August 2020 - MLP Law

Cross Option Agreements

If you are a small or medium sized enterprise run by owner-managers, the death of a shareholder can have a major impact on the company.  It can cause major disruption, particularly if the shareholder is a key decision maker within the business.  Will the deceased shareholder’s shares pass to a family member?  What if they are inexperienced or have no interest in the business? What if they do not want the shares?  Can the other shareholders purchase the shares of the deceased?

A Cross Option Agreement grants each shareholder an option for their shares in the event of their death to:

  • Grant to the surviving shareholder(s) a right to buy the deceased’s shares; and
  • Enables the deceased’s family to compel the surviving shareholders to buy the deceased’s shares

The question of whether the surviving shareholders have funds to buy the shares at the time of death may well be an issue.  For this reason, the option is usually backed by an appropriate life assurance policy taken out by each shareholder to ensure there are funds available to cover the purchase of shares and avoid cash flow issues.

Considerations:

  1. Valuation

The valuation at which the shares of a deceased can be purchased must be agreed between the parties and set out in the Cross Option Agreement. This may be the fair market value of the shares at the time of acquisition, or an agreed value fixed in advance, or simply the sum of the life policy in relation to the deceased shareholder’s shares.

  • Life Assurance / Key Man Policies

The value of the shares should be regularly assessed and the policies updated regularly, usually every 12 months, or if a significant life event occurs.  If the policy is not updated, it may not cover the value of the shares of the deceased shareholder.

  • Costs

When considering a cross option (backed by a life policy) the shareholders need to consider whether the risk of shares falling into unwanted hands (ie. a deceased shareholder’s family members) outweighs the cost of the insurance premium.  For some companies, the loss of a key man could have adverse consequences and significantly change the business.

  • Tax

There are tax implications to shares changing hands.  By structuring the transfer of shares in this way in the cross option, business property relief may be available and, in valid circumstances, relief from inheritance tax.  Please note that tax law can change so you are advised to consult your tax advisor.

Cross Options can also be used in the event of serious/critical illness and bankruptcy situations, but this is outside the scope of this article.

Please also refer to the following related blogs:

Shareholders Agreements and Articles of Association: Does my company need them?  shorturl.at/rMNU2

Update: Shareholders’ Agreements – Is your house in order?  https://www.mlplaw.co.uk/update/

Everything you wanted to know about…Grievances…but were too afraid to ask!

From time to time, every employer will receive a grievance from one of its employees. But what exactly are grievances and how should an employer respond?

To help employers, we have set out below some answers to some frequently asked questions about grievances.

What is a “grievance”?

Essentially, a grievance is any complaint from an employee about an issue regarding their employment. Grievances can relate to a wide range of matters, but they typically concern the employee’s treatment by their employer or their relationships with their colleagues.

Do I need a “grievance policy”?

It is highly recommended that you have one, as having in place a formal grievance policy provides an effective means by which employees can raise their concerns or problems and gives employers a way to resolve them in fairly.

Do all grievances need to be dealt with via a formal procedure?

Many grievances can be resolved informally, without the need for formal investigations and meetings. In fact, an attempt to resolve concerns informally will often be the first stage of an employer’s grievance procedure.

How should I investigate a grievance?

This will depend on the nature of the complaint, but will typically involve talking with witnesses, reviewing relevant documents (such as emails and messages) and speaking with the employee who has raised the grievance to ensure you have a full understanding of their grievance.

How do I formally respond to a grievance?

Giving the employee a full opportunity to explain their complaint and present evidence in support is key. This will usually take the form of a grievance meeting, at which the employee should be given the right to be accompanied by a work colleague or trade union representative.

As the conclusion of the grievance, the outcome should be confirmed in writing and the employee should be given a right to appeal against the decision.

It is not uncommon for the resolution of a grievance to include additional measures, such as mediation between individuals or reassigning of individuals. Occasionally, upholding a grievance may also result in disciplinary proceedings being commenced against other employees, for example where there has been bullying or mistreatment of one employee by another.

Are there any other issues I need to consider?

Employers should ensure that anyone appointed to investigate and consider an employee’s grievance is fully trained on how to do so and that they have the full authority of the employer to make the necessary decisions.

Employers also need to be mindful of the Acas Code of Practice on Disciplinary and grievance Procedures, which states the following in relation to grievances:

  • employers and employees should deal with issues promptly, including not unreasonably delaying meetings or decisions;
  • employers should carry out any necessary investigations to establish the facts;
  • employees should be given the opportunity to put their case before any decisions are made;
  • employees should be able to be accompanied to grievances meetings; and
  • employees should have the right of appeal.

An unreasonable failure to follow the Code of Practice can result in an increase of up to 25% in relation to any compensation awarded in a subsequent Employment Tribunal claim.

Please don’t hesitate to contact the team at MLP Law with ideas about topics or for detailed advice in connection with any of the issues raised. You can reach us at employment@mlplaw.co.uk or @HRHeroUK or on 0161 926 9969.

Succession Planning for Business Owners Part 1 – Some Exit Options

A large proportion of business owners running small to medium sized enterprises (SMEs) do not make succession plans.  Succession planning is considering ways for the business owner/main shareholder to retire and where their shares should go, i.e. family members, existing employees/management team, sale to a third party, etc. 

It is important to make long term plans well in advance of retirement or exit of the main shareholders.  In addition to the practical and commercial issues this involves, there are both tax and legal considerations.  Advice from professional advisors is crucial and should be sought as early as possible.

This blog looks at some of the legal options for succession planning and, in particular, a company buy-back of shares, a management buy-out (MBO) and an employee ownership trust (EOT).  Sales to a third party purchaser are covered separately and outside the scope of this blog.

  1. Company buy-back of shares

A company buyback of its own shares (Buyback) can be advantageous to facilitate the retirement of the main owner of the company, particularly where a direct purchase of shares may be impractical due to a lack of funds.  A Buyback allows the company to fund the purchase.  However, the rules of the Companies Act 2006 must be followed. The company must have sufficient distributable reserves to fund the purchase and immediate payment is required, so no deferred payment terms.

Tax advice should be sought at the outset for both the company and the selling shareholder.  Briefly, considerations for tax clearances are as follows:

  • the company must be an unquoted trading company and the purpose of the Buyback must be for the benefit of the company’s trade 
  • the selling shareholder must be a UK resident, held the shares for at least 5 years, must sell all or substantially reduce their shareholding and they cannot be ‘connected’ immediately after the Buyback, i.e. they cannot hold more than 30% of the issues shares, loan capital or voting rights

HMRC advance clearance should be sought at the outset and there are post transaction reporting obligations, which you tax advisor will assist with.  Stamp duty is payable on the purchase at 0.5%

Please also see our previous blog, Company Buyback of Shares

  • Management Buy-Out (MBO)v

Under an MBO, a newco will be incorporated to acquire the business from the selling shareholder.  The newco will be made up of the management team who wish to take over the business.  The existing shareholder(s) may also take part in the MBO to retain a stake in the company (vendor-induced management buy-out, VIMBO).  This can be a flexible option as it allows for new and existing shareholders, it is easier to obtain CGT treatment and there is no need for reserves or immediate cash.  Funding may come from cash reserves of the company, MBO team money, third party funding such as private equity investments and/or deferred consideration.  Often it will be a combination of these.

If considering an MBO, it is important to identify key individuals and communicate with them about the possibility of them taking over at some stage.  There will be tax consequences for all the parties and it is important that advice and clearances are sought at an early stage.

MLP will be publishing a series of blogs on MBOs in the coming months. 

  • Employee Ownership Trust (EOT)

Under an EOT, the controlling interest of the company is held in trust for the benefit of all the employees.  All employees have a stake in the business, so it is thought to drive positive behaviours in employees and help a business thrive.  Many refer to this option as the ‘John Lewis model’.

An EOT can be a practical solution if a third party purchaser cannot be found or an MBO is not a viable option.  It is a tax free option for the disposing shareholder as it is treated as a no gain/no loss disposal.  The Trust can make an income tax free bonus to all employees on an annual basis.

To get the CGT exemption, the company must be a trading company and the EOT for all eligible employees.  There is a ‘controlling interest’ requirement so more than 50% of the shares and voting rights must be held by the Trust.  Smaller businesses may not meet the criteria as the ratio of participators benefitting from the exemption on sale to the number of employees participating must not exceed 40%

Practical considerations will include: How will the consideration be funded? Who is leading/driving the business? How flexible is it to sell in the future? Can managers be better incentivised with minority shareholdings, EMI schemes or similar?

Please refer to our Guide to Employee Ownership, which is available upon request.

WOULD YOU WANT TO CARRY ON SUPPLYING A CUSTOMER WHO COULDN’T PAY YOU?

Covid Regulations for businesses mean that you may be required to continue supplying such goods or services – even if your customer cannot pay you.  The detrimental impact is clear. We explore what you can and should do now to help protect yourself.

In our recent blog on trading terms https://rb.gy/vktdic we set out aspects you should consider to determine if your terms and conditions are fit for purpose. We will now consider, specifically, your rights as a supplier if your customer cannot pay or enters insolvency, which many of our clients are currently having to deal with as a result of Covid-19.

The Corporate Insolvency and Governance Act 2020 (CIGA) was introduced in June 2020, as a direct result of Covid-19 and the impact it is having on all types of businesses sectors. One of the effects of CIGA is that it amends the existing termination provisions in the Insolvency Act 1986.

These ‘customer friendly’ amends provide that where a company has entered certain insolvency procedures, such as administration, liquidation, and restructuring procedures, their supplier of goods or services will no longer be able to rely on contractual terms to terminate the contract. Before CIGA, such restrictions only applied to so called ‘essential’ supplies such as utilities, telecoms, and IT. Now however, these restrictions apply to all suppliers of goods and services.

You may therefore be required to continue supplying such goods or services – notwithstanding your customer’s inability to pay you. This is clearly detrimental to you as a business, who no doubt, will too be facing the harsh impacts of Covid-19.

Small company exception

Note that CIGA will not apply to you if your company is considered to be a ‘small’ company. To qualify as a ‘small’ company under CIGA, two of the following conditions in your most recent financial year must be met:

  1. your turnover must not be greater than £10.2 million;
  2. your balance sheet total must not be greater than £5.1 million; and
  3. you must not employ more than 50 employees.

Options

If you are a supplier with customers who are at risk of becoming insolvent due to Covid-19, your options for terminating the supply of goods in the event that one of your customers becomes insolvent are now more restricted as a result of CIGA.

We recommend that you review your terms and consider how protected you actually are in the event that one or more of your customers faces difficulty; in these trying times, this is a possibility – so you should be prepared. You may want to consider amending your terms of business in one or more of the following ways:

  1. Adding a clause which allows you to recover goods if your customer is unable to pay for them (known as a retention of title clause). This would of course need to be incorporated in a separate clause from anything insolvency related, which as stated, might be ineffective under CIGA. There is a chance that the courts may find a clause of this kind to be ineffective amidst Covid-19 – therefore we will not actually know the position until the courts have had to consider it.   
  • If you don’t have it already incorporated into your terms, consider making a late payment by a customer an event which allows you to terminate. You may want to interpret this strictly, i.e. following any late payments you may be able to terminate the agreement, or, you may wish to offer your customers a ‘grace’ period of say, 30 days.
  • You may want to state that any future contracts will be for a limited period, after which they will automatically terminate, or must be renewed. You may also wish to consider using framework agreements – this way, each order of goods will be considered to be a separate contract with no on-going obligation to continue providing goods.
  • Furthermore, a provison which allows you to terminate the agreement if there is a change of control of the other party will be permissible. If for example, a customer undergoes a major restructure following Covid-19, and as a result, you lack confidence in their ability to pay going forward, this clause will entitle you to terminate the agreement as a result of this change.
  • If appropriate, you may also want to consider requesting personal guarantees from your customers’ directors before accepting of an order.

In light of the above therefore, are your current terms currently fit for purpose amidst the Covid-19 landscape? Are you sufficiently protected in the event that your customers are no longer able to pay you, or if they can no longer trade due to Covid-19?   

If you think this is the case and if you would like us to review your current terms to ensure they are on your side, contact our Commercial and IP team on 0161 926 9969 or commercial@mlplaw.co.uk to receive expert legal advice for your business.

Succession Planning for Business Owners Part 2 – Issues to Consider

When owners of a business are looking for an exit, there are a number of considerations:

  • Who may buy the company?

Will it be a trade sale, management buy-out (MBO), restructure, company buy-back of shares, employee ownership trust (EOT) or other share incentive scheme

  • Is my house in order?

Ensure that any issues or potential issues that may concern a purchaser are addressed

  • Who are my advisors?

Both tax and legal advice is required and it is important to get the right team in place as early as possible

  • What is the value of the Company?

Your financial advisors will assist here but it is important to be realistic about the price you are seeking to achieve, balanced against what you require to retire or move forward with new plans

  • What financial/tax planning do I need to undertake?

Your tax advisors will be crucial here as the exit route you take may well be influenced by the tax consequences and reliefs available

  • Are my key employees/management team incentivised?

If looking at a trade sale, ensure that key employees are not going to leave and consider the use of management incentive plans

Our previous blog entitled Succession Planning for Business Owners – Part 1: Some Exit Options https://rb.gy/6jsw66 discusses some of the exit options, in particular, a company buy-back of shares, a management buy-out and an employee ownership trust.

Other considerations and planning required before determining an exit route are as follows:

  • Restructure the shareholdings

You may look to transfer shares to a spouse or children or a family trust prior to a sale.  Tax advice should be taken to ensure that a business owner would qualify for entrepreneurs’ relief on a sale, which is 10% tax rate as opposed to the higher CGT rate.

  • Reorganise the company/group

If the company holds property of shares that the seller wishes to retain, a demerger can be used to extract assets in a tax efficient manner. A demerger can also be used to separate part of the business, so that part can be sold and part retained. This does require early planning and appropriate tax clearance so needs consideration well advance of a sale.

  • Management incentive plans

Consider ways to lock in and incentivise managers and key employees with the use EMI schemes, Company share option plans (CSOP) and growth shares.  It is important to consider this well in advance and to get clearance where necessary.

  • Sale Proceeds

Another consideration will be how the consideration will be paid, ie. cash on completion, deferred consideration, loan notes, earn-out provisions and consideration shares in the Purchaser.  There will be different tax treatments and tax will be payable at different times dependent upon the consideration, so early tax advice is advisable.  One of the effects of COVID is likely to mean that more sellers will need to assist sales by accepting deferred consideration from a purchaser.