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Through the legal maze

We have reached the latter stages in the recommendation and implementation of a share-purchase arrangement within a limited company using a fairly typical example – Owl Sewerage Services Ltd.

The final major remaining piece of the jigsaw is to establish and help to implement an appropriate form of legal agreement so that there is a clear and written basis as to what has been agreed between all the parties – and also to maximise tax efficiency.

As I mentioned in my previous article, it is my experience that a number of training programmes (including all of those I was subjected to throughout my induction into this profession) either completely overlook or ignore this aspect of a share-purchase arrangement or, at best, mention in passing that the clients should seek legal advice.

After all, I was told, we are there to sell the insurance policies, not to value the company shares or establish a legal agreement – the client should go to their accountant and solicitor for those tasks.

This attitude is not acceptable. The financial adviser is by far the most appropriate focal point to bring together all the professional services required to ensure that the share-purchase arrangement is established as efficiently and effectively as possible. Without such a focal point, it is highly likely that one or more crucial aspects of the arrangement will be overlooked or inappropriately completed.

But why, in any case, do advisers not welcome this opportunity to make themselves indispensable to all parties? By working closely with the company&#39s accountant (valuation of shareholdings) and solicitor (drafting of legal agreement) the adviser establishes much enhanced credibility with these other professionals which, at least in time, could quite conceivably lead to introductions to give financial planning advice to other clients. This opportunity – with all parties benefiting – strikes me as obvious and valuable.

Rather than leave the content of the agreement entirely to the discretion of the company&#39s solicitor, a little guidance from the financial adviser will almost certainly be welcomed.

The first instance should be whether the agreement should be a buy/sell or a double-option agreement. Most readers will know the difference between these two agreements but a short recap might be helpful.

Under a buy/sell agreement, on the death of one of the shareholders party to the agreement, he is obliged to sell his shares to the survivors who are obliged to buy. No one can back out of the deal, following this death, even if both parties did not want to proceed.

The advantage of this form of agreement is that of certainty – the transfer of shares will proceed. The main disadvantage, besides the obvious lack of flexibility if one or both of the parties do not want to proceed, is the likely loss of certain tax reliefs which apply to the inheritance and transfer of shares in these circumstances.

The Inland Revenue has long ago deemed these inheritances to be cash rather than shares as the beneficiary has no choice but to liquidate the inheritance immediately.

Accordingly, the majority of share-purchase agreements now use doubleoption agreements which allow either the surviving shareholders or the beneficiary of the deceased&#39s shares to insist on a sale of the shares. But if both parties agree, such a transfer need not proceed.

Thus, the Inland Revenue agrees, the beneficiary truly does inherit shares, not cash, and valuable tax reliefs are retained. Moreover, all surviving parties have the potential for greater flexibility, for example if they deem it mutually beneficial for the beneficiary to sell some of the shareholding, retaining the balance.

In these circumstances, the original agreement may be ignored and a new “deal” agreed.

However, the flexibility of these double-option agreements should not mask the importance of the inclusion of very important terms and conditions. In particular, without going too much into legal detail (which, of course, should be left to the solicitor) the following aspects – all of which we have discussed in some depth during this series of articles – should be covered:

•Which shareholdings are to be transferred on death? In our example company, there is agreement that two of the shareholdings will pass to, and remain with, their nominated beneficiaries.

•To whom are the shares to be sold on a shareholder&#39s death, and in what proportions?

•What price is to be paid for each individual shareholding? Note that this might not be pro rata to the number of shares – majority and minority shareholdings and all that – hence the need for the involvement of the company&#39s accountant.

•How is the purchase of the shares likely to be funded? Here, primarily, we will be looking at the commitment to effect and maintain premiums for life insurance policies, with provisions noted on how these premium payments will be met.

•What legal agreement is to be made regarding all these arrangements (as discussed above).

I am aware of sample agreements being issued by some insurance companies which may be, at least in part, applicable to some share-purchase arrangements but I am not aware of any which are obviously and easily adaptable to all these crucial points.

I am also well aware that not every solicitor will be up to this task. Every solicitor has his or her specialisation, or is a “general practitioner” and I think the task of drawing up a share-purchase agreement is a very specialist task even for lawyers.

It is as safe to assume they can all do this job properly as much as it is safe to assume that every financial adviser with G60 can draft a good set of occ-upational pension scheme rules.

No one is suggesting financial advisers should try to become legal experts in these matters. Rather, we should recognise and understand the principles of the roles which accountants and solicitors should be ready, willing and able to undertake to ensure these arrangements are completed in the best interests of everyone concerned.

As a footnote, before I summarise in my next article all of the main issues we have looked at so far in this series, as well as identify and discuss the crucial ongoing commitment from the financial adviser to the client, I regret to report that I have recently been assisting a client who was widowed in her early 40s. Her husband was a director and significant (but not major) shareholder in a successful local company. The rest of the footnote you can guess – surviving shareholders unhappy with a significant “sleeping” shareholder and therefore remunerate themselves by salary and pension contributions rather than dividends. Nobody wins.

I was not (and now do not want to be) the financial adviser, but the accountant and solicitor are long-standing company appointees, yet no one ever even broached the subject of share purchase arrangements with the company or its shareholders.

To my mind, this is a little bit like paying big fees for an accountant who only gives you tax advice when you approach him with an idea.

Book-keepers come cheap – if accountants only want to provide the level of service of book-keepers they should only charge book-keepers&#39 fees. A fairly close (and reasonable?) analogy to what Sandler has said about financial advisers, is it not?

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