Evanna Phoon wrote the below article and she is a Senior Franchisee of Rockwills. She can be contacted at firstname.lastname@example.org
In the previous article on Oct 8 issue, we covered the important elements of Buy Sell Agreement in Item #3 of Diagram A. Buy Sell Agreement generally is a forced buy or forced sell if triggering events such as death, coma, total permanent disability or critical illness happens. There is no room for further consideration – a transaction must take place. However, there is another type of agreement, which offers a more flexible approach so that the business owner is not locked in to a forced buy or sell position. We call this the Cross-Option Agreement.
Diagram A: General Structure of Business Exit Agreement
A Cross Option Agreement is also known as a “wait-and-see” Agreement or Double Option Agreement. It is considered as “wait-and-see” because it may be difficult to decide in advance what action is to be taken by the business owners upon the occurrence of triggering events. Under such an agreement, the business partners give each other both a Put Option and a Call Option (some, however, may only want one or the other but not both, depending on how flexible they want things to be). Only when a business owner exercises the option given, shall it bind the other business owner(s).
In a Cross Option Agreement, the surviving business owner(s) have an option to buy (“call”) the business interest from the affected business owner’s legal representative, and the legal representative of the affected business owner has an option to sell (“put”) the shares to the surviving business owner(s).
For example, if the surviving shareholders want to buy the deceased shareholder’s shares then the latter’s legal representative must sell them in accordance with the terms of the Cross Option Agreement. Likewise, if the shareholding is offered by the personal representative to the surviving shareholders then they must buy. Just like in the case of a Buy-Sell Agreement, the Cross Option Agreement must state the trigger events for the option to be exercised and also the agreed period for an option to be exercised when a trigger event occurs.
Different events may allow the exercise of different types of options available to the business owners under the Cross Option agreement, for example:
Event #1: What happens upon the death of any of the business owner? “Double Option” is given to the parties – here the personal representative of the deceased business owner shall have the option to require (“put option”) the other surviving business owners to buy the interest of the deceased business owner and at the same time the other surviving business owners shall have the option to require the personal representative to sell (“call option”) the interest of the deceased business owner. Please see Diagram B for this scenario.
Diagram B: Business Owners execute a Double Option and surviving owners execute call option upon death of one
Event #2: What happens upon the occurrence of any critical illness and disability of a business owner? “Single Option” is given to the critically–ill or disabled business owner, he/she shall have the option to require (“put option”) the other surviving business owners to buy his interest. This prevents a disabled business owner who can still contribute to the business effectively from being forced to sell (and forced out of the business) to the other co-owners when they exercise their call option. Diagram C illustrates the usage of Single Option.
A, B and C enters into a cross option agreement and in the event B suffers from a minor heart attack, he is not forced to sell to A & C. After a few months of resting, if he is able to continue to work, he can then choose not to exercise his put option. If in this example, after a few years of working, a second heart attack strikes and this time, it is more severe and B becomes disabled, he can now choose to exercise his put option & sell his shares to A & C. The money he receives may be used for his maintenance and medical purposes.
Diagram C: When to a Single Option Agreement is used
In some cases especially when there is an inactive business owner who does not intend to buy out the others when an event occurs, a Call Option is preferred and is given to the active business owners. This is because it will give the “buyer” an option as to whether they would want to purchase the business interest of the inactive party. But note that in the event something happens to him, there is no compulsion for the active business owners to purchase from him so he or his family can be stuck with the shares.
Both a Buy-Sell Agreement and Cross Option Agreement, when executed by the business owners is a legally binding contract ensuring the protection of the business value and smooth transition of the business when a partner suddenly exits the business due to unforeseen circumstances. The agreement must be drafted by experienced corporate lawyers who are familiar with Business Value Protection.
In the next issue, we’ll explore some of the defective agreements which were not done properly. It is our responsibility as a Professional Estate Planner to educate the Malaysia SME business owner on the do’s and don’ts when executing such important agreement. Stay tuned …
About the Author:
Evanna Phoon is CEO & Founder of www.MalaysiaWills.com, Malaysia’s first online will writing service provider for Rockwills Corporation Sdn Bhd & as-Salihin Trustee Bhd. Visit her website to download FREE ebooks & watch over 300+ videos on the topic of Will Writing for Personal & Business. She can be contacted via email@example.com.