Death of a Shareholder

Shareholders in a private company should have an agreement to cover what happens to the shares of a deceased shareholder.

For most companies, the best solution is an agreement for the shares of the deceased to pass to the surviving shareholder(s) on payment of an agreed price for the shares, probably paid off over a period of time.

Should the deceased estate continue to be a shareholder?

The answer is no, in almost all cases. The family of the deceased probably do not understand exactly how the business is conducted, and the surviving shareholders usually resent interference by the family in the running of the business. For these reasons, a continuing shareholding by the estate leads to misunderstandings and possibly hostility.

The best solution is to have a clear agreement for the shares of the deceased to be transferred to the surviving shareholders, with the estate being paid for those shares.

Determining the price

Many shareholders agreements or buy/sell agreements provide that the price is whatever the shares are worth, as determined by an accountant. The problem is that if you ask 7 accountants to value a business, you will probably get 7 very different answers.

The solution is to have a clear agreement as to how the shares of a deceased shareholder will be valued, for example, as a multiple of earnings. In that way, the price for the shares can be easily determined without having to negotiate with the grieving family of the deceased shareholder.

If there are policies of life assurance as referred to below, the price to be paid for the shares should be equal to the insurance payout. If so, the amount of the insurance cover should be reviewed regularly, to keep it in line with the value of the shares.

Buy/sell agreements

If a shareholder dies and their shares are transferred to the surviving shareholders, this triggers capital gains tax (CGT). The law requires that, if you enter into a contract to sell an asset, CGT liability is triggered immediately on the date of that contract, even if the transaction is completed sometime later.

Some years ago, some lawyers put forward the idea that a shareholders agreement for the shares of a deceased shareholder to be transferred to the survivors would be a contract triggering CGT. If so, CGT would be payable at the time the shareholders agreement was signed.

Those lawyers suggested a solution to avoid this trap. Rather than having such a provision in a shareholders agreement, there should be a separate option agreement whereby the estate of the deceased or the survivors could serve a notice creating a contract to sell the shares after the death of a shareholder. These came to be known as “buy/sell agreements”.

However, the trap was not a trap. A shareholders agreement to transfer shares after the death of a shareholder is not a contract triggering CGT. It is a conditional agreement whereby the contract to transfer the shares only comes into existence if and when a shareholder dies. The ATO has published a ruling confirming this.

Undaunted by this fact, solicitors still prepare buy-sell agreements containing options to be exercised after the death of a shareholder, separate from shareholders agreements. This is completely unnecessary. There is no legal or tax problem in having a provision in a shareholders agreement stating that the shares of a deceased shareholder must be transferred to the survivors.

Life assurance

It is often a good idea for shareholders to take out policies of life assurance on each other. Then, if one of them should die, the survivors receive the insurance payout and use it to purchase the shares of the deceased from the deceased estate.

Conclusion

The death of a shareholder is a difficult and stressful time. To minimise that stress, there should be a shareholders agreement with a mechanism for the survivors to buy the shares of the deceased from their estate. The mechanism, including determining the price should be as clear and simple as possible.

For more information  contact Tim Somerville  or Andrew Somerville on (02) 9923 2321.