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Life Insurance in Buy-Sell Agreements
Buy-sell agreements should address the disposition of life insurance policies
when the need for coverage ends
A well thought-through buy-sell agreement is critical in any business that has
multiple owners. Buy-sell agreements serve many purposes; they are generally
structured to allow co-owners to agree, in advance, on how business ownership
transfers will be addressed if one of the owners dies, retires, becomes
disabled, gets divorced, files bankruptcy, wants to sell his interest, defaults
on his responsibilities spelled out in the company’s operating agreement, and so
To spare the company and its owners from having to come up with large sums of
cash to buy the interest of a departing member or his survivors, many buy-sell
agreements call for the purchase of insurance that will fund the buy-out under
certain circumstances, such as the death of an owner. Most policies are owned by
the business or its owners, or they might be owned by a trust, an LLC or a
Dispute. But what happens when the need is no longer there for the insurance,
but one of the parties wants 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.
In this case, two business owners bought a $2.5 million life insurance policy on
each other to fund a cross-purchase buy-sell agreement. This is a common and
prudent approach. The twist came 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 be either transferred to him or canceled, arguing
that Jacobs no longer held an insurable interest in Hilliard’s life.
The court disagreed, noting that Indiana law does not require the presence of a
continuing insurable interest.
It is noteworthy that 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 tried to address the issue in either
the agreement or through the closing documents of the business sale.
Lesson. For business owners and their professional advisors, this case carries
an important lesson: Be sure that buy-sell agreements address the disposition of
life insurance policies when the need for coverage ends. Or, alternatively,
include language that gives an insured party the opportunity to acquire
ownership of a life insurance policy that was originally intended for buy-sell