Trauma payouts and buy sell agreements – what’s the best thing**?

One question that arises regularly in insurance funded buy sell arrangements is where there is trauma or critical illness cover and an insurable event occurs. For example, a principal meets a definition of under the policy but they are uncertain as to whether they want to remain in the business.

Broadly we see two main alternatives in this area, namely:

1. The options to force the buy out of the principal are triggered if they become eligible for an insurance payout under the trauma policy, regardless of whether they are able to return to the business; or
2. The options are only triggered if the principal becomes eligible for an insurance payout and they are unable to return to work within an agreed period of time (say, 6 months).

Best practice is normally to adopt the second approach.

If the principal returns to active involvement in the business but has received a payout of the insurance policy, our preferred position is that the principal who has suffered the trauma event can simply retain the insurance proceeds and there is no obligation to provide any of the payout to the other principals. The insurance arrangements and buy sell agreement would be updated at that point in time to reflect the changes in circumstances.

If another insurable event is then suffered by the same principal at a later time and no further insurance proceeds are received, the amendments made to the agreement after the first event would typically ensure the previously received insurance payout is offset against the purchase price.

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** For the trainspotters, the title of today's post is riffed from the PJ Harvey song ‘Beautiful feeling’.

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