News

January 31, 2017

It is well known that Australian companies are legally bound to adopt and defer to a constitution when determining the way in which an entity will operate.

However, a constitution does not usually provide a comprehensive set of rules governing how shares are bought and sold between company shareholders or third parties, nor how such parties deal with each other.

A ‘Buy Sell Agreement’ can be drawn up to specify those arrangements in detail.

What is a Buy Sell Agreement?

A Buy Sell Agreement is a contractual arrangement entered into by members of a jointly owned business, which sets out how a departing principal’s interest will be reabsorbed by the surviving owners or company, subject to the occurrence of certain events.

Such events may include:

• Death

• Trauma or long-term disability

• Divorce of a partner

• Bankruptcy of a partner

• Retirement at compulsory age or sooner

• Dismissal from the partnership

Generally, the agreement is written in such a way that it does not matter which business structure the partners have chosen to own the business i.e. partnership, company, family trust.

Types of Buy Sell Agreements

There are two types of Buy Sell Agreements and while there are some differences in the way they are handled, their purpose is the same — namely to ensure that equity in the business remains closely held.

A secondary effort of a Buy Sell Agreement is to reduce the likelihood of members having to remain ‘in partnership’ with unwanted ‘partners’.

1. Cross-Purchase Agreement

Under this agreement, the surviving principles are to be the purchasers and are given the option, or are obliged, to purchase the outstanding interest of the departing principle.

2. Corporate Entity Redemption Agreement

This arrangement allows the entity to purchase back the interest of a departing principle. The principle, or their estate, would receive cash from the company for the sale and cancellation of the shares.

Funding Options

A Buy Sell Agreement is usually linked to insurance funding arrangements on each partner’s life.

The insurance policy, once paid, will provide the surviving partners with the funds necessary to buy out the deceased, disabled and or departing partner’s interest without suffering financial hardship.

Advantages of a Buy Sell Agreement

Should a principal suffer a triggering event — in this case, death — the executor of their Will could exercise the option of forcing a sale of shares to the surviving principles.

However, a Buy and Sell Agreement can take precedence over the provisions of a principal’s Will, ensuring the validation or price mechanism operates on a fair and reasonable basis pursuant to the contract.

This provides certainty for the personal estate plans of each of the principles in partnership, and for the business as a whole.

Reinforcing the Future of Your Business

As the potential impacts and flow-on effects created by the unexpected exit of a principal are generally negative, the need to safeguard one’s business through a Buy and Sell Agreement becomes all the more important.

Contact David Lewis, Partner at LBH on dlewis@lbandh.com.au if you would like more information or need a Buy Sell Agreement drafted for your jointly owned business.