5 common mistakes to avoid when drafting shareholders’ agreements

It is no secret that there are benefits to funding your client’s shareholders’ agreement with life insurance.

It is less well known, however, that a significant number of agreements are drafted incorrectly, being either out of date or inadequate to deal with insured buyouts. The following are 5 common errors and omissions your clients should avoid in their shareholders’ agreement.

Lack of Tax Planning
Tax rules change quite a bit and clients are not always willing to incur additional professional fees to revise their shareholders’ agreement after every change. While it is not advised that you provide direct tax advice to your client, you should be aware of the importance of tax and its applications to life insurance.

No Reference to the Capital Dividend Account (CDA)
The CDA is a focal point for planning when a shareholders’ agreement is funded with corporate owned life insurance. In this situation, it is important to include a clause regarding the payment of the capital dividend in the agreement. If this is not mentioned then there is no requirement that it will have to be paid, and no guarantee that your client will receive their expected tax benefits.

Optional Buyouts on Shareholder’s Death
Except in unusual circumstances, the purchase and sale of shares on a shareholder’s death should be mandatory. An optional buyout may seem appealing to surviving shareholders and their corporation, but this lack of clear direction often causes more anxiety than it should. The future of your client’s business could be put at risk while the disposition of the deceased’s shares is contemplated.

Inaccurately Defining “Disabled”
In a case where disability buyout insurance is in place, insurance policies are used to determine whether or not a person is disabled, or in other words, whether or not they can benefit from the agreement. Referring to both physical and mental incapacity, and providing a sufficient waiting period to determine the extent of the disability are proactive steps towards insuring an effective shareholders’ agreement.

Wrongly Determining the Ownership of a Policy
Making an operating company the owner and beneficiary of a life insurance policy is not always ideal. Corporate-owned policies can be subject to corporation creditors and life insurance policies are not considered active business assets for the purpose of the capital gains exemption.

Please contact your local PPI office for more information.

 

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5 common mistakes to avoid when drafting a shareholders’ agreement