One of the challenges of holding shares in a private limited company is that, generally speaking, the only market for those shares is the company’s other shareholders. If a shareholder, who is also a director or manager of a limited company, was to die or have to leave as a result of their critical or terminal illness, there’s no guarantee that the other shareholders would have the financial resources to purchase their shares. This means that the shares remain locked up in the company until there is some kind of exit, when instead it would be preferable for the shareholder (in the event of their critical or terminal illness) or their personal representatives (in the event of their death) to receive money for those shares.
A cross-option agreement, sometimes referred to as a ‘business protection agreement’, aims to address the above challenge through the grant of two-way or ‘cross’ options that may be exercised on the death or critical or terminal illness of a shareholder. While not strictly necessary, these options are usually supported by insurance policies that are taken out on the life of a shareholder as a means of providing the financial resources necessary to enable the purchase of their shares.
This document is a cross-option agreement between a company and an individual shareholder, whereby the company takes out an insurance policy on the shareholder’s life with the company having the right to purchase a shareholder’s shares in the event of their death or, if the policy provides, their critical and/or terminal illness (known as a ‘call option’) and the shareholder having the right to require the company to purchase their shares (known as a ‘put option’).
The main challenge, in the context of a cross-option agreement between a company and an individual shareholder, is that there are specific rules in the Companies Act 2006 relating to the purchase by a company of its own shares. A company is only able to purchase its own shares out of profits that are available for that purpose, from the proceeds of issuing new shares for that purpose or out of capital. Those requirements can be difficult for companies to satisfy, for example, if a company made significant losses, then receipt of the proceeds of the insurance policy may mean that it has insufficient available profits, even though it has the cash. As such, the document provides some options for what should happen if the rules prevent the company from purchasing all of a shareholder’s shares.
It's important that tax advice is obtained when entering into a cross-option agreement, as tax rules are liable to change and a cross-option agreement must not operate as a binding contract for the purchase of shares if the estate of a deceased shareholder is to receive business property relief from inheritance tax on the value of the shares.
