What Happens to Life Insurance Used to Fund a Buy-Sell Agreement?
Steve Leimberg’s Estate Planning Email Newsletter (membership required, but trial subscription available) contained an article about Hilliard v. Jacobs (requires Adobe Acrobat), an Indiana Court of Appeals case. The article is entitled “Hilliard v. Jacobs: What Happens to Life Insurance Used to Fund a Business Continuation Agreement” (newsletter Issue 1615, March 1, 2010).
Hilliard and Jacobs were 50-50 partners in Advanced Marketing Technology, LLC. They initially purchased $200 thousand of life insurance on each of their lives in a cross-purchase agreement. The policy provided that if one should die, the other would be able to purchase the interest owned by the deceased.
The company prospered, and the life insurance policies were increased over time to $2.5 million each. The company was sold in 2002. The Leimberg newsletter article provided this in a portion of the executive summary of the case:
Hilliard v. Jacobs dealt with a business relationship that was severed and what happens to life insurance used to fund a cross purchase buy-sell agreement. The central issue at the lower level was whether continued insurable interest was necessary for the owner of the policy on the insured to retain it and the rights under it to the death proceeds.
The bottom line is that the buy-sell agreement did not specify what would happen to the life insurance policies after the company was sold. The article provided this warning:
One point planners should take away from this case is the importance of specifically stating in the buy-sell agreement itself how the parties want the policies to be disposed of in the event of a sale or liquidation of the business or death or retirement or other termination of the relationship. In the case of a cross purchase agreement, should they be conveyed to the insured? Should they be terminated? Should they be sold to a life settlement company? Should the insured have a veto power?
This case involved a cross-purchase agreement. With significant companies, we more often see corporate-owned life insurance policies associated with buy-sell agreements. The point is the same, however. It is critical that your buy-sell agreement state how life insurance proceeds for company-owned policies are to be treated. There can be a wide gap in value conclusions depending on whether the proceeds are used as a funding vehicle (specifically to repurchase shares) or as a corporate asset (and added into value in determining the buy-sell agreement price).
If there is corporate-owned life insurance associated with your buy-sell agreement, my challenge to you is to determine, as soon as possible, whether the treatment of life insurance proceeds is covered. If not, then you and the other owners need to agree and change it.
If life insurance is mentioned in your agreement, my next challenge to you is to think about whether the treatment makes sense for you and the other owners. If not, then it is time to agree and change it.
If you know anyone who has corporate-owned life insurance and a buy-sell agreement, please send this post to them. If you have a cross purchase agreement and life insurance, be sure to heed the advice above from the Leimberg newsletter.
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