Cross Option Agreements – Protecting You and Your Business

It may not be a comfortable thought, but at some point a business may be confronted by the critical illness or death of one of its founders. Have you considered what might happen to your company if you were to die or became critically ill? Or indeed, if one of your fellow shareholding directors were to die, or have an accident or illness, making him or her incapable of returning to work?

One way of protecting your business in the event of a shareholding director’s death or critical illness is for the shareholders to enter into cross option agreements supported by life insurance policies.

A cross option agreement gives surviving shareholders the right (but not the obligation) to require the deceased shareholder’s personal representatives to sell the shares to them (known as a “Call Option”). It also gives the personal representatives the right (but not the obligation) to require the surviving shareholders to buy the deceased shareholder’s shares (know as a “Put Option”). By combining a Call Option with a Put Option in a single agreement each side has the option of ‘forcing’ a sale of the shares.

Cross option agreements should also oblige each party to insure their lives under a life insurance policy for a value which reflects the value of their shares. The proceeds of the policy should be held on a trust for the other shareholders who will be the beneficiaries. These proceeds provide the remaining shareholders with the cash to buy the shares of the deceased shareholder.

The cross option agreement should provide a mechanism for determining the price payable for the shares on the exercise of the option. By providing the price and terms of payment in advance a significant area of dispute is minimised.

The structure of the cross option is vitally important for taxation planning purposes.  Important tax reliefs for both inheritance tax and capital gains tax can be lost if the documentation is not properly structured.

The arrangements described above create an instant market for the shares left by a deceased shareholding director and the linked life insurance policies held on trust for the remaining shareholders provide the funds to complete the purchase. The business of the company is left in the hands of those who are committed to the long-term success of the company whilst loved ones receive the value of the shares in cash assisting them to rebuild and move on with their lives.