Wade Law Blog

Interesting Court Decision Illustrates Mistake in Buy-Sell Agreement

Feb 24, 2011| BY: Wade Law Offices

A well thought through Buy-Sell (or sometimes called shareholder agreement) is critical in any business for succession planning. But what happens when the need is no longer there for the insurance, but one of the parties desires to keep the policies in place?

A recent Indiana court case, Hilliard v. Jacobs, 916 N.E. 2d 689, highlights the need for business owners to close the loop on ownership of life insurance policies that fund a buy-sell arrangement when such coverage is no longer needed.

Typically, buy-sell agreements use life insurance to fund buy-out obligations that are created by the death of a business owner. Most such policies are owned by the business or its owners. Sometimes, they are owned by a Trust, an LLC or a partnership.

Hilliard v. Jacobs Case

In this case, two business owners bought a $2,500,000 life insurance policy on each other to fund a cross-purchase buy-sell agreement. This is a common and prudent approach. The twist came later when they sold their business to a third-party. After the sale, Hilliard requested an exchange of policies. Jacobs refused and continued to pay premiums on the policy he owned.

Hilliard filed a lawsuit requesting that the policy either be transferred to him or canceled, arguing that Jacobs no longer held an insurable interest in Hilliard’s life. The court disagreed, saying Indiana law did not require the presence of a continuing insurable interest.

Interestingly, the owners had two chances to address final disposition of life insurance policies before things elevated to a lawsuit. Their first opportunity was the buy-sell agreement itself. A second arose through a settlement agreement when the company was sold. It’s hard to tell from the reported case itself whether the parties attempted to address the issue in either the agreement or through the closing documents of the sale of the business.

Takeaway Lessons

The takeaway from this case is to make sure that your Buy-Sell agreement addresses the disposition of life insurance policies when the need for coverage ends. An alternative approach is to make sure that the agreement includes language that gives an insured party the opportunity to acquire ownership of a life insurance policy originally intended for buy-sell funding purposes.

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