34 The Need For Partnership Insurance

34. The Need For Partnership Insurance What happens when a partner dies? Few partners realize that when a member of a partnership dies, the partnership is automatically and immediately dissolved. In the absence of a special agreement to the contrary, a partnership no longer exists - except for the purpose of winding up its affairs. The dissolution of a partnership therefore, becomes a reality in the time it takes a heart to beat - or to stop beating. The surviving partners cease to be part of an active, productive business venture. No longer can your energies and abilities be devoted to the growth of the business. If no special agreement was entered into before the death of a partner, the dissolution of the partnership brings an end to the authority of the surviving partners to act for the partnership except to wind up the firm's business, the partners become what is known as "liquidating trustees". In this role of liquidating trustees of the partnership, the surviving partners must, with reasonable dispatch, do the following: (1) Complete all partnership transactions started before the death of their partner but not as yet completed. (2) Collect the accounts receivable . (3) Pay the partnership debts. (4) Convert the remaining assets into cash. (5) Pay to the surviving partners, and to the executor of the deceased partner, the net amounts owed to each in relation to their respective partnership interests. If, after all the above transactions take place, there is a deficit, then each partner (including the estate of the deceased partner) must contribute his or her proportionate share to make up the deficit. If they are unable to pay, then their shares must be made up by the other partners. Each partner is liable for the full amount of the partnership indebtedness, and this liability extends not only to that partner's assets invested in the business, but also to his or her entire personal assets. A properly executed and funded buy-sell agreement is the ideal solution to the problems incurred by a partner's death. Such an agreement assures the continuation of the business without interruption, to the advantage of the surviving partners and the deceased partner's heirs. The partners enter into a binding agreement - prepared by their attorney - setting forth the disposition of a partner's interest in the event of his or her death. Agreements must contain the following seven commitments: (1) All partners agree not to dispose of their partnership interests during their lifetimes without first offering their interests for sale to the other partners (or the partnership) at an agreed upon price. (2) The partners agree that if a partner dies, the surviving partners (or the partnership) will buy and the deceased partner's estate will sell the interest of the deceased partner. (3) An agreed-upon purchase price to be paid by the surviving partners (or partnership) for the deceased partner's interest must have been set (or a valuation formula or procedure selected to determine a definite price at the time of death). (4) The partners (or the partnership) agree to purchase and maintain life insurance in a stated amount for the purpose of financing the purchase of the deceased partner's interest. (5) An agreement is made as to the ownership and control of the policies and the manner by which the policies on the lives of the surviving partners owned by the estate of the deceased are to be exchanged. (6) The agreement should also specify as to the time and method of paying any balance of the purchase price in excess of the insurance proceeds, and conversely, the manner in which any proceeds in excess of the purchase price are to be used. (7) The agreement should specify that the surviving partners will take over all of the debts of the partnership releasing the deceased's estate from any obligation toward those debts. Business life insurance provides the most efficient and economical way to fund a partnership buy-sell agreement. Each partner's life is insured in an amount equal to his or her interest in the business, and the premiums are paid by the other partners or the partnership. At a partner's death, the proceeds are paid by the life insurance company income tax free to the surviving partners or to the partnership. With insurance on the lives of all partners in amounts equal to their respective business interests, the purchase price is automatically created in its full amount exactly when it is needed. The surviving partners are spared the problems and the embarrassment of trying to borrow the funds or to pay out of surplus and future earnings the funds to meet the purchase price at the very moment when the firm's credit has dried up and its' earning capacity has been impaired. A Vital Consideration When your partner dies, will you liquidate or reorganize? Unless you and your partner have made a definite agreement to the contrary, the law says that the death of a partner dissolves the partnership--immediately and completely. So, without that agreement, the only thing to do is liquidate everything, or reorganize on a new basis. Most surviving partners want to reorganize. They want the business to live, to provide the satisfactions and income that go with business success. And besides, they know that liquidations can shrink assets by 35-50% while debts remain at the full 100%. But Can You Reorganize Part of the business still belongs to someone else. The executor of your partner's estate, his heirs, and the court if any heirs are minors, must all agree that reorganization is the best thing--and they must agree to the conditions. If any parties do not agree--it's liquidation whether you want it or not. The Rocky Reorganization Road The surviving partner carries the full load but must share the profits. . .The heirs never seem to understand why they received so much less than the deceased partner used to bring home. If the heirs, needing additional income, become active in the business, the surviving partner discovers that their lack of experience or basic aptitudes will handicap if not ruin the operation. Heirs Try to Sell to Outsider They may find it difficult. There may not be many people who know the business. . . Those who do may not have the money to buy. If they can buy, they may not make good partners. They may find it impossible to agree on a fair price because the heirs will again be thinking of the income they have to replace. Someone may be willing to buy at a high price, but why. . .to get a foothold in the business. . .to learn trade secrets. . .to eliminate competition? Heirs Sell to Surviving Partner They still want that unreasonable price because they still need the income. If an agreeable price is reached, the surviving partner has his choice of payment plans--he can pay cash by depleting the working capital and loading the business with as much debt as it will carry, or he can eliminate any chance of a good profit picture for years to come by signing installment notes. Not a thrilling series of choices, so far. Fortunately there is one other road, a little known short-cut that's broad and smooth and gets you where you want to go--fast. Your Plan of Action Enter into a legally binding buy and sell agreement with your partner. Establish the price now, while everyone is living and has equal bargaining power. Each partner purchases sufficient business insurance on the others life to provide the cash necessary to buy his interest in the event of death. This plan of action eliminates the rocky reorganization road and nullifies the threat of forced liquidation. It establishes the right price for the business for all parties and establishes the value of the partners' interest for death tax purposes. It strengthens the credit line by guaranteeing to creditors that their interests won't be compromised when one partner dies, and perhaps best of all, it gives the survivor full ownership and control of the business with no huge additional current or deferred debt load. The Cross Purchase Agreement When partners agree that the ones who live longest should take over the business with as few complications as possible, it is just good business to put everything down on paper in a legally binding agreement so that neither the surviving partner nor the heirs of the dead partner are surprised or disappointed at a later date. A cross purchase agreement is drawn by the firm's attorney and usually mentions-- --that the estate will sell the deceased partner's interest to the survivor. --that the surviving partner will buy. --a method of establishing the selling price. (Usually set by formula when the agreement is drawn and then periodically reviewed.) --a method of payment. (All cash, or cash plus annual notes, or monthly income.) --full release to the estate for liabilities of the business. --that a partner cannot sell his interest in the business while he is alive without first offering it to the other partner at the agreement price. --the purchase of business insurance by each partner on the life of the other so that the cash needed to buy the business interest will be there when it's needed. --other provisions to protect all partners and all heirs. These may include mention of alternate means of paying premiums, cessation of business, simultaneous death or mutual desire to discontinue the agreement. The Trustee Cross Purchase Agreement When partners agree that those who live longer will take over the business with as few complications as possible, it is just good business to put everything down on paper in a legally binding agreement so that neither the surviving partners nor the heirs of the deceased partner are surprised or disappointed at a later date. When three or more partners are involved, a trusteed cross purchase agreement can be drawn by their attorney. It usually mentions-- --that the estate will sell the business to the surviving partners. --that the surviving partners will buy in proportion to their share of the partnership. --a method for establishing the selling price. (Usually set when agreement is drawn, and then periodically reviewed.) --a method of payment. (All cash, or cash plus annual notes or monthly income.) --full release to the estate for liabilities of the business. --that a partner cannot sell his interest in the partnership while he is alive without first offering it to the other partners at the agreement price. --the purchase of business insurance by the trustee with funds supplied by the partners on the life of each partner so that the trustee will have the cash to buy the interest of the dead partner. --other provisions to protect all partners and all heirs. These may include mention of alternate means of paying premiums, cessation of business, simultaneous death, mutual desire to discontinue the agreement and right to change trustees. The Entity Purchase Agreement When partners agree that those who live longer will take over the business with as few complications as possible, it is just good business to put everything down on paper in a legally binding agreement so that neither the surviving partners nor the heirs of the deceased partner are surprised or disappointed at a later date. When a large number of partners are involved, a partnership entity purchase agreement can be drawn by their attorney. It usually mentions-- --that the deceased partner's estate will sell his interest to the new partnership. --that the new partnership will buy. --a method of establishing the selling price. (Usually set when agreement is drawn, and then periodically reviewed.) --a method of payment. (All cash, or cash plus annual notes, or monthly income.) --full release of the estate for liabilities of the business. --that the partner cannot sell his interest in the business while he is alive without first offering it to the other partners at the agreement price. --the purchase of business insurance by the partnership on the life of each partner so that the new partnership will have the cash to buy the deceased partner's interest. --other provisions to protect all partners and all heirs. These may include mention of cessation of business, transfer of surviving partners' life insurance and mutual desire to discontinue the agreement. Tax reference verification 1-800-829-1040 Back