It is critical that shareholders consider what will happen to an outgoing shareholder’s shares in the following situations (usually referred to as an Event of Share Buy-Back).
Is the Outgoing Shareholder an Individual or Company?
If the Outgoing Shareholder is an individual:
- The Outgoing Shareholder dies or becomes mentally incapable, or their estate becomes liable to deal with the shares under mental health laws; or
- A sequestration order is made against the Outgoing Shareholder’s estate or against the Outgoing Shareholder under the Bankruptcy Act 1966 (Cth), or the Outgoing Shareholder is declared bankrupt.
If the Outgoing Shareholder is a company:
- an order is made or a resolution passed for the Outgoing Shareholder to be deregistered or wound up; or
- a receiver, and/or manager or an administrator is appointed to all or substantially all of the property of the Outgoing Shareholder.
Usually, the Remaining Shareholders will not want the Outgoing Shareholder’s shares to pass to its estate or creditors as they could find themselves running a company with someone they do not know or see eye to eye with, or someone who has no experience with this particular type of business. Equally, the Outgoing Shareholder’s estate or creditors may not want the address stress of involvement in a company it knows nothing about, particularly after having just lost a loved one.
What are the Solutions?
There are two options.
The first is for all of the shareholders to agree that if an Event of Buy Back, the Outgoing Shareholder offers his of her shares for sale to the Remaining Shareholders and the company. Usually, the shares are purchased at an agreed purchase price between the parties, or a purchase price determined to be fair market value by an independent valuer. The Shareholders Agreement should document this.
The second is for the shareholders to enter into a Buy-Sell Option Agreement. This agreement obliges each of the shareholders to maintain insurance, commonly in respect of death or permanent total disability. If a particular insurable trigger event occurs, then the Remaining Shareholders can oblige the Outgoing Shareholder to sell its shares back, or the Remaining Shareholders to purchase its shares.
The purchase price is ordinarily fair market value less any insurance proceeds which the Outgoing Shareholder has received (or should have received if it had had the proper insurance in place).
These two options provide the Remaining Shareholders with the opportunity to continue running their company without the involvement of random external parties. It also means the shareholder’s estate does not need to worry about becoming involved in an unfamiliar business.
It is sensible to consider what will happen to an Outgoing Shareholder’s shares if a situation arises which results in the Outgoing Shareholder no longer being the shares’ owner. You do not want inexperienced hands dealing with the shares, or someone with no business experience, or who disagrees with your business strategy. It is then necessary to pre-empt this and put agreements in place dealing with what will happen to an Outgoing Shareholder’s shares. These agreements should be put in place as early as possible.
If you would like more information on Events of Buy Back or Buy-Sell Option Agreements, or you require a review or drafting or a Shareholders Agreement or Buy-Sell Option Agreement, please do not hesitate to contact LegalVision today. One of our specialist business lawyers would be delighted to assist you!