Business Law: Does Your Buy-Sell Agreement Have a Loophole?

Buy-sell agreements are commonly used in small businesses to control the transfer of ownership interests. Among other purposes, this control allows the ownership group to avoid becoming saddled with a stranger as a co-owner. Accordingly, events such as the death, permanent disability and termination of employment of an owner (“DDT Events”) frequently trigger the right of the business or the other co-owners to buy out the interest of an owner who becomes the subject of a DDT Event.

Just as commonly, individual business owners engage in estate planning which includes the formation of a living trust into which substantially all of his or her assets are transferred, including business ownership interests. So, what happens when a part owner of a business enters into a buy-sell agreement that includes rights to purchase on the occurrence of a DDT Event and then transfers his or her ownership interest in the business to a living trust? Does the occurrence of a DDT Event regarding the individual trigger a right to purchase the ownership interest that is now held by the living trust?

In the recent decision of Han v. Hallberg (May 21, 2019), the Second District Court of Appeal addressed a similar situation. There, four dentists entered into a partnership to own a dental office building and one, Dr. Hallberg, then transferred his partnership interest to his living trust. In recognition of the transfer, the partners amended their partnership agreement to substitute in the trustee of the living trust as a partner in place of Dr. Hallberg. Years later, Dr. Hallberg passed away. The remaining partners then sought to exercise their buy-sell rights under the partnership agreement against the living trust asserting that Dr. Hallberg and the living trust were the same person for purposes of DDT Events. However, the Court disagreed and determined that the living trust was a separate “person” under the Uniform Partnership Act and was permitted to associate in the partnership. Therefore, Dr. Hallberg’s death did not trigger any right of the remaining partners to purchase the partnership interest since the living trust (not Dr. Hallberg) was then the partner in the partnership and thus the owner of the partnership interest.

While Han v. Hallberg deals with partnership law, the decision may also implicate corporations and limited liability companies, as many shareholder agreements and operating agreements contain similar buy-sell provisions triggered by owner DDT Events. Are you a party to a shareholders agreement or an operating agreement? If so, how does your agreement handle DDT Events when owners hold their ownership interests in their living trusts?

Silence on this issue is not golden. Rather than leaving the issue to future litigation, a shareholders agreement or operating agreement can be amended to address whether a DDT Event of an individual triggers a buy-sell right on an ownership interest held in the individual’s living trust. The lawyers at Poole & Shaffery LLP are adept at drafting buy-sell provisions to carry out the intentions of its clients so that continuity of business ownership interests can be assured and the prospect of future litigation minimized.