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Thursday, November 22, 2012

Business owner dies leaving a mess that could have been prevented

I recently received this letter from a reader talking about the fact that one of his business partners has passed away. This letter was so frustrating for me to read, because the lack of planning by the deceased and the partners is so obvious (and if it's frustrating for me, I'm sure that's nothing compared to how the people involved must feel). There are several issues arising from the situation and everyone involved is bogged down in them. An hour or two with an estate planning lawyer could have averted the mess. Anyone who is operating a small business, please read this post!

Here is the reader's note:

I'm one of three partners in a small business. One of the partners passed away and has willed his shares to his two children. However the company has made only a couple of thousand dollars and has over $70,000 in debt. The partner’s executor claims there is nothing in the estate and therefore his share of the company debt can't be paid. Our shareholders' agreement states that myself and my other partner have to purchase the shares back to either our selves personally and if we chose not to do this then the company has to buy them back. The thing is the company has not been successful so paying anything to buy them back of a worthless company seems odd when we will be responsible paying the deceased partner's debt.
The first issue is the deceased's will, which gives his shares to his children. His shareholders' agreement states that the shares must be purchased back by the company. Normally this would be resolved by the shares passing to the children (assuming they are of legal age) and then being purchased by the partners or by the company, as opposed to the shares being purchased from the estate. It's adding an extra step but it works for everyone.
If the children are not of legal age, there is the added problem that they cannot inherit the shares until they are adults. Normally an inheritance would be held in trust until that time. A properly drafted will that took the shares of the company into consideration would have dealt with this specifically.
In this case, however, nothing is going to work as it should, because apparently there is no life insurance in place. Generally, when shareholders sign an agreement that they will buy back someone's shares, they insure that person's life. The company should have owned life insurance policies on all three of the shareholders for exactly this situation. This is a huge problem for this particular company. They still have a binding agreement to purchase the shares.
Another problem brewing in this particular case is the misinformation about the payment of debts. One of the major goals of individuals who incorporate a company is to separate the business from the personal. This reader seems to think that the deceased's estate is responsible to pay the debts of a company. But it is not. The estate is only responsible for the deceased's personal debts. The debts of the company are not the estate's problem. Isn't that protection one of the main reasons people incorporate in the first place?
However nobody seems to be aware of that, as the reader has asked for payment from the executor, and the executor has said there is nothing in the estate (as opposed to refusing to entertain the request). So the executor isn't aware of the law as it affects the estate either.
It seems to me that the people who set up and operate this company, who unfortunately lost a partner before they had a chance to get things up and running properly, are operating with some real handicaps, including:
- lack of understanding about how corporations work
- lack of understanding the effect of a shareholders' agreement
- failure to foresee the need for life insurance, even though this is pretty much standard when there is a buy-back provision
- lack of personal planning that takes the family and the company into consideration
I understand that doing things yourself saves costs in the short term, but an experienced estate planning lawyer could have prevented all of the problems this poor fellow is going through in the long term. It's worth it to get some decent advice at the beginning to ensure that everything works the way you think it will.

1 comment:

  1. Wow this was an amazing read. Many thanks for your insights and well thought out points of clarification


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