Death of a shareholder1 June, 2009
Where shareholders own a company and are employed in the business, the unexpected death of one of them could have serious and adverse consequences for either the company or the bereaved family. The main issues that would need to be addressed include:
• What happens to director’s loans made to the company?
• Does the company’s bank overdraft / loans become repayable?
• The likely loss of profit
• The costs of recruiting a replacement
• What happens to the deceased’s shareholding?
In many private companies not all the funding comes from the bank. It is common for shareholders to make directors loans to the company. Such loans can range from short terms loans (e.g. until the company can afford to pay out a declared dividend) to longer term loans. Such loans are not normally documented and in the absence of an agreement there may be disagreement as to when they should be repaid.
The directors may have given personal guarantees in respect of the company’s borrowing facilities. The death of one of the guarantors may trigger a repayment obligation. If the company cannot renegotiate the facilities and is unable to repay the bank then the guarantees could be called including the guarantee of the deceased which would need to be met from the estate.
Loss of Profit
The dead shareholder would presumably have been key to the business. Maybe he was the sales director and responsible for key customers or perhaps the brains behind the business. His death may leave the company exposed to a fall in sales which could have a dramatic effect on the bottom line.
In addition to the loss of profits the dead director will need to be replaced. It will take time not only to recruit a person and for them to actually join but also for them to get fully up to speed and that assumes they are going to be as effective as the person they have replaced. This process could take up to a year. There will also be a recruitment fee to pay which may be considerable.
The deceased shareholder’s shares will pass under the terms of his will to his named beneficiaries in the absence of any agreement providing otherwise. The continuing shareholders may find themselves with their former shareholder’s spouse as a significant shareholder in the company who will be entitled to equal dividends although not playing a part in the running of the business. That new shareholder may feel aggrieved that their shares haven’t been bought by the continuing shareholders for market value. Even if the shareholders are prepared to buy the shares if it is a minority holding in the absence of any agreement to the contrary the value of the shareholding will be materially discounted to take into account it is a minority holding.
All of these issues can be planned for in one or more ways to ensure that both the company and the bereaved family do not suffer adverse financial consequences. Planning will involve a combination of business protection insurance in the form of life cover and legal agreements.
Key man life insurance can be taken out by the company on the life of the shareholders for a sum assured sufficient to cover the possible liabilities to the bank, the likely loss of profit and the costs of recruiting a replacement. Life cover can also be obtained with the beneficiaries being the remaining shareholders. On the death of a shareholder this will put the surviving shareholders in funds to pay the heirs of the deceased shareholder full value for their shares in the company. When putting cover in place it would be prudent to put in place critical illness cover at the same time to allow the business to continue paying someone who is no longer in a position to work due to a serious illness.
The shareholders should enter into a shareholders agreement addressing what happens in the event of death by giving the deceased’s beneficiaries the option to sell their shares to the continuing shareholders who will be required to buy the shares and in return giving the continuing shareholders the option to require the beneficiaries to sell the shares. It is important that the options are structured carefully so that any tax payable is minimised. The agreement can also provide that the value of a minority shareholder is not discounted. A number of other important issues can also be dealt with in the agreement when undertaking this exercise. It will be necessary also to review the company’s articles of shareholders association to ensure these do not conflict with the provisions of the shareholder’s agreement. With the changes made by the new Companies Act articles should be reviewed in any event to ensure they do not conflict with some of the new provisions that have been introduced and that they are drafted to take account of some of the relaxations now permitted.
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.
Reviewed in 2015