Using a Trustee with Your Insurance-Funded Buy-Sell Agreement

What Is a Trust/Trustee?

A trust is a legal entity often used as a device for property management. A trustee may be an individual (professional or nonprofessional) or a corporation (such as a trust company or a bank) that has the legal capacity to hold title to property (thereby excluding minors and those judged mentally incompetent). The responsibilities of and restrictions on the trustee are set out in a trust agreement. The role of the trustee in a buy-sell agreement has been compared to that of an escrow agent in that the buy-sell trustee doesn't necessarily take legal title to the property under management.

When Can a Trustee Be Used In a Buy-Sell Agreement?

Cross Purchase Agreement

A trustee is most commonly used with the cross purchase buy-sell agreement. In this case, it becomes a trusteed cross purchase (buy-sell) agreement. A trustee is especially useful when there are more than three or four shareholders involved in a cross purchase agreement.

Entity Purchase Agreement

Although less common than with a cross purchase agreement, a trustee can also be used with an entity purchase (stock redemption) buy-sell agreement.

One-Way Buy-Sell Agreement

Use of a trustee can be effective in the proprietorship one-way buy-sell agreement setting. If there is even a remote chance of conflict over the purchase price at the time of transfer, the trustee can be a valuable intermediary. With the one-way buy-sell, the proprietor often wants to receive the highest possible price for the sale of the business, while the buyer (often an employee or competitor) wants to pay the lowest possible price (just like any other sale!).

Depending upon the specific wording of the pricing/valuation clause in the buy-sell agreement, there could be a potential for disagreement over the valuation of the business or the choice of appraiser to make the valuation. The trustee can perform the usual functions of intermediary and, perhaps more importantly in this case, be the neutral party responsible for setting the purchase price. Of course, the trustee will have only those duties specifically set forth in the trust agreement, so it will be necessary to spell these out.

What Are the Duties of a Trustee In a Buy-Sell Agreement?

Administer Paperwork

The buy-sell agreement trustee is responsible for obtaining and filing any documentation that is needed to effectuate the transfer of the stock. The trustee may also be responsible for updating records of stock ownership and preparing and delivering reports to the shareholders.

Handle the Funding Insurance

When insurance is the chosen funding method, the trustee typically buys a policy on the life of each shareholder and is the named beneficiary on the policies. The trustee collects payment for the premiums from the shareholders. At the death of a shareholder, the trustee collects the insurance proceeds, pays the family or estate of the deceased shareholder, and distributes the deceased shareholder's stock to the new owners.

Enforce the Agreement

The trustee's function is to ensure that the terms of the agreement are carried out. The trustee has custody of the share certificates representing the business interests covered by the buy-sell agreement, thus preventing the transfer or assignment of the shares. The trustee is often responsible for any updates to the value of the business that may be required under the terms of the buy-sell agreement. When a shareholder dies, the trustee handles the transfers of the payment and the stock between the buyers and the shareholder's family or estate.

What Are the Benefits of Using a Trustee?

Relieves the Business Owners of the Administrative Duties Involved In Maintaining the Buy-Sell Agreement

With a trustee, the shareholders can focus on the business itself and leave the administration of the agreement to the trustee.

Simplifies the Funding When Insurance Is Used

The trustee generally owns the life insurance policies on the lives of each buy-sell participant. The trustee needs to buy only 1 policy on each shareholder. In an agreement with 6 participants, only 6 policies are needed. Compare this to the number of policies needed when no trustee is used--there would be a total of 30 policies needed! Each participant would have to buy 5 insurance policies, one policy on the life of each of the other participants.

Trustee Legally Bound to Carry Out Agreement Promptly

As possessor of the stock (and the insurance policies if used), the trustee is legally bound to carry out his, her, or its duties under the trust agreement promptly. A trustee may eliminate any possibility of a change of heart concerning the transaction on the part of the heirs or the surviving owners and ensure that your family or estate receives prompt payment for your interest.

What Are the Drawbacks?

Potential Transfer-For-Value in Trusteed Cross Purchase Agreement

When a trustee is used with a cross purchase buy-sell agreement funded with life insurance, there is a potential transfer-for-value situation at the death of a shareholder.

Technical Note: Under the usual trusteed cross purchase agreement, the trustee owns the policies on the lives of the shareholders. When the first shareholder dies, that shareholder's estate still owns an interest in the policies on the lives of the other shareholders. When the policy interest is transferred to each surviving shareholder, each gains (through his or her beneficial interest in the trust) an interest in insurance proceeds that he or she did not have before. While there is no transfer of ownership within the trust, the transfer-for-value rule requires only the transfer of an interest in a policy. At subsequent shareholder deaths, there would be additional transfers of interest in the policies of the surviving shareholders. The reciprocity of the transfers of beneficial interest provides the valuable consideration. One possible way to solve the potential transfer-for-value at the death of a shareholder is for the company to buy the policies on the surviving shareholders from the estate of the deceased. The trustee would continue to hold the policies on behalf of the corporation, which would be a new grantor of the trust. This would shift future purchases of a shareholder's interest into a combination purchase, much like a wait and see buy-sell agreement. Under this particular arrangement, future purchases of shareholder stock could be part stock redemption, using the policy proceeds payable to the corporation, and part cross purchase, using the policy proceeds payable to the individual surviving shareholders.

Trustee Must Be Paid

The services of the trustee are not free. You and the other parties to your buy-sell agreement must decide how the fee will be split.

Tip: Select a trustee carefully. Discuss the fee structure and the services provided by the trustee before you make any definite arrangements.

How Do You Set Up the Trustee Arrangement?

Consult an Attorney

State law governs the creation, operation, and termination of a trust, and the trust document is a legal document. Consequently, you should consult an attorney to set up your trustee arrangement.

Select a Trustee

The trustee can be an individual, such as a lawyer. It can also be a corporate entity, such as a bank or trust company. The corporate trustee is sometimes preferred, especially when insurance policies are used for funding the buy-sell agreement. This is because the corporate trustee, unlike an individual, can't die. The trust agreement should contain provisions naming an alternate trustee, as well as the power of substitution. The permanence of the corporate trustee can be important when the agreement is expected to cover a long period of time. Ideally, the trustee should be an impartial third party, so it is generally not recommended to use the company's own legal representative in the trustee role for your buy-sell agreement.

Draft a Trust Agreement

The trust agreement can be part of the buy-sell agreement, or it can be a separate agreement. Whichever form of documentation is chosen, the agreement should specify the duties and responsibilities of the trustee. Provisions should be specified in the agreement for a successor trustee. The successor trustee provision will be extremely important if your chosen trustee dies or is unable to continue as trustee. Consult your attorney who will draft the trust agreement.

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of  The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that focuses on transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.

The Retirement Group is a Registered Investment Advisor not affiliated with FSC Securities and may be reached at www.theretirementgroup.com.