They are concerned that a Life Insured might not want to sell their Equity, just because they have suffered a Trauma Condition and received a Trauma Benefit (e.g., $400K Buy/Sell Cover).

Sometimes, the early diagnosis and treatment of a Trauma Condition can allow the Life Insured to return to work in better health.

If they don't want to sell, in a sense, the Trauma Buy/Sell Cover and the Premium has been "wasted".

This concern can be overcome by the Business Succession Agreement.

Standard Clover Law Trauma Buy/Sell Provisions

The standard Clover Law Agreement does not require a sale of the Proprietor's Equity, just because the Life Insured has suffered a Trauma Event and received the Insurance Proceeds attributable to the Pre-agreed Sale Price.

Instead, it contains a "Crediting Provision" that requires the Vendors to give credit for the original Trauma Insurance Proceeds upon a subsequent sale.

Payment to Life Insured or Vendors

If the Buy/Sell Policy is self-owned, the Life Insured will receive the Insurance Proceeds directly from the Insurance Company.

If the Policy is owned by an InsuranceTrust, the Trustee must pay the Insurance Proceeds to the Vendors.

Either way, the Vendors must give credit for the Insurance Proceeds upon a subsequent sale.

Subsequent Sale

A sale might take place subsequently, if:

the Life Insured is unable to resume full-time, active employment within 12 months;
their condition worsens and they are forced to retire;
they become disabled; or
they die.

At the time of the eventual sale, the Purchasers would receive credit for the Trauma Insurance Proceeds (e.g., $400K) against the Sale Price.

If the Pre-agreed Sale Price was still $400K, they would not have to fund any additional payment.

In a sense, they still obtain the benefit of the Trauma Buy/Sell Cover.

Their Premiums have not been wasted.

If the Equity has increased in value in the meantime, the Purchasers would only have to pay the shortfall.

Example

The Life Insured has Trauma Buy/Sell Cover of $400K.

The Life Insured suffers a Trauma Condition and receives a payment of $400K.

The Life Insured is not obliged to sell their Equity.

However, when they do, they must give the Purchasers credit for the $400K originally received by them.

Two years later, the Life Insured's condition worsens and they decide to retire.

If the Pre-agreed Sale Price of their Equity has increased to $600K in the meantime, the Purchasers would only have to fund the shortfall of $200K.

Buy/Back of Death Cover

In the case of Policies that bundle the Death and Trauma Benefit onto one Policy, the payment of the Trauma Benefit will reduce the Death Benefit by an equivalent amount.

A Life Insured may elect to have a "Buy/Back Option" that allows them to "buy back" the Death Cover 12 months after the payment of the Trauma Claim.

The Option allows them to increase their Death Cover to the original Sum Insured at the same level of Premium that would have been payable if they had not suffered the Trauma Condition.

Upon the exercise of the Buy/Back Option, the parties would normally have reinstated a complete funding strategy for a Death.

The new Death Cover would therefore include provision for the original Pre-agreed Sale Price.

Unless otherwise agreed, the original Trauma Proceeds would then constitute a windfall of a personal nature to the Life Insured.

If the Pre-agreed Sale Price had increased, the parties could agree to credit the original Trauma Proceeds to any future Sale Price.

Buy/Back of Trauma Cover

Some Insurance Companies now allow the Policy Owner to reinstate the Trauma Cover after 12 months.

The reinstatement would normally be restricted to Trauma Conditions other than the Condition that resulted in the original Claim.

Upon the exercise of the Buy/Back Option, the parties would normally have reinstated a complete funding strategy for a Trauma as well as Death.

Duration of Crediting Provision Can Be Limited

The standard Clover Law Agreement allows the parties to "switch off" the Crediting Provision after a period of time specified in the Agreement.

This period can be as long or as short as the parties consider appropriate when entering into the Initial Agreement or upon a variation.

However, the default period is 12 months (i.e., the duration of any Buy/Back Option).

If the Life Insured sells their Equity within the specified period, they must credit the Insurance Proceeds against the Pre-agreed Sale Price.

However, when the specified period has expired, they are no longer required to credit the Trauma Proceeds against the Pre-agreed Sale Price.

From this point onwards, the Purchasers must fund the Pre-agreed Sale Price.

However, usually the parties would have bought back the original Death Cover at the same time.

This means that the Purchasers will now have a complete funding strategy, at least for Death.

If the parties are concerned about the risk of losing the benefit of the Trauma Buy/Sell Cover, they can set a longer period (e.g., five, ten, 20 years).

Vendor Finance for Any Shortfall

If it is not possible to increase the Death Cover in the case of future increases in the Purchase Price, it might be necessary to consider Vendor Finance arrangements for any shortfall.

Trauma Buy/Sell Arrangements in the Absence of Trauma Cover

The standard Clover Law Agreement does not make the occurrence of a Trauma Condition (whether insured or not) a Trigger Event for a Sale of the Proprietor's Equity.

If Trauma Cover is not available or obtained, Clover Law does not recommend that there be a Sale triggered solely by the occurrence of the Trauma Condition.

The Trauma Condition itself might not immediately lead to the departure of the Proprietor.

Often, the early detection of the condition can result in its successful treatment and the return of the Proprietor to work.

In these circumstances, it would not be fair to impose a Sale on the Proprietor.

However, the standard Clover Law Agreement does make provision for an Option to Purchase (or Call Option) exercisable by the Purchasers, if the Proprietor wishes to retire or sell their Proprietor's Equity.

The Option is triggered not by the Trauma Condition itself, but by the fact that it caused the Proprietor to want to retire or sell.

Thus, the Agreement treats this situation the same as a Retirement caused by any other personal or commercial factor.

Adviser Tip

All standard Clover Law Agreements are intended to give a Business greater functionality, security, tax-effectiveness and cost-effectiveness than Business Succession Agreements prepared by other Lawyers.

See more Adviser Tips

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