Ask the Experts!
The professionals at Advanced Underwriting Consultants (AUC) answer the tax questions posed by producers. Here’s the question of the day.
Question: My clients have sold their business. What happens to their buy-sell agreement and its funding?
Answer: There’s no general abstract answer to that question. The clients should consult with their business attorney to decide what to do about the buy-sell agreement and its funding. If they fail to do so, they may run into the kind of problem from Parduhn v. Bennett, 2002 UT 93, 61 P.3d 982 (2002).
In 1979, Brad Buchi and Glade Parduhn formed the University Texaco Company partnership to operate a service station business. After the business was formed, the parties entered into a cross purchase buy-sell agreement funded with life insurance. Insurance in the amount of $250,000 was purchased on Buchi’s life, and $300,000 of coverage on Parduhn.
Buchi and Parduhn sold their service station business’s assets in July, 1997. Buchi subsequently died in August, 1997. Parduhn, as beneficiary, received the $300,000 death proceeds from the life insurance policy originally intended to fund the buy-sell agreement.
Buchi’s heirs sued to have Parduhn turn over the death benefit to them. They argued that Parduhn was always intended as a conduit for transferring the death benefit to Buchi’s family. In support of their argument, they maintained that the buy-sell agreement remained in effect after the business’s assets were sold.
The Supreme Court of Utah ruled that the buy-sell agreement was no longer in effect because the underlying partnership—because of the business transfer—had been effectively dissolved.
The dissenting judges observed that while the service station may have been sold, the partnership itself was never formally terminated. In the absence of a termination, they argued, there was still a partnership interest that could be transferred by the buy-sell agreement.
Here are some lessons from Parduhn:
- Add language about disposition of policies in the event a business is terminated, or the coverage is no longer needed for buy-sell funding.
- Make clear in the buy-sell agreement what constitutes termination of a business, and what consequences it has for the buy-sell obligaton.
- As a professional agent, seek to be included in situations where your business owner clients are selling their businesses.
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