Understanding Buy-Sell Agreements
Dec. 31, 2022
Buy-sell agreements are an important part of effective business management. But what happens when there are disputes with buy-sell agreements? How can you and your business move forward with confidence?
Martinez Law Office, Inc is here to help. No matter where you live in California, I’m ready to guide you toward positive legal solutions—and resolutions—for you and your business. From my office in Santa Ana, I’m proud to represent clients throughout Southern California including Orange, Los Angeles, and San Diego Counties. Set up a consultation today.
What Is a Buy-Sell Agreement?
A buy-sell agreement refers to a binding contract between business owners. The purpose of a buy-sell agreement is to regulate the relations between owners when one of the parties dies, gets divorced, goes bankrupt, retires, or becomes temporarily or permanently disabled. These agreements settle buyout terms whereby one owner’s interests are transferred to the other in exchange for a specified compensation.
What Are the Types of Buy-Sell Agreements?
There are three main types of buy-sell agreements in California:
Entity-purchase agreement. In this buy-sell agreement type, the business purchases an owner’s interests at an agreed price when a specific event is triggered (i.e., death, disability, or dismissal). Insurance payouts are generally a source of funding for this agreement type. For example, the business purchases life insurance policies for each owner. The business is the beneficiary. When one of the owners dies, the insurance payout is used to purchase their interest in the business. The compensation is paid to the owner’s lawful heirs.
Cross-purchase agreement. In this type of agreement, the remaining owners agree to purchase an owner’s stake when they die or become disabled. The owners generally fund compensation with their own funds.
Wait-and-see agreement. This agreement type is a mix of entity-purchase and cross-purchase buy-sell agreements. The business gets the first crack at purchasing the deceased party’s stake when the triggering event occurs. If the business fails to purchase this stake, one or several of the remaining owners can purchase the outstanding stake.
What Happens When a Buy-Sell Agreement Does Not Exist?
The absence of a buy-sell agreement can lead to complicated circumstances. Let’s take a look at three scenarios.
Death of an owner. When an owner (or multiple ones) dies, their business interests remain uncertain. By law, their lawful heirs inherit their shares in the business. This situation can lead to a complex situation within the organization itself. While the remaining owners can offer to purchase these interests, heirs might try to take advantage of the situation. Moreover, the remaining business partners may have to deal with multiple shareholders. For instance, the deceased partner’s three children inherit their interests. Now, there are three new owners the company must incorporate into its management structure. This situation can lead to disputes among all business owners.
Divorce of an owner. In the case of divorce, a business owner’s former spouse may be awarded half of their business interests. This situation can lead to a new shareholder complicating business management operations. While it is possible to buy out the former spouse, this individual may attempt to take advantage of the situation.
Incapacitation of an owner. Incapacitation is a complicated scenario. Heirs cannot legally take possession of the owner’s interests. While the other business partners may offer to buy out the incapacitated party’s interests, the family may resist. Consequently, this may lead to an uncomfortable tug-of-war between all interested parties.
What Are Typical Disputes in Buy-Sell Agreement?
Three main disputes may arise in a buy-sell agreement:
The owner or family does not want to sell their interests. For instance, a deceased owner’s family does not want to sell their shares. Instead, they wish to keep their shares in the company.
The owner or family does not agree on the buyout price. For example, the family disputes the agreed share price in the agreement. They ask for a higher price claiming the business has a higher market valuation.
The owner or family plan to sell their interests to a third party. This situation is a violation of the buy-sell agreement. Nevertheless, family members may claim fiduciary responsibility with the deceased party’s estate.
These disputes may lead to commercial litigation. That is why enlisting the support of a professional commercial attorney is always recommended. A lawyer can help you understand your situation, evaluate your options, and find a path forward that protects your business interests.
Getting the Right Legal Counsel in Santa Ana, California
At Martinez Law Office, Inc, my team and I are standing by to help corporations and business owners protect their interests. I understand how valuable your hard work is. That’s why my goal is to help you protect your business with the right buy-sell agreements in place. Call my office today to set up a one-on-one consultation with a professional commercial attorney.