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Unintended Consequences: What Does Your Buy-Sell Agreement Say and What Does That Do to Your Surety Support?

A case study by Gene Lilly Surety Bonds and the Ash Johnson Company
by: Jake Buss and Jim King-Gene Lilly Surety Bonds and the Professionals at Ash Johnson Company

In our introductory article in February, we discussed some of the most common mistakes that are made in the business succession planning arena. Lack of collaboration/communication among your advisory team can be detrimental on many fronts. (Hint: Every advisory team needs a QB) The following is a “real-life” example of what can happen when the left hand doesn’t know what the right hand is doing.

Two brothers owned a small construction company and over a 15-year period, build it into a very successful business. Their success and character allowed them to develop a strong surety relationship. As is often the case with success, their many achievements added more levels of financial complexity to the planning process, so one-by-one they began forming various alliances with professional advisors: an attorney, a CPA, a surety and an insurance agent. Somewhere along the line, it was recommended that they consider creating a formal succession plan. The brothers/partners agreed, and began scheduling meetings with each advisor (separately) until finally they felt they had a “plan” in place that would protect the continuity of the company and maintain family unity. Buy-Sell agreements were drafted and $2 million dollars of life insurance was purchased. (Hint: No Team Here).

Nine years go by and the business grows as did their surety relationship. The two brothers were able to bond virtually any project that they had requested. Their kids are now in high school and college, when the oldest brother finds out he has cancer. He spends the next 18-months fighting to stay alive, and you guessed it, he passes away. All parties pull out the dusty documents that were executed ten years earlier and the story unfolds as follows: (BTW, where has the QB been all these years?)

A new team of legal, insurance and bonding professionals are introduced to the widow just weeks after her late husband’s funeral. They are asked to assist her with understanding the terms of the brother’s buy-sell agreement which had been developed for the partners and the LLC. The plan (as the widow understood it), was for her brother-in-law to use the $2,000,000 of life insurance proceeds – which he received income tax free – to acquire her share of the construction company. This would allow the company to carry on without affecting their balance sheet and therefore the company’s bonding capacity. However, she had reached out to him and hadn’t heard back. Well, here goes………….

Come to find out, the life insurance was issued on a “cross-purchase” arrangement – meaning that each brother owns a policy on the life of the other, and is the beneficiary of its proceeds. This typically would be perfectly fine for this situation; however the buy-sell agreement was structured as an “entity purchase”. (The buy-sell agreement had only a Purchase Option provision, NOT a Mandatory repurchase provision which was not exercised)

The surviving brother kept the $2 million bucks, along with his interest in construction company … and prepared to retire in the Caribbean. He requested off the indemnity with the surety company and off the guarantee notes with the bank. The surety company became weary of future support and the bank retracted the credit it had extended. The widow was left to try to run the company her late husband had started. She struggled through the remaining jobs. Project owners were questioning the validity of this once strong contractor. With little to no surety or bank support, she was left with no options. Ultimately there was an auction of equipment and she was left with the meager proceeds which she had to split with the surviving partner.

The moral of this particular story is to appoint a QB to keep everyone working together. They had all the right people around them, but they were not on the same page. They even put a buy-sell agreement together and purchased life insurance. However, what was originally meant to be a tool designed with everyone’s best intentions ended up being a detriment that led to the demise of a strong company.