Partnership cross-option agreement guide

A cross-option agreement considers what happens in a partnership on the death or critical illness of one of the partners. There are potentially some undesirable outcomes for the unfortunate partner and the partnership:

(a) the partnership will automatically dissolve and the assets will be divided equally between the surviving partner and the deceased partner’s estate/next of kin; and then…..

(b) the surviving partner may wish to purchase the partnership share from the deceased shareholder’s estate but the parties may struggle to agree on terms or a price;

(c) the deceased shareholder’s estate may wish to sell their inherited partnership share to the surviving partner but he/she may not wish to purchase it. The next of kin of the deceased shareholder may be left with partnership assets that are not capable of sale and no way of turning those assets into cash.

So what is the solution? A cross-option agreement is a simple contract between business partners that gives the surviving partner an option to buy the partnership share of the unwell/deceased partner, and a corresponding option that gives the next of kin of that unwell/deceased partner an option to force the surviving partner to purchase their partnership share and thus turn paper shares into real money.

These ‘crossing’ options are what gives the agreement its title.

A secondary problem in this scenario is that the surviving partner may not have access to sufficient funds to purchase the partnership share. This can be planned for by each partner taking out insurance on the life of the other, or the partnership taking out insurance on the lives of the partners. This would usually be arranged by an Independent Financial Adviser.

Protection insurance establishes a method by which the partnership interest can be valued and the funds automatically raised to assist with the purchase of the partnership share on the death of a partner.

The structure of the cross option is vitally important for taxation planning purposes. Important tax reliefs for both inheritance tax and capital gains tax can be lost if the documentation is not properly drafted.