Buy-Sell Agreement Formation/Amendment Considerations
I. Introductory Information
A. Representation ethics
1. Who is your client? ______
2. Is the engagement letter signed? yes ______no ______
3. Who is not your client? ______
4. Has the “I don’t represent you” letter been sent? yes ______no ______
5. Are there conflicts with existing clients? yes ______no ______
a. Is it waivable? yes ______no ______
b. Has it been waived? yes ______no ______
B. Who are the players?
1. Company: ______
2. Shareholders (list):
Name / Shares / Percentage / Legal Counsel /3. Life insurance agent: ______
4. Accountant: ______
C. Company is: C corporation (C-Corp) ______S corporation (S-Corp) ______
1. If S-Corp, was the company ever a C-Corp? yes ______no ______
2. If S-Corp, buy-sell agreement must not create second class of stock
D. Consider redemption (company buys) versus cross-purchase (other shareholders buy) nontax consequences:
1. The number of insurance policies required if it is a cross-purchase (consider limited liability company or partnership to own policies)
2. The differences in a shareholder’s ability to fund purchases not covered by insurance
3. Whether the corporation has authority under MCL 450.1345 if it is a redemption
4. The transfer for value issues when transferring corporate-owned policies now or after first death
5. The different life insurance premium burdens in a redemption versus a cross-purchase: in redemption, majority shareholder bears higher percentage of cost to fund its buyout and in cross-purchase, younger minority shareholder pays more on life of older or majority shareholder
E. “Wait and see” combination of redemption and cross-purchase:
1. Corporation has first option, shareholders have second option, and then corporation must purchase remainder
2. Offers greatest flexibility
F. Are estate tax values important here? Consult estate planners representing each shareholder
G. For corporate decisions, who votes on the board of directors for company decisions regarding whether to exercise options or make other decisions under a buy-sell agreement?
1. Make sure voting rules allow remaining shareholders to control corporate decisions under the buy-sell agreement
2. Who votes for shares in the deceased shareholder’s estate?
3. Chart the possible scenarios to see who will have control
II. Transfer Restrictions
A. No outright transfer to nonshareholders without prior written consent of company and shareholders?
B. No outright transfers among shareholders?
C. No transfer for security without prior written consent of company and shareholders?
D. Possible exceptions to A and B:
1. Transfers to living trusts with family members as beneficiaries (if transferee signs buy-sell agreement)
2. Transfers among current shareholders
E. No transfers that void S election
F. Attempted transfers in violation are void
III. Triggering Events
A. Shareholder’s desire to sell (receipt of written good faith offer):
1. First option to buy: company ______or other shareholders ______
2. Second option to buy: company ______or other shareholders ______
3. Shareholder options pro rata ______or other: (describe) ______
4. Price:
a. Lesser of offer price or price determined under agreement
b. Match offer price (will not fix estate value)
c. Price determined without reference to offer price
5. Tag-along rights to minority shareholders when majority interest is being sold? ______
B. Death
1. First option to purchase (“call”) by ______, second option to purchase by ______
2. Option to purchase (“call”) by ______, then mandatory purchase by ______
3. Mandatory purchase by ______
4. “Put” by deceased shareholder’s estate (option to sell)
5. Tag-along rights to any particular shareholder on purchase by certain shareholder’s shares (or “put” to certain shareholders)?
C. Disability
1. Define disability in terms of both duration (permanent versus temporary) and activities (total inability to do job?) and also coordinate with any disability buy-out insurance
2. First option to purchase (“call”) by ______, second option to purchase by ______
3. Option to purchase (“call”) by ______, then mandatory purchase by ______
4. Mandatory purchase by ______
5. “Put” by affected shareholder (option to sell)
6. Tag-along rights to any particular shareholder on purchase by certain shareholder’s shares (or “put” to certain shareholders)?
D. Termination of employment in any of three situations: termination for cause, termination without cause, and voluntary quit (company controls only the first of these three situations; the shareholder employee controls the other two)
1. Irrelevant for shareholders who are not employees when the triggering event occurs
2. First option to purchase (“call”) by ______, second option to purchase by ______
3. Option to purchase (“call”) by ______, then mandatory purchase by ______
4. Mandatory purchase by company or shareholder if termination is involuntary?
5. “Put” by affected shareholder (option to sell) —applies only to involuntary
6. Tag-along rights to any particular shareholder on purchase by certain shareholder’s shares (or “put” to certain shareholders)?
E. Court order for involuntary transfer
1. Possible events: attachment, execution, or divorce (can include bankruptcy, but federal law makes this unenforceable as an “ipso facto” clause)
2. Mechanism is needed for the purchase to occur before the court older is final
3. First option to purchase (“call”) by ______, second option to purchase by ______
4. Option to purchase (“call”) by ______, then mandatory purchase by ______
5. Mandatory purchase by ______
6. “Put” by affected shareholder (option to sell)
7. Tag-along rights to any particular shareholder on purchase by certain shareholder’s shares (or “put” to certain shareholders)?
F. Deadlock
1. Among shareholders evenly split
2. Among board of directors evenly split
3. Russian roulette (offer to sell can either be accepted or turned into offer to buy)
4. First option to purchase (“call”) by ______, second option to purchase by ______
5. Option to purchase (“call”) by ______, then mandatory purchase by ______
6. Mandatory purchase by ______
7. “Put” by affected shareholder (option to sell)
8. Tag-along rights to any particular shareholder on purchase by certain shareholder’s shares (or “put” to certain shareholders)?
G. Transfer (or attempted transfer) that would disqualify corporation’s S election
1. State that any disqualifying transfer is ineffective
2. First option to purchase (“call”) by ______, second option to purchase by ______
3. Option to purchase (“call”) by ______, then mandatory purchase by ______
4. Mandatory purchase by ______
5. “Put” by affected shareholder (option to sell)
6. Tag-along rights to any particular shareholder on purchase by certain shareholder’s shares (or “put” to certain shareholders)?
H. For any options, specifically state that (1) late notice of exercise is ineffective and (2) once exercised, notice cannot be withdrawn
IV. Security for Purchase
A. Pledge of shares: ______
B. Guarantee by company ______or certain shareholders ______
1. Security for guarantee ______
2. Is guaranty backed by consideration?
C. Other collateral: ______(If the company assets pledged, is this permitted under existing financing? Will it be subordinate to existing financing? Even if subordinate, it may interfere with company’s ability to obtain future financing without seller’s consent.)
V. General Price and Payment Terms
A. Price
1. Book value
2. Adjusted book value
3. Capitalized earnings based on multiple of
a. Net income (define)
b. Gross receipts
4. Fair market value (appraisal)
5. Agreed-on price: ______
a. How often is the agreement required: ______
b. If there is no agreement within ______months, price is most recent value as adjusted ______or other formula ______
6. Minimum down-payment equal to $______of identified insurance proceeds after taxes
B. Payment Terms
1. Down payment:
a. Stated amount or ______% of purchase price
b. If there is insurance, down payment is greater of ______% of purchase price or ______% of net insurance proceeds
c. If there is insurance, insurance proceeds available after closing ______% must be paid as principal prepayment
d. Consider disability buy-out insurance
2. Interest Rate (fixed versus floating)
3. Term: ______
4. Amortization
a. Equal periodic payments of principal including interest
b. Interest only, with one or more deferred principal (“bullet”)
c. Equal principal payments, plus accrued interest to date
5. Frequency of principal installments: ______
6. Frequency of interest installments: ______
7. Joint and several liability of multiple buyers
C. Release selling shareholder from guarantee of company debt? Absolute promise or only best efforts?
D. Do interested transaction rules apply?
E. Default and remedies
1. Coordinate with MCL 450.1345 if it is a corporate purchaser
2. Cross-defaults with other agreements
3. Is there notice and opportunity to act?
4. Are payment defaults treated more strictly than nonpayment defaults?
5. Remedies
a. Specific performance
b. Damages
c. Execution on guaranty, collateral, etc.
d. Prevailing party reimburses collection expenses, including attorney fees
VI. Other Provisions
A. Shareholder agreement regarding governance, voting, etc. (follow MCL 450.1488 procedures)
1. Ensure board representation
2. Company agreement not to issue shares to dilute voting or admit new shareholders
3. Company agreement regarding employment of certain shareholders
4. Voting of shares
B. If the company cannot purchase without MCL 450.1345 conditional debt
1. Other shareholders must purchase ______
2. Company must attempt to revalue assets ______
C. Noncompetition by seller after closing
1. Terms: ______
a. Prohibited activities
b. Geographic scope
c. Duration
2. Setoff for damages: ______
D. Confidentiality
E. Arbitration to break deadlock
F. Insurance
1. Policies must be purchased on life of each shareholder ______or each shareholder owning more than ______%
a. Company must buy ______
b. Shareholders must buy ______
c. Split-dollar arrangements permitted ______
G. Closing—if it is an S-Corp, have closing occur before receipt of any life insurance proceeds by company
H. Vote case against S-Corp termination or election
I. Dissolution, liquidation, or change in control of entity shareholders
J. If selling shareholder personally guaranteed corporate debt, will company promise to obtain release?
K. How to handle a second triggering event occurring before closing, especially if life insurance proceeds become available (e.g., termination of employment followed by death of ex-employee before closing)
L. Should bylaws permit transfer of shares without surrender of certificates? (It is helpful if it is a recalcitrant shareholder.)
M. Should bylaws require registration on books for any transfer to be effective? (Helpful to prevent dissident shareholder from threatening to destroy S election by transfer to disqualified shareholder.)
N. Limitations on company activities pending payoff (what affirmative or negative covenants would a lender impose, since seller is acting as lender for the buyer)
O. Option to purchase life insurance policies
1. Seller can buy policies on seller’s life from company or other shareholders
2. Remaining shareholders can purchase policies on their lives from selling shareholders
3. Watch transfer for value rules
P. Setoff rights
1. Adjustments at closing for money owed by seller by company or other shareholders
2. Adjustments at closing for money owed by seller to purchaser, company, or other shareholders
Q. Other S-Corp provisions (override all other terms)
1. Preserving S election (transfers void)
2. Sale of shares occurs at instant of death (basis purposes) before receipt of insurance proceeds
3. Separate tax years on sale—if seller wants tax year cutoff and other shareholders do not agree, is there any protection to selling shareholder? Seller will want right to distributions to pay taxes after seller ceases being a shareholder
4. Require distributions sufficient to pay taxes, especially if there are nonemployee shareholders
5. Indemnification by shareholders for wrongful termination of S election selling shareholders pro rate share of tax liabilities
R. General provisions
1. Entire agreement and amendment
2. Applicable law and conflicts (multiple shareholders)
3. Severability
4. Waiver
5. Remedies (specific performance and arbitration)
6. Endorsement on share certificates
7. Notices—require whether notices and clear rules for how notices can be given (FedEx, e-mail, etc.) and when notices are effective (important when options can be exercised or lost)
8. Define “days” and extension of time limits for deadlines falling on week ends, specified holidays, etc.
9. Multiple triggering events (what priority applies)
10. Third-party approvals required before closing
a. Must lender approve change in shareholder control?
b. Does change in control violate loan, lease, or other contract restrictions?
c. Are license approvals needed?
d. Does the company lease significant assets (real estate) from family controlled entity? How will buyouts affect negotiating positions when lease is up for renewal?
11. Investment representations from all persons acquiring shares
12. Expenses of company (including attorney fees) are reimbursed by party at fault
13. Legal advice—disclose your role as attorney for company, not shareholders, and have shareholders acknowledge opportunity to seek independent legal counsel
S. Acknowledge that transactions between corporation and shareholders are OK (leases, salaries, supply contracts, other executory contracts, related company activities, etc.)
T. Disclaim MCL 450.1489 definitions of “oppressive” conduct
U. Disclaim reasonable expectation of employment other than “at will” for any shareholders who are employees
V. Prevent shareholders from setting up competing businesses while they are shareholders, especially when they are neither directors, officers, nor employees
W. Net operating losses—remaining shareholders may want protection from loss of net operating loss carryovers in certain ownership transfers, see IRC 382