The death of a shareholder and director can give rise to a host of adverse consequences for a business.
When so much time is taken up by building and running a successful business, dealing with estate planning for business owners and entrepreneurs is bound to be a low priority. However, taking the time to plan for unexpected illness or unexpected death is vital to avoid the potentially devastating consequences for the loved ones of the business owner, other shareholders, investors, employees and for the business itself.
What happens when a shareholder dies?
When determining what happens to the shares of a deceased shareholder, the starting point is to check the most recent shareholders agreement and articles of association. If there are no specific provisions relating to the death of a shareholder, the shares will pass in accordance with the deceased's Will or, if there is no Will, under the intestacy rules.
The risk with not including any specific provisions in the shareholder's agreement (or not having one at all) is that family members with no real knowledge of the business or how it operates may be required to make business decisions, sometimes with potentially huge consequences, at an already incredibly difficult time. The beneficiaries' interests may not, necessarily, align with those of the other shareholders, or they may not have any desire to be involved with the business. This can cause tension between relatives, as well as tension between the family and the shareholders and the company.
A big potential problem could arise if the new shareholders do not understand their responsibilities or, sometimes more disruptively, do not engage with the company. This could mean no decisions in relation to the business can be made because the required percentage for board or shareholder decisions cannot be reached without their involvement.
If the deceased is the sole shareholder, further issues can arise and are set out in more detail below.
What happens when a director dies?
If the company has more than one director, the company can still run as usual. Practically speaking, the remaining directors will divide the deceased shareholder's responsibilities between them. However, it is worth bearing in mind that the death of a director may leave difficulties in reaching a quorum for meetings, depending on what the company's constitution states.
If the deceased is the company's sole director, but there are other shareholders, the surviving shareholders can hold a meeting to appoint a new company director.
What if it is the sole shareholder and director?
In the event that the deceased was the sole director and sole shareholder of the company, the options to transfer the shares from the deceased's estate will, ultimately, depend on what the articles of association of the company state.
For companies incorporated before the implementation of the Companies Act 2006 (and assuming that no bespoke articles of association have been adopted), the personal representatives of the deceased have the duty to request a court order to appoint a new director, which is likely to be time-consuming and expensive. This is because "Table A" Articles (the standard set of articles before the new legislation came into force in 2008) do not give the personal representatives the right to appoint a new director who, in turn, can deal with necessary formalities within the company in order to register the personal representatives as the owners of the shares.
The delay caused by the need to apply to the court can cause huge problems for the business in the interim. While there is no director appointed, assets in the name of the company cannot be accessed, contracts cannot be signed and decisions cannot be made. This could mean that suppliers and employees cannot be paid for some time, as there are no directors to authorise any payments. Clearly, this could have a significant impact on business.
Where a company has been incorporated after the implementation of the Companies Act 2006 (and Model Articles, the current set of standard articles, have been adopted) the personal representatives can appoint a new director without the need to seek a court order. If bespoke articles have been adopted, it will depend on what those articles say.
As set out above, the eventual ownership of the shares will depend on what (if anything) is written in any shareholders agreement or bespoke articles of association.
What are the solutions?
The issues detailed above can, either on incorporation or afterwards, be mitigated by a regular review of the articles of association and shareholders' agreements, incorporating specific provisions dealing with the death of a shareholder. However, this becomes more important where a company is currently relying on "Table A" articles under the Companies Act 1985, or where a company has a sole director and sole shareholder.
There are many different possible solutions, with the most suitable depending on the circumstances of each company. It could be as simple as including the right for the personal representatives to appoint a director on the death of a sole director, or including rights to allow surviving shareholders the first opportunity to buy the deceased's shares..
At the same time as reviewing the shareholders' agreement and the articles of association, it is vital to review your Will and Lasting Powers of Attorney.
What about cross option agreements?
This is a mechanism which can be put in place in addition to any amendments which might be required to the articles of association. It works like this:
- Shareholders grant each other options which will only come into effect when one of them dies;
- Each shareholder agrees that upon their death their fellow shareholders have the option to buy their shares at market value;
- In addition, the shareholders agree that their personal representatives have the option on their death to sell the deceased's shares to the surviving shareholders.
At the same time as the cross option agreement is put in place, each shareholder would take out a term assurance life policy under which any amount which becomes payable under the policy is held in trust by the surviving shareholders to pay for the deceased's shares.
This would mean a shareholder can ensure that the value of their shareholding will be received by their family, without the need to leave the shares themselves to relatives who may not actually want them.
It is vital when considering a cross option agreement that the provisions of your Will are considered at the same time to ensure that the shares will still qualify for Business Property Relief ("BPR") for Inheritance Tax purposes. It goes without saying that the value of BPR on the death of a shareholder may constitute a significant tax saving for the estate and careful drafting is essential.
When dealing with a review of your current arrangements, our teams will work together to ensure there is a joined up approach in dealing with your Will and corporate governance documents. If you would like to arrange a review, please do just get in touch.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.