So, you are a part of a limited company SME with a team of director/shareholders, and you have all invested a lot of time and energy into ensuring you have a great working relationship, and your business is thriving.
However, if one of the team dies, what happens to their shares? How can you all ensure you do not find the company has an unexpected (and possibly unwelcome!) new shareholder? Solicitor Justine Harris Hughes from WHN’s corporate and commercial team outlines the process and options in this scenario.
The first stage is to understand what would currently happen to one of the team’s shares in this situation – and then, if this doesn’t align with what the team wants to happen, to then understand how to put in place a regime that works for everyone and then implement the new approach.
Understanding the current position for directors/shareholders
All limited companies must have ‘articles of association’ – the ‘rulebook’ which the company’s officers (directors and company secretary if there is one) must follow when running the company. Many companies are incorporated using the standard default articles of association set out in the applicable legislation at the time of incorporation – which for companies incorporated on or after April 28, 2013 will be the ‘Model Articles’ prescribed by the Companies Act 2006 (CA 2006).
Under CA 2006 shares are transferable in accordance with the company’s articles of association (Articles) and therefore as a general principal, title to shares can be transferred freely unless the Articles expressly say otherwise.
In the event of a shareholder’s death, the shares will form part of their estate to be dealt with by the shareholder’s personal representatives. What can be done with the shares by the personal representatives (PRs) will then be governed by the Articles.
If your company only has Model Articles, and no other documentation governing share transfers, then once the PRs have provided the company with evidence of their right to deal with the shares, then (subject to the directors right to refuse to register a transfer, which must be exercised in good faith in a manner that promotes the success of the company as a whole) they have the right to either transfer the shares to the person entitled to inherit them, or apply to be registered themselves as the shareholder (if they themselves are to inherit them).
Clearly, this raises a very real possibility of your company having a new shareholder with no knowledge or experience of the business – and potentially someone totally unknown to the remaining director/shareholders – at what will undoubtedly be a challenging time for the company.
Advance planning is therefore key to ensuring that the outcome in such situations is one that the director/shareholder team would be happy with, whoever may pass away.
The current position doesn’t work for our company – what can we do?
There are several options to consider when planning for how the transfer of shares should be dealt with on death, and various methods of implementing such processes and procedures. For example, you may wish to provide for:
- Rights of pre-emption for the remaining shareholders – that is, giving the remaining shareholders the ‘right of first refusal’ to purchase the shares themselves, including a mechanism to determine the price at which the shares will be sold.
- The identification of specified individuals to whom the shares can be transferred – for example, to specified family members such as spouses or children of the relevant shareholder or named individuals (to be kept under review).
Corresponding rights for the remaining shareholders to purchase the shares, and for the PR and specified family members of the deceased shareholder to require the remaining shareholders to purchase such shares. However, such an obligation on the remaining shareholders to buy the shares should only be considered if there will be a specific pot of funds available to these shareholders to buy the shares, without having to raise the funds themselves – for example by way of life insurance policy in support of a cross-option agreement (see below).
When choosing a method to implement the agreed restrictions, the options to consider include the following:
- Amending the Articles – as noted above, under CA 2006 shares are transferable in accordance with the company’s Articles, and therefore this is the first consideration for introducing restrictions on transfer. A key benefit of using this approach is that the Articles form the basis of a statutory contract between the shareholders, and between each shareholder and the company – and new shareholders are automatically bound by them.
- Shareholders agreement – unlike the Articles (which are publicly available) this is a private contract between the shareholders and each other (and often the company itself). While they generally govern many aspects of a company’s management unrelated to share transfers, they can be used to address such issues, in particular where the shareholders wish to keep such arrangements private. One disadvantage is that such an agreement only binds the parties to it, and therefore it is important to ensure that any new shareholders ‘sign-up’ to the agreement, via a ‘deed of adherence’, immediately on becoming a shareholder.
- Cross-option agreement – as with a shareholders’ agreement this is a private contract between the shareholders, but in this case designed only to address the issue of share transfer on death. They generally operate by each shareholder granting ‘put and call’ options over the shares, exercisable on the death of a shareholder – a ‘call option’ to the remaining shareholders to have the right to buy the shares, and a ‘put option’ to their PR and specified family members to require the remaining shareholders to buy such shares (to the extent they have not been purchased under the call option).
In addition, in order to ensure that funds are available to the remaining shareholders to make any such share purchase, such agreements also include obligations for life insurance policies to be taken out by each shareholder, written in trust for the others. It is therefore important to keep these policies under review.
As with a shareholders’ agreement, this type of agreement has the benefit of privacy – and the additional benefit of addressing the question of funding. It does, however, also have the disadvantage of not binding new shareholders.
Each of these approaches has its advantages and disadvantages. It may, therefore, be beneficial to take a combined approach – with amended articles in conjunction with entering a shareholders’ and/or cross option agreement. Seeking professional legal advice and having a plan in place in advance is highly recommended.
Based at WHN’s Bury office, Justine specialises in corporate matters including company incorporation, constitution and structure, share sales and buybacks, and corporate property work.
If you are the director/shareholder of a limited company SME and would like to discuss suitable options to address the death of a shareholder, please contact Justine on 0161 761 4611 or by email at firstname.lastname@example.org