Cross option Agreements and Shareholders Agreements

Cross Option Agreements and Shareholders’ Agreements – Now more important than ever

As ‘Lockdown 2.0’ begins, it is now even more important than ever for business owners and shareholders in jointly owned businesses to consider what their intentions are should the worst happen and they pass away.

Prudent business owners and shareholders should consider entering into a cross option agreement or shareholders’ agreement with their fellow shareholders to put in place measures to protect the business in the event of a shareholder's death, and to avoid potential conflict or difficulties arising where the deceased’s shares are transferred to their beneficiaries under their Will (or under the intestacy rules where there is no Will in place).

What happens when a shareholder dies?

The provisions of a shareholder’s Will, or the rules of intestacy, will apply in the event of a shareholder’s death unless a company’s shareholders’ agreement or articles of association contain provisions dealing with a shareholder passing away. The beneficiaries, often a deceased shareholder’s family members, may have no interest in taking over the deceased’s role in the business and may not have the experience required to fulfil such a role.

In such circumstances difficulties can arise if the surviving shareholders do not have the funds to purchase the deceased’s shares. This is when a cross option agreement, backed by the appropriate shareholder protection life insurance policy, is important.

What is a cross option agreement?

The purpose of a cross option agreement is to grant the surviving shareholders a ‘call option’, which is an option (so not a mandatory obligation) to purchase the deceased’s shares at market value, whilst also granting the deceased’s personal representatives a ‘put option’, which is an option (so again not a mandatory obligation) to sell the shares to the surviving shareholders at market value.

To avoid the apparent affordability issues that could arise in these circumstances, a life insurance policy, written in trust for the benefit of the other shareholders, is also taken out which ensures the sum required to purchase the shares is available to the surviving shareholders at the time of death, as the proceeds of such policy will be paid out directly to the surviving shareholders in such circumstances.

When is a shareholders’ agreement more suitable?

Whilst a cross option agreement is an agreement which concentrates solely on the death of the shareholders, a shareholders’ agreement can also address other matters which the shareholders may want dealt with whilst the shareholders are alive, such as (but not limited to): what is intended should a shareholder wish to transfer their shares; certain matters requiring a specified level of consent (or consent from a specific shareholder); and/or how the business is intended to be funded.

A shareholders’ agreement can also include the options on death described above that would be included in a cross option agreement. Therefore a shareholders’ agreement would be more appropriate should you wish to address other matters in respect of the business as opposed to just death.

Need further legal advice?

If you require further assistance or advice on any of the above, including if you would like assistance with drafting or reviewing a cross option agreement or shareholders’ agreement, please do not hesitate to contact Scott Richardson on 01329 227907 or by email on scott.richardson@glanvilles.co.uk.

The contents of this article are intended for general information purposes only and shall not be deemed to be, or constitute, legal advice, and should not be relied upon as advice. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article. All content was correct at the time of publishing. Legal advice should always be sought in relation to specific circumstances.