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This scenario is a real threat that arises if a buy-and-sell arrangement does not fully address how to deal with a split between business partners, and can cause hostility between you and your partner in future, says Sanlam Legal Adviser David Thomson.

Thomson says while some business owners realise the importance of taking out a life policy as part of their buy-and-sell arrangement, they fail to put their agreement to writing and to deal with a parting of the ways.

"Business partners often have risk cover in place, but there is no clear distinction on whether it's business or personal cover. Sometimes the policy is actually not structured to enable the execution of a buy-and-sell arrangement. There may even be a life policy in place, but no buy-and-sell agreement or the agreement doesn't address what will happen to the policy if the partners split. Business owners should note that an insurance policy contracts are only half of the deal; there should be a 'buy and sell' agreement signed by the parties as well," says Thomson.

Thomson explains that the question of 'insurable interest' is only relevant at the time of implementing the cover. This means that neither of the business partners can cancel the policy on their life by simply arguing that they are no longer business partners. The cancellation of the policy or a decision to hand it over to the other partner is entirely the choice of the individual who owns the policy, unless the buy-and-sell agreement provides otherwise.

Thomson warns business owners to ensure that their buy-and-sell agreements provide for a business split or termination. They should, ideally, include a clause that will ensure the policies will be ceded to the lives insured.

"You can agree on compensation such as refunding all the premiums paid by the partner who owns the policy. So, if you currently have a buy-and-sell contract that doesn't have this clause, you should prioritise updating it and ensure that you involve both financial planning and legal specialists."

Thomson says business partners should also pay special attention to how the value of their shares is determined. Many buy-and-sell agreements make provision for the value of each partner's share and loan account to be determined on the day when the respective partner dies or is declared disabled. However, Thomson explains, it is practically difficult to do so because accountants seldom draw up financial statements on the day that one partner dies or exits the business.

"Financials are usually prepared at the end of the financial year and when one goes back to determine the value on date of death the necessary records are either not available or unsatisfactory. As a result disagreements arise over the value of the shares. We sometimes find that two to three years after the split or death of one partner, there is still no agreement on the valuation and it becomes a protracted and expensive arbitration process."

Thomson explains that meanwhile, the family of the deceased will be left with no source of income because although the policy pays out, the policy owner cannot take transfer of the deceased partner's shares until the executor has determined the price payable.

Thomson says the South African Revenue Services (SARS) must assess the valuation of shares held in a private company or CC before a business owner's estate can be wound-up. He, however, recommends attaching a fixed agreed price to each partner's share as a more practical solution.

"In the case of death, the executor will not have a problem winding up your deceased partner's estate if the agreed price is in accordance with SARS' valuation. If you have life cover in place that exceeds or is less than the agreed price, your buy-and-sell contract should provide for a solution on how the shortage or excess will be dealt with.

"Furthermore, if both business partners are still alive at the time of the split and there is no valid disability claim, the policy will not pay out and the parties must have a clear idea of what the price is and how they intend to finance payment of the purchase price."

Thomson says business partners should ensure that their buy-and-sell agreement makes provision for reassessing the value of their shares every year, preferably when they have just finalised their financial statements or if there has been a material change in the business.

Sanlam Life Insurance is a licensed financial service provider.
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