Life insurance clauses
The legal structuring of a buy-sell agreement is vital to ensure that all objectives of survivors and the estate are met. The agreement should provide clear guidelines with respect to the life insurance used to fund such an arrangement. The alternative types of life insurance funding for buy-sell agreements are:
- Cross-purchase, individually-owned insurance
- Cross-purchase, split-dollar ownership as between shareholder and company
- Cross-purchase, corporate-owned insurance
- Corporate repurchase, corporate-owned insurance
- Combination of (c) and (d)
- Bequest to spouse, sale of survivor(s)
The following provides a checklist of life insurance clauses shareholders should consider when establishing a buy-sell agreement.
- On termination of the agreement by reason other than death, the policy of insurance on the life of the withdrawing shareholder and the policy which the withdrawing shareholder holds on the other lives should be assigned to the persons whose lives are insured or, alternatively, be permitted to lapse.
- On the death of a shareholder, the estate of the deceased should assign the life insurance policies, if any, held on the lives of the survivors to the persons insured. Provision can be made for distribution of excess funds where the proceeds exceed the value of the interest purchased.
- Insurance policies could be listed on a schedule to the agreement with provision to add additional insurance funding.
- The shareholders should be restricted from dealing with the insurance policies during the term of the agreement.
- The shareholders' agreement may provide that the purchase price for the shares shall be the fair market value or the greater of an amount equal to the insurance proceeds and the fair market value of the shares otherwise determined pursuant to the agreement (insurance proceeds would be excluded in the fair market valuation). The agreement may provide that the minimum price will be equal to the insurance proceeds if it is desired that all insurance proceeds be paid to the estate. This may result in an increased tax liability to the estate, but the estate would receive funds to pay the tax. Alternatively, the operating company or the survivors may retain any excess insurance.
- The timing of the purchase on death could be the earlier of the date of receipt of the insurance proceeds, and say, 153 to 364 days after death. This clause would ensure that the sale takes place within one year of death. It will also ensure that the purchasers are in receipt of the insurance proceeds, if applicable. If the insurance proceeds are insufficient to discharge the purchase price, any excess may be payable over a period of, say, one to two years with interest payable on the balance outstanding.
- The shareholders would agree to exercise their influence and to vote their shares as to ensure that the corporation would declare the maximum capital dividend on the death of a shareholder. Depending on the terms of the buy-sell agreement, the dividend may be payable to the estate or to the survivors.
- The agreement may provide that a shareholder shall be presumed to be dead if he or she disappears for a period of, say, six months. The agreement may provide for a payment over the time should the insurance proceeds not be payable (e.g. suicide). Alternatively, the timing of purchase on death indicated in (6.) may apply.
- The agreement may contain special provisions for the death of more than one shareholder. This would be important if the insurance coverage was not adequate to finance the buy-out of more than one shareholder at the same time.
- In the event that the Canada Revenue Agency assesses the estate on the basis that the fair market value of the shares on the actual sale (e.g. on a deferred sale) was an amount in excess of the amount to be received pursuant to the buy-sell agreement, then the estate will be potentially subject to an increased tax liability. That agreement may provide that such excess tax liability shall be borne by the other shareholders, that the purchase price will be increased to an amount equal to the value finally determined, or alternatively, that such additional tax liability shall be borne by the estate.