Why Cross-Purchase Agreements Are Used

One factor that sometimes influences the decision to implement a cross-purchase agreement is that there will be no alternative minimum tax consequences. Thus, if shareholders of a corporation are concerned about preference income and potential tax liabilities, a cross-purchase agreement may be preferred. In addition, the stepped-up basis for surviving owners is an important consideration if owners perceive the likelihood of a lifetime sale of a business interest.

The Wait-and-See Buy-Sell Agreement

Buy-sell agreements funded with life insurance can be pivotal to the success of a business. The surviving business owners (as well as a deceased owner's estate) receive funds precisely when they are most needed. As an insurance professional, it is your responsibility to work with the client's legal counsel and to know the unique features of each type of buy-sell arrangement to help prepare you to meet each client's needs.

The wait-and-see buy-sell agreement is a special type of buy-sell agreement between the owners of a business and the business itself. Unlike the traditional entity buy-sell and cross-purchase agreements, the specific purchaser of an owner's business interest remains uncertain until death, retirement, or disability actually occurs.

Let's assume that we have three shareholders: Tom, Dick and Harry. In the typical wait-and-see buy-sell agreement, this would be the situation at Tom's death:

• The corporation would have a first option to buy Tom's stock from his estate.
• Should the corporation fail to exercise this option, or exercise it only with respect to a portion of Tom's stock, then Dick and Harry would have a second option to buy Tom's stock (or the remainder of it).
• If Dick and Harry should leave any of Tom's stock unpurchased, then the corporation must purchase any remaining portion (or all) of Tom's stock. This assures Tom's family that all of the stock will be purchased, and assures the surviving shareholders that they will succeed to full control of the corporation.

Each of the individual owners and the business entity are potential life insurance buyers. The entity has the greatest exposure since it has a binding obligation to purchase the interest if the two options are unexercised, or incompletely exercised.

The wait-and-see approach is obviously not appropriate for a sole proprietorship or a single-owner corporation. Further, if the owners are related, the family attribution rules are a potential problem in the event of a redemption under the first option, or a mandatory purchase under the third step.