Company Law: What happens on the death of a shareholder?

Introduction

According to the office of national statistics, sole proprietor businesses and partnerships are decreasing and the use of private limited companies is increasing. 72.5% of total UK businesses are either private or public limited companies – London remains the region with the largest number of such businesses with 19.2% of the UK total.

It could be assumed the relatively recent increase in the use private of limited companies is broadly due to the simplification of company law and the ability to register a company online without the need for a costly accountant.

However, running a private limited company provides unique challenges to the directors and shareholders, one of which is what happens to the shareholders holdings on death? The sudden loss of a majority shareholder can disrupt the company as the shares will pass to their beneficiaries.

What happens on the death of a shareholder?

Shareholdings in a private limited company and how they devolve on death is controlled by the Companies Act 2006.

For example, A&G Insurance Limited (A&G) is owned by Mr Atwal and Mr Gill who hold an equal, 50% shareholding in the company. Both directors have wills that leave their respective shareholdings to their spouses. The company is valued at £2 million, and the shares qualify for business property relief.

Mr Gill dies in 2021 and leaves his 50% holding to his wife who, in addition, is his sole executor. A&G incorporated in 2010 using the model articles for private limited companies, therefore she may rely on the model articles for private companies limited by shares, ss 27 and 28, which outline the rules the company must follow on the death of a shareholder.

    1. Transmission of shares

27.—(1) If title to a share passes to a transmittee, the company may only recognise the transmittee as having any title to that share.

(2) A transmittee who produces such evidence of entitlement to shares as the directors may properly require—

(3) But transmittees do not have the right to attend or vote at a general meeting, or agree to a proposed written resolution, in respect of shares to which they are entitled, by reason of the holder’s death or bankruptcy or otherwise, unless they become the holders of those shares.

    1. Exercise of transmittees’ rights

28.—(1) Transmittees who wish to become the holders of shares to which they have become entitled must notify the company in writing of that wish.

(2) If the transmittee wishes to have a share transferred to another person, the transmittee must execute an instrument of transfer in respect of it.

(3) Any transfer made or executed under this article is to be treated as if it were made or executed by the person from whom the transmittee has derived rights in respect of the share, and as if the event which gave rise to the transmission had not occurred.

The process of transmission of shares

Mrs Gill would provide evidence of probate (CA 2006, s 774) and execute an instrument of transfer (CA 2006, s 773). Mr Atwal at this stage must transfer the shareholdings to Mrs Gill. It should be noted the Companies Act 2006, s 771(1), allows the company to refuse any share transfer, however this cannot be relied upon in the case of a transmittee as detailed in section 711(5).

(5) This section does not apply—

(a) in relation to a transfer of shares if the company has issued a share warrant in respect of the shares (see section 779);

(b) in relation to the transmission of shares or debentures by operation of law.

The problem for Mr. Atwal

On the basis the shares are transferred to Mrs Gill, Mr Atwal must now face conducting his business with a new business partner, who may not wish to be involved on a day-to-day basis. More likely, Mrs Gill could:

  1. ask Mr Atwal to buy the shareholding
  2. sell the shares to a third party, possibly a competitor
  3. transfer the shares to other family members
  4. demand a 50% share of the dividends, while providing no meaningful contribution to the business

What is the solution?

The solution for shareholders in a private limited company is to plan a strategy before the eventual death of any shareholder, in principle pre-empt the problem. The first consideration is the articles of association, and the following clauses should be considered.

  1. The basis of how the shareholdings is valued, fair value, pro-rata or any reductions for minority shareholdings.
  2. The shareholdings values should be agreed for a period of time, for example five years.
  3. Pre-emption clauses must be included to allow the remaining shareholders the option to buy the shareholdings from the deceased’s beneficiaries.
  4. Cross option agreements should be drafted.

The legal transmission of shares cannot be limited by the articles of association, for example clauses that refused share transfers on death or attempted to transfer the holdings to other shareholders to mitigate the transfer to any executor would be deemed void.

Business Property Relief

The main consideration when drafting cross option agreements or any share purchase agreement when purchasing shareholdings from a deceased shareholder is the loss of business property relief (BPR).

BPR allows shareholdings in private limited companies an exemption from inheritance tax. The shareholdings must qualify as relevant property, been held for a period of two years and more importantly no binding contract for sale of the shareholdings can have been entered into (IHTA 1964, s 113).

Cross Option Agreements

Taking into consideration that any agreement must not be binding, the shareholders of the company can agree the value of any shareholdings and enter into a cross-option agreement. This allows either party – the other shareholders or the beneficiaries – the option to either buy or sell the shareholdings, if one side invokes the option, then the shares must be bought or sold.

A&G Insurance Limited: Key Points

Before the death of either shareholder, Mr. Atwal and Mr. Gill ought to have agreed a fixed value for five years (reviewable at that date) of £1 million for each shareholding. The articles of association would have been revised to include pre-emption rights and details of how the shareholdings are valued and on what basis.

As the articles of association are a public document, it is normal practice for more private agreements to be executed outside of the articles of association. Therefore both shareholders would sign a separate, cross-option agreement without creating any binding agreement.

On the death of either shareholder the company can invoke its option to buy the shares from, in this case, Mrs. Gill.

It is standard practice subject to the health status of the shareholders to effect life insurance in trust to pay for the shareholdings. This provides cash for the purchase without the need for the company to utilise its own cash resources (should these be available) or the requirement to affect any borrowing.

Richard C. Bishop is the author of Articles of Association: Guidance and Precedents and Articles of Association for Charities and Not for Profit Organisations: Guidance and Precedents.

Richard C. Bishop

Written by Richard C. Bishop

Richard is lecturer in finance at Leeds Beckett University teaching in the Centre for Tourism and Hospitality Management. Prior to working at Leeds Beckett, Richard taught marketing and business strategy at Wolverhampton University, specializing in delivering CIM modules and lead the financial service degree program at Coventry University College.

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