the full extent of a shareholders agreement at least have a proper cross-option agreement written.
If you are looking for cross option insurance in Leicester, get in touch and I can recommend advisors to help you with the relevant shareholder protections.
When shareholders have a cross-option agreement in place, it allows them to plan for the unexpected and provides protection for the remaining shareholders. Without a cross-option agreement, the death or incapacity of a shareholder could lead to significant financial loss for the remaining shareholders, as the shares may have to be sold at a discounted price or the remaining shareholders may be forced to buy the shares at an inflated price.
Having a solicitor cross-option agreement in place also ensures that the remaining shareholders have the right to purchase the shares of the deceased or incapacitated shareholder, rather than leaving it open to outside parties. This can help to maintain continuity and control within the company.
However, the benefit of using a shareholders agreement would be that on death, we can state that the deceased shares are automatically transferred to the remaining shareholders. With a cross-option agreement, the shares are effectively inherited by the deceased’s estate and purchased from the estate at the given rate.
This can cause a significant tax difference for inheritance tax purposes and should be considered fully.
Business Property Relief
Shares in an unquoted trading (rather than investment) business which are held for more than two years will generally qualify for 100% business property relief from inheritance tax (IHT). This is an extremely valuable relief but it will be lost if the shares are subject to a binding contract for sale at the date of death. Therefore it is crucial that any cross option agreement is drafted carefully to ensure it is just that, i.e. an option to buy rather than an obligation to buy, which would defeat the planning!
In summary, cross-option insurance is a type of insurance that provides a mechanism for shareholders to purchase the shares of a deceased or incapacitated shareholder at a predetermined price, as outlined in a cross-option agreement. Having a cross-option agreement in place can protect shareholders from financial loss, provide continuity and control within the company, and provide certainty and peace of mind for shareholders.
Always consider your company’s articles of association and any other agreements between all or any of the shareholders when thinking about a cross option agreement. Your lawyer will check for any transfer provisions and pre-emption rights on the transfer of shares that may conflict with the cross option agreement.
Shareholders looking at cross-options should generally have a shareholders agreement and revised articles of association to achieve their needs.
You should also look at having a Will for business owners and business owner estate planning.