What is a Buy-Sell Agreement?

Buy-sell agreements, also known as business continuation agreements or buyout agreements, are vitally important for anyone who owns all or part of family business or a closely-held business. These agreements are put in place to act as a binding contingency plans if certain events occur. Buy-sell agreements outline what will occur if an enumerated "triggering event" happens to an owner, and provide for the "buying out" of the departing owner's interest. Such triggering events may include divorce, bankruptcy, retirement, disability, and/or death of the owner, among others.

Where appropriate, the agreement should set out how the triggering event is to be determined. For example, if a disability contingency is included, the parties to the agreement must provide how and by whom a determination of disability will be made. If a retirement contingency is included, the agreement should specify under what conditions and time the owner is permitted to retire and potentially at which point the departing owner's interest will be bought out.

The parties to the agreement will specify what will happen to the owner's interest once he can no longer continue in his ownership role, and how the owner (or his estate, if the owner has passed away) will be compensated for the owner's previous role in the business. The chief aims of the buy-sell agreement are to ensure the smooth transition of ownership.

The goal is to have the departing owner's interest in the business remain with parties already involved in the business and not, for example, to the owner's survivors or other third party. Other goals of the agreement include setting the fair compensation for the departing owner, and the prior arrangement of a source of funding for the buyout so as not to disrupt the liquidity of the business. If a business's liquidity is impacted, it could result in the business failing.

The parties involved in drafting a buy-sell agreement must answer the following questions with respect to a departing owner's interest:

  • Who is responsible for purchasing the interest? (Another owner? One or more shareholders? A third party? The company itself?)
  • Can there be a sale of the interest to a third party? What are the other owners' rights in accepting or refusing such an offer?

Related questions concern the valuation of the departing owner's interest and the means through which the buyout will be financed and conducted are also sources of contention. Where the owner's interest is valued at a fixed sum, but even if a formula for calculation is employed, the method of valuation in the agreement should be evaluated frequently. And, any method of valuation should be modified to reflect the prevailing market conditions and the needs and goals of the business.

Once the parties settle on a means of valuation, they will also need to determine how the buyout will be funded. For the disability and death contingencies, the owners, individually or in the entity's name, can take out insurance on their business partners. Insurance will yield proceeds based on these triggering events to be put towards the buyout. For the other types of contingencies that are not amenable to an insurance arrangement the funding can be trickier and require a balancing of buying out the owner's interest and retaining liquidity. One of the problematic contingencies is when an owner of the business individually declares bankruptcy. The agreement may provide that the other owners can require the bankrupt individual to sell his shares in the company to the entity itself or to the other owners. The valuation in that case would be determined on a previous valuation of the co-owner's interest.

The importance of buy-sell agreements for any closely held company should not be understated. An estate planning attorney's expertise in the areas of tax and business law should be employed in drafting such an agreement to ensure that in the case of one of the triggering events described above, the company will be amply protected and the departing owner's interest adequately provided for.

Basics of Estate Planning: What are the Basic Differences Between a Personal Representative and a Trustee?

One of the more frequent questions I receive from clients is related to trying to understand the difference between the role of the personal representative and the role of a trustee. While we see there a major contrasts between the two, the basic difference revolves around what assets are under control of the personal representative and the trustee.

A personal representative ("PR") is charged with administering the probate estate of the person who has died, i.e. the decedent. Typically the PR is a person but the PR can also be an entity, such as a bank (here, referred to as a person for simplicity). You can read more about personal representatives by clicking here.

Many people use the term executor in place of the PR but that technically in only half the story. To be legally accurate, the PR is really called an executor (male)/executrix (female) or an administrator(male)/administratrix (female). The distinction depends on whether or not the decedent left a last will and testament. If the decedent left a will and named a person to administer his estate, this person is called an executor and is tasked with carrying out the provisions in the decedent's will. On the other hand, if the decedent has died intestate (without a will), the probate court will appoint someone to be the estate's personal representative. In this case, the representative is known as an "administrator." To make it easier for nonlawyers, the industry has been moving to the more general form of "personal representative" and eliminating the testate/intestate and gender differences.

Broadly speaking, the personal representative's job is to collect the decedent's assets, pay off any liabilities the decedent may still have (including any applicable taxes), and distribute the decedent's property according to the directions in his will or, if there is no will, according to the state's intestate provisions. The personal representative carries out these duties under the supervision of the probate court, at which time he is discharged from his obligations. Certain events may terminate a representative's role before this time, including death, resignation, or dismissal of the representative for misconduct. (The latter could have other legal repercussions, to be discussed in a later post.) If this were to happen, an alternate representative would be appointed. However, once all of the probate assets are distributed and the estate is closed, the personal representative's duties are completed and the personal representative's role is over.

That cannot be said of a trustee. And many times, especially in the case of a will with a testamentary trust, a trustee's duties are just starting.

A trustee, like a personal representative, is a fiduciary - meaning that he has the authority to act on the trust-maker's behalf and the duty to do so in his best interest. (In some cases, as discussed below, the trustee may even be the trust-maker himself.) Like a PR, a trustee can be either a person or a company. A company that acts as trustee is formally called a corporate trustee.

However, in contrast to a personal representative, a trustee is specifically tasked with managing the assets in a trust for the benefit of its beneficiaries. This management may take various forms, and the trustee's role in each is dictated by the circumstances under which the trust is set up. For example, a person who creates a revocable living trust may be the sole beneficiary of the trust and also act as its trustee. Click here and here for more on trusts.

In contrast, there are situations where the trust-maker is neither the beneficiary nor acts as the trustee - for example, in a testamentary trust, which is included in a person's will to be funded after his death. In this case, the trust-maker might designate the same person or entity to act as both the trustee of the testamentary trust and as the personal representative of his estate, or he may choose wholly different people or entities to serve in each role. This example demonstrates the breadth of choices available to the trust-maker in choosing a trustee according to the circumstances of his trust and his own management capabilities.

The trustee would manage the trust pursuant to the terms of the trust document until either the assets in the trust are expended or the trust term is reached. At that point, the trustee's duties are completed.

One other major difference is that a trustee or personal representative can have different time periods covering their roles. A personal representative's role generally lasts at most a couple of years. In fact, D.C. states a PR's duties only last until the end of three years from the date appointing the person the PR. A trustee's duties can last much longer. For example, a trust established by the death of a Michigan man back in 1919 recently distributed all the trust assets out in 2011. In this example, the trust-maker stated the trust assets would only be distributed upon the death of his last living grandchild. Clearly, a corporate trustee was used here.

Thus, while both a trustee and a personal representative manage a person's assets in a fiduciary capacity, a trustee's obligations are specific to a trust, created either during the trust-maker's life or at his death, while a personal representative is charged with the broader administration of a decedent's estate.

Estate of the Month: Extra! Extra! Estate Battle Royale on Page 6!

Many people like to sarcastically claim that the down fall of Western Civilization occurred with the recent rise of TV celebrity gossip shows; where entities like TMZ, Perez Hilton, "The Insider" and "Access Hollywood" and others battle for the current title of King of the Celebrity trash heap. But, celebrity gossip is not new. One of the founding members of celebrity gossip was Claudia Cohen. She became famous in her own right as a gossip columnist for the New York Post's "Page Six," and was a well-known socialite and TV personality as well. She regularly had a segment on Live with Regis and Kathy Lee and the rest of that show's progeny.

Claudia was the daughter of the founder of Hudson News, Robert Cohen. She married billionaire Ronald Perelman in 1985. They had a daughter Samantha in 1990. Cohen and Perelman divorced in 1994. Samantha, now 23 years old, is at the epicenter of a legal battle between her father and her mother's side of the family after the death of Claudia Cohen in 2007 from ovarian cancer.

At the heart of the many legal disputes that ensued after Claudia Cohen's death are allegations of undue influence, by Ronald Perelman against Claudia's only living sibling, her brother, James. Recall from August's Newsletter on incapacity that a finding of undue influence can void a binding agreement, such as a will. To further complicate the matter and enlarging the estate "pie", Robert Cohen passed away in 2012 from a rare brain disorder called progressive supranuclear palsy. Contentious litigation has only ratcheted up since.

Perelman is the executor of Claudia's estate. I will state that appointing an ex-spouse as the executor of an estate is not normal. His appointment has also engendered some discontent. Claudia had originally designated a friend, Sharon Hess, to play that role. The executor provision in Claudia's will changed in a private meeting between Perelman, Claudia and a lawyer serving both of them. The meeting took place while Claudia was in the hospital being treated for cancer. Yes, the irony is not lost on me about who is charging who with "undue influence" in this legal battle. To me there also appears to be a conflict of interest on the part of the attorney acting on behave of a divorced couple with regard to their differing estate planning goals. The attorney's representation would appear to violate Rule 1.7 of the Rules of Professional Conflict: Current Clients. But, maybe there is more to the story than is being distributed.

In his capacity as executor, Perelman is claiming that James Cohen unduly influenced his father, Robert, in various ways after Claudia passed away. Perelman essentially argues that James tried to cheat his sister's estate out of money that was rightfully Claudia's estate. His assertions include everything from oral promises of Robert that he would leave half of his assets to Claudia to business deals from which he claims Claudia's estate never received her rightful share.

While Perelman's prior lawsuits alleging such misconduct by James Cohen have failed spectacularly. In one instance, Perelman's lawyers were ordered to pay $1.9 million for filing what one judge determined a "frivolous claim." The dismissals of these suits occurred while Robert Cohen was still deemed to have testamentary capacity. This determination of capacity meant that Robert was free to continue to change his will, with no presumption that any of his potential beneficiaries were unduly influencing him to leave them more than their share. Now that Robert Cohen has passed away, Perelman seems to have renewed his desire to continue a legal war that has raged since Claudia's death.

This is where Samantha Perelman comes in. More money from her grandfather (Robert Cohen) to her mother Claudia's estate would eventually result in a much larger inheritance for Samantha. However, reading between the lines, Samantha's father seems to be the clear driving force between the litigation. It should not go unmentioned that Perelman has been involved in a number of litigations. He has spent his fair share of time in the courtroom. He has sued two former executives in his company, in addition to all four of his ex-wives. I guess you don't become the 26th richest American by not suing a couple of people.

Samantha has been quoted as saying that the object of the lawsuits - which have been estimated to cost around $60 million in legal fees combined for all involved - is to preserve her mother's legacy and carry out her wishes. However, what Claudia really seems to have wanted, as evidenced by the words in her will saying so, was family unity. It seems that that goal was left by the wayside years ago. It remains to be seen whether Samantha's lawsuits, funded by her father, will do more financial harm than they have good, as relations between the two sides of Samantha's family seem beyond repair.

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