Is Your Buy-Sell Agreement Funded with Life Insurance? There May Be a Problem

On June 6, 2024, the Supreme Court upheld the Connelly v. United States ruling. The Supreme Court looked at the case because there were divergent rulings on whether corporate-owned life insurance (to be used as a funding mechanism to repurchase shares upon the death of a shareholder) increases the value of the company or if the “obligation” to purchase the shares offsets the life insurance proceeds. The 2005 Estate of Blount v. Commissioner ruled that the company’s liability to repurchase the shares offset the life insurance proceeds and did not increase the company’s value to the Estate. The original June 2023 ruling of Connelly v. United States held that the life insurance proceeds received by a company are an asset of the company and increase its value to the Estate. In their June 2024 ruling, the Supreme Court upheld the Eighth Circuit Court’s decision that the corporate-owned life insurance does increase the company’s fair market value and, in effect, the value to the Estate.

It is unknown to us when or if there will be additional cases challenging the Supreme Court’s decision. There are some issues with the ruling, which I believe could be challenged. But, given the ruling we have today, many buy-sell agreements will be impacted. In my experience reviewing hundreds of buy-sell agreements, virtually all the agreements reviewed which use corporate owned life insurance as a funding mechanism do not consider that the life insurance proceeds will increase the value of the company. The belief has been that the repurchase obligation offsets the proceeds. Under the Connelly ruling, the current amount of life insurance may not be sufficient. The Company would have to pay for the shortfall out of existing working capital or incur additional debt to redeem the stock. This could have a devastating impact on the Company.

What Can You Do?

At a minimum, I believe that one should have their buy-sell agreement reviewed by competent legal and valuation counsel; alternative funding mechanisms could be explored. The agreement should be reviewed to ensure the appropriate valuation wording is used and a valuation process established. All trigger events should be identified. In my opinion, it is a great time to have the fair market value of one’s company calculated, so that the correct amount of corporate-owned life insurance can be determined. Now is the time to act and address the new reality that the recent Connelly ruling establishes.

Should you have questions about your buy-sell agreement, or business valuations in general, please reach out to T. Eric Blocher, Partner and Director of Business Valuation Services.

About the Author

Related Services