Will your buy-and-sell contract stand up in court?
Many prudent business owners entered into contracts to regulate the situation where a co-owner dies or becomes disabled.
These contracts are commonly known as buy-and-sell contracts. A buy-and-sell contract stipulates that the surviving owner will buy the share of the deceased owner upon the death of the latter.
The purchase price, or a formula to calculate the purchase price, is included in the contract. Each party then insures the life of the other party for the purchase price.
The contract may also include a provision that a disabled business owner’s share must be bought by the other owner upon the disablement of one of them.
The Companies Act of 2008, which came into effect on 1 May 2011, brought about important legal changes with regard to the operation of buy-and-sell contracts.
Before the 2008 Companies Act, any contract between shareholders (including buy-and-sell contracts) could alter the founding document of the entity. Following the enactment of the Companies Act of 2008, the founding document is now called the Memorandum of Incorporation (previously referred to as the Memorandum and Articles of Association).
Section 15(7) of the Companies Act of 2008 changed this position. Any contract between shareholders must now align with the provisions of the Companies Act, as well as with the provisions contained in the Memorandum of Incorporation. If any subsequent contract (including a buy-and-sell contract) does not align with the provisions already incorporated in the Memorandum of Incorporation, the provisions of the subsequent contract are void. This means that many buy-and-sell contracts are void and unenforceable – which those prudent business owners who entered into the contracts are not aware of.
I would strongly recommend that every business owner who entered into a buy-and-sell agreement should seek the help of a qualified financial adviser to ensure that the buy-and-sell agreement and the Memorandum of Incorporation of the company are in alignment.
While doing so, it may also be worth your while to ensure that the sums assured of the policies taken out to fund the buy-and-sell contract are still reflecting the value of the business. If not, business owners may find themselves in the situation where one is obliged to buy a partner’s share of the business, but the amount of money the policy pays out is totally inadequate.
Article Written by Adv. Kobus Engelbrecht, Marketing Head: Sanlam Business Market.