For Advisers – Be A Good Neighbor

I have spent five hours reviewing a shareholder agreement for a valuable group of companies.  It is rather ingenious in the way it allocates equity value, control and day-to-day income distributions.  It is tax efficient and probably durable.  People have spent a lot of time making this come together.  But, it is needlessly complicated and it has some definitional issues.

The complication could have been solved with a single additional holding company.  One that holds all the shares in all of the various opcos.

Holding companies for individual shareholders are a wonderful idea, especially when owned by a trust as these are here, but they don’t work as well when they own fractional interests in many companies and are tied to other shareholders.  You don’t want to have the individual holdco shares being the subject of the buy-sell arrangements.  All of their tax value is lost to the surviving family members on death. Never mind that they may hold assets the surviving shareholders don’t want to buy.  Probably too late for this one.  I will check next week.

The thing that troubled me because it so easy to overcome is the definitions and requirements around disability insurance.  Sometimes lawyers put common sense ideas into agreements that refer to other contracts in a way that the other contract never considered.

For example, one of the disabled definitions is – “A shareholder is disabled if they qualify for disability benefits on the basis of permanent incapacity under the provisions of any disability insurance coverage maintained by any of the Corporations for the benefit of its employees.”

I think that this definition will never be operational.  With the exception of some individual policies that provide for catastrophic injury situations, I know of no group or individual carrier that talks about “permanent incapacity.”

There are two other definitions for disabled in the agreement but they conflict so now what?

There is a provision that if the agreement terminates life insurance will be transferred to the insureds at cash value.

There are four things to notice here.

  1. The transfer is required by the agreement
  2. It does not address the case where fair value may be higher than cash value.  That will be deemed to matter by CRA.
  3. It seems not to recognize that there could be material tax costs to transfer it out even if Cash value approximates fair value.
  4. The agreement never specifies who should own the insurance in the first place.  If it is the individual’s holdco, why force it out?

Now here is where it can become interesting for advisers.

Why do you not photocopy some disability definitions out of both individual and group contracts and share them with lawyers who prepare agreements like this?  I know of not a single lawyer who dislikes learning more and especially if it comes with precedent wording.

Similarly a little extra knowledge about how insurance contracts are taxed when they are transferred to and from corporations and trusts might be useful to them.

It might not be crazy to send these to accountants too.

Spreading knowledge to the professionals in your network who use it infrequently is a good neighbor sort of thing to do.  Who knows, they may be able to help you some day.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.  |  Twitter @DonShaughnessy  |  Follow by email at moneyFYI

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