Buy-Sell Agreement: An Absolute Necessity

July 7, 2014

Virtually every insurance agency is confronted with the necessity of perpetuation/succession planning. For some agencies, it is a top priority. Other agencies recognize it is an important issue to address, but “…we are too busy right now and will address it at a later date.” In the latter instance, a “little later” can stretch out to several years.

On more than one occasion I have encountered insurance agents who have begun the process of perpetuation/succession planning by obtaining life insurance upon the lives of each other. However, they have yet to complete the process. They have not prepared a definitive buy-sell agreement, which is to be funded by the insurance they have purchased. Whenever I encounter such a situation, I become extremely concerned. What happens if one of the owners dies without the benefit of a valid buy-sell agreement?

The foregoing circumstance was addressed in a case entitled, Selzer v. Dunn, 2014 WL 356992, No. 12-12-00150-CV (Ct. App. Tex. Jan. 31, 2014). In that case, the two stockholders, each owning an equal number of shares, purchased insurance on each other’s lives for the purpose of funding a buyout at the time of death. The insurance was in the sum of $2 million on each person. The business paid the premiums. Both owners retained the services of an attorney to assist in the preparation of a buy-sell agreement; and several draft documents were exchanged. However, none were executed.

Unfortunately, one of the stockholders died. The other stockholder received the $2 million proceeds. The estate of the deceased stockholder demanded the surviving stockholder purchase the interest of the deceased, and apply the insurance proceeds to pay for that interest. The surviving stockholder refused to do so. Needless to say, a lawsuit ensued. Both the trial court and the court of appeals determined the surviving stockholder was not required to purchase the interest of the deceased stockholder and apply the insurance proceeds. There simply was no valid and binding buy-sell in effect between the stockholders. Evidence of this was the fact that various draft agreements had been prepared, none of which had been signed by the parties. The estate of the deceased stockholder did not receive the benefit of the insurance proceeds; and continued to hold the stock. Presumably, the value of that stock, since there was no ready market, would be severely depressed in the circumstances presented.

The foregoing case illustrates the necessity of preparing and executing a binding buy-sell agreement that obligates the owners of a business, to implement the agreed upon plan of perpetuation/succession. Whenever owners use life insurance to fund a business buyout, it is absolutely essential that along with the purchase of the insurance, the parties execute such an agreement. That way, their original intent will not be frustrated.

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For more information about "Buy-Sell Agreement: An Absolute Necessity," contact Timothy D. Fenner at tfenner@axley.com or 608.283.6733.