What You Need to Know about Involuntary Disability Triggers
By: Barry E. Haimo, Esq.
May 3, 2024
Disability is a common trigger of an involuntary transfer. If someone cannot perform, they are not able to contribute to the business. They will, meanwhile, continue to own shares and receive distributions (not salary). That alone is a difficult pill to swallow for partners who are working tirelessly to build the business.
In addition, a disabled person will have either an agent under power of attorney or a guardian acting on their behalf. That means that a third party will be participating in the business for them, including possibly voting on matters.
Learn more about how this works and what you can do to protect your business below.
The 411 on Involuntary Disability Transfers
Let’s talk a bit more about what happens when a business partner becomes disabled and the two types of agents that might take over for them.
Read Transcript
Thanks for tuning in to another dose of Bite-Sized Bits of Knowledge, where we give you meaningful information in a short amount of time. Today we’re talking about involuntary transfers, specifically on disability as a means of triggering a sale back to the existing partners.
And here’s why that might be a good idea. You have your business, you’ve worked hard, you’ve put it in your blood, sweat, and tears, your energy, your time, and your money into this business to develop into something special. It is now becoming a profitable asset and one of your partners becomes disabled.
Whether it’s a physical disability, it’s a mental disability, maybe it’s a mental incapacity like Alzheimer’s or dementia, it doesn’t really matter. The point is that this person cannot meaningfully contribute to the business any longer and they’re occupying a significant amount of shares.
So it puts you in a bad spot because you need to have that role filled. And unless you have the finances to do it, you can’t give equity because you’re going to dilute everybody else. So even if you could find the right person to hire without equity, then this disabled person is still benefiting from the hard work and labor of everybody else.
Now, that might be totally acceptable. That might be the original intent. But if it’s not, you have to do something about it. Because it’s kind of like one of those things where if you don’t do something about it, then that disabled person is going to continue to own the shares whether you like it or not.
So, what happens if they continue to own the shares? Here’s what happens. One of two things is going to happen, or I should say one thing will happen in one of two ways.
And what I mean by that is that you’re going to have a third party step into the shoes of the person to exercise control over their shares, voting, participation and management, rights to receive notice of things that are going on, and overall just being involved. That person is either going to be a guardian or an agent under power of attorney.
If you don’t have your estate plan documents done, you should get them done. You should watch my other videos on that. But if you don’t have them done, you don’t have them done.
You’re going to go through the probate court, which is the guardianship court, which is the probate court’s cousin. The guardianship court – it’s a whole other video for what the guardianship is, but basically a guardianship court is going to result in the disabled partner being evaluated and ruled incapacitated to some degree and a guardian being appointed over this person to make their decisions and take care of them, take care of their financials, their legal insurance, their business interests. The guardian is going to be your partner.
Guardians can be professional guardians. They could be family members as guardians. Most likely not going to be qualified to be your partner. Or interested and focused and committed to being your partner. I can’t imagine being a guardian being a good idea to be a partner.
By that same token, the other way it could happen is that that person did some planning and they appointed somebody that they thought would be a good fiduciary on behalf of their financial, legal, insurance, banking, tax, business needs, and that’s their agent.
Under a power of attorney, that agent is the same thing as a guardian in this context. It’s a third party who’s going to be involved in your business. It may not be the right people. Again, might not be qualified, interested, committed, liked, or they might not be fitting in and you might not like them.
So again, you have a problem with the disabled person in your business that can’t contribute and someone else is going to start basically taking over their shares and then ultimately, like everybody else, they’re going to pass away. And then that triggers a whole death problem that we already talked about. So you got to think it through. You really got to think this stuff through or else it’s going to bite you in the butt.
I hope that this was helpful. Please feel free to download the free materials in the description. One is a Business Planning Stress Test, the other is a formation chart for Florida, and there will be some other goodies in there as well. Thank you for stopping by and stay tuned for more.
The question you’re probably wondering right now is: how can I stop this from happening to my business?
Setting Up a Trigger to Deal with Involuntary Disability Transfers
No one wants to imagine their business partners going through something like this, but the reality is that it happens. And when it does, it can cause havoc for businesses.
Because of that, there are legal steps you can take – preferably when you’re first forming the business – to guarantee that the company has the opportunity to regain the disabled partner’s shares. Namely, you want to make sure you create a clear Buy-Sell Agreement that covers involuntary disability transfers.
What exactly is a Buy-Sell Agreement?
Essentially, this is a contract established between a business entity (such as a corporation or limited liability company) and its owners to address both voluntary and involuntary transfers of ownership. It serves as a prearranged plan that becomes effective only when specific conditions or events occur. In other words, when those events occur or conditions are met, the Buy-Sell Agreement is “triggered” and comes into play.
Typically, these conditions or events encompass (i) the voluntary transfer of ownership interests to a third party and (ii) occurrences like death, permanent disability, divorce, or termination of employment of one of the owners, which could lead to or trigger an involuntary transfer of ownership interests.
Determining the course of action for ownership interests in these circumstances should be tailored to each company’s distinct ownership structure, developmental trajectory, and the requirements and situations of the owners and their families.
How Does the Trigger Work in the Case of Involuntary Disability Transfers?
To deal with situations like this, you would put language into the Buy-Sell Agreement stating that in the event of an owner’s disability or incompetency, the company and/or other owners have the option to purchase some or all of the shares owned by the disabled owner.
Unlike in the case of death, where the owner is no longer alive, in a disability scenario, the owner may still be living and capable of affecting decisions regarding the shares. Therefore, it’s important for the parties involved to consider whether to include such a provision and, if so, how to define disability to trigger this provision. For instance, disability could be defined as the inability to use limbs, perform daily job functions, make decisions, or control mental faculties.
Additionally, it’s worth noting that if there’s already a provision addressing death, then even if a disability provision isn’t present, the death provision will eventually come into effect and address ownership issues at that time. Similarly, if there’s a termination of employment provision in place, it might not be necessary to include a disability provision because if the owner becomes unable to fulfill job duties, the employment provision could be activated.
Parties also have the choice to fund the buy-out through permanent disability insurance, which the company can cover, helping to finance part of the purchase price. However, it’s crucial for all parties to understand the workings of permanent disability insurance, as it differs from life insurance in its mechanics and coverage.
Don’t Let an Involuntary Disability Transfer Leave Your Business Unmoored
As you can see, there are a lot of things to think about and quite a bit of specific language that needs to be used in these types of “triggered” documents. Crafting them in a way that best fits your business can be challenging.
Make sure your business does everything the right way by getting in touch with us to talk about your needs. We’re always ready to help.
Educate yourself – don’t forget to download our FREE:
Florida Business Entity Comparison Chart
Originally published 03/03/2022. Updated 05/03/2024.
Author:
Barry E. Haimo, Esq.
Haimo Law
Strategic Planning With Purpose®
Email: barry@haimolaw.com
YouTube: http://www.youtube.com/user/haimolawtv
YOU ARE NOT OUR CLIENT UNLESS WE EXECUTE A WRITTEN AGREEMENT TO THAT EFFECT. MOREOVER, THE INFORMATION CONTAINED HEREIN IS INTENDED FOR INFORMATIONAL PURPOSES ONLY. EACH SITUATION IS HIGHLY FACT SPECIFIC AND EXCEPTIONS OFTEN EXIST TO GENERAL RULES. DO NOT RELY ON THIS INFORMATION, AS A CONSULTATION TO UNDERSTAND THE FACTS AND THE CLIENT’S NEEDS AND GOALS IS NECESSARY. ULTIMATELY WE MUST BE RETAINED TO PROVIDE LEGAL ADVICE AND REPRESENTATION. THIS INFORMATION IS PROVIDED AS A COURTESY AND, ACCORDINGLY, DOES NOT CONSTITUTE LEGAL ADVICE.
