As the name suggests, an involuntary transfer of your ownership share of a business is a transfer that you are not choosing to make. It is a transfer that is forced upon you due to specific circumstances, which are generally beyond your control.
What kind of circumstances? Things like death, disability, divorce, or termination of employment.
Below, we’re going to delve more deeply into what happens when these triggers occur, why involuntary transfers are generally bad for your business, and what you can do to minimize the damage.
Why Involuntary Transfers Are Bad for Business
Hi, thanks for stopping by and 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. What does it mean and why should you care?
So, involuntary transfers, as the name suggests, are transfers that are triggered by something automatically – and it’s usually not desirable. It’s usually something that would not be voluntary. So, for example, bankruptcy, divorce, death, total disability or disability, termination of employment, or something else. Those are situations where, in most of those cases, you’re going to either find someone else coming in and stepping in as the owner, which we’ve talked about is a bad thing.
For example, bankruptcy. That means a creditor is going to come in and take over ownership of the shares. That means you’re partners with a creditor. That means your new partner is a creditor. That means that person or business has rights as a partner to books and records, communications, notice. Voting most likely.
You don’t want to be partners with a stranger, and you certainly don’t want to be partners with someone who doesn’t care about your business. They just want to get paid. They just want to get their money and probably sell their shares as soon as possible or liquidate their shares or force you to liquidate the company. You don’t want that situation. So that’s why that’s generally one of the triggers for an involuntary transfer.
Similarly, divorce. If you have an asset that’s a business and it’s a marital asset in the marital estate, it’s going to be on the chopping block for the split in what’s called “equitable distribution.” And if that happens, you could find yourself partners with one of your partner’s spouses.
Great if you like that spouse and they have an MBA from Wharton and for some reason they’re focused on your business and only your business. But most likely that’s not going to be the case. You might not like this person. They might not be qualified. You might not want them to fit in to the culture. They might not fit into the culture. They might have no interest in fitting into the culture and they just want to be a couch potato.
Regardless, in most cases you don’t want to have a former spouse of a partner as a partner. I’ve already explained most of the reasons why. So that’s another example of a trigger that would prompt a transfer or sale of shares of a company to keep it all in the family, so to speak. And I’ll explain, again, the mechanics in another video.
So another trigger you’ll find will be death. Again, death, a person can’t contribute. You need to have somebody fill the role. Unfortunately, their shares are going to go by statute or by will or trust. That’s it. State Planning 101. Watch those videos.
Their shares are going to go through probate if it’s in their name. Their shares are going to go to the appropriate beneficiaries or heirs by statute, by will or trust. That’s it. It’s very simple. You don’t want to have it go through probate. It’s a whole other story. I have a whole other video dedicated to that.
But what’s most important relative to this video is that you don’t want the heirs or the beneficiaries to now be your partners. Same reason: they don’t know. They may not be qualified. They may not be interested. You may not be interested. They might not fit into the culture. I’m repeating myself. That’s okay.
So bankruptcy, divorce, death – disability is a little different because it doesn’t vest rights in another person necessarily, but it could. So not only can this person not contribute to the business, now you kind of have shares owned by someone who’s not able to perform.
I’m not being insensitive on being realistic. But you’re either going to have two situations. If someone is incapacitated, they’re either going to have a guardianship appointed or a guardianship proceeding, which results in a guardian being appointed, which means a third party who definitely don’t know and probably don’t want acting on their behalf and voting on their shares. And that’s a disaster.
Or you have their power of attorney because they’ve done some planning as their agent, acting on their behalf, which is, again, a third party. You may or may not know, may or may not like, may not be qualified, may or may not be focused or interested in your business.
So these are situations where you want to get the partner shares out, transferred out, sold, and the mechanics are in another video.
How Do Various Kinds of Involuntary Transfers Work?
Here, we’re going to take a look at how some of the different types of involuntary transfers work in the real world.
As mentioned above, a dead person can’t contribute to the business. So, if an owner dies, their company shares will go through an involuntary transfer where they are transferred either to that person’s estate or to a third party whom they designated, such as a non-profit or a foundation. This means that the entity who gains those shares will essentially become an owner and have full voting rights.
Disability or Incompetence
Similar to death, if an owner is declared incompetent or becomes disabled to the point that they are unable to perform their functions as an owner, their shares may transfer to a designated entity or individual outside of the company’s choosing. Alternatively, businesses can create a provision that allows them to transfer the individual’s shares back under their control if something like this occurs.
Divorce or Marriage Termination
Why differentiate between those two things? Because they can be two different things – a marriage can be “terminated” via divorce or when one spouse dies. In either situation, it is possible that the business owner’s shares might go their former spouse, putting them in the proverbial driver’s seat of the company.
Sometimes the life change that results in involuntary transfers is more business than personal. Such is the case when a company terminates the employment of an owner. While it is possible for former employee-owners to continue to maintain control over their shares even after termination, many businesses use provisions that enable them to regain control over these shares.
What Can Businesses Do to Minimize Involuntary Transfers?
We’ve already touched on this a bit. The short answer is: they can draft rules and governing documents that detail what happens in the event that any of these situations occur – so that they are able to maintain or regain any shares that would otherwise leave their control.
Namely, they need to craft a robust buy-sell agreement that covers both voluntary and involuntary transfers. This is accomplished by including specific language that refers to involuntary transfers and details how these types of situations are to be handled.
Generally, this means creating a framework by which the business can conduct a fast and fair buyout of any shares that are awarded to entities without the company’s permission. In other words, while it’s nearly impossible to stop shares from being awarded outside of the company’s control, a strong buy-sell agreement can enable your business to get those shares back quickly – so you never have to deal with having an unwanted partner.
Want to learn more about involuntary transfers and how you can protect yourself and your business? Haimo Law can help. Contact our office today to speak with an experienced Florida business planning attorney.
Originally published 2/3/2022. Updated 2/1/2024.
Barry E. Haimo, Esq.
Strategic Planning With Purpose®
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