Understanding the relationship between a corporate business succession plan and the current lending requirements of the business can lead to important opportunities for life insurance professionals.

When a business borrows money, the owners sign a loan agreement with their lending source. In today's business environment, the owners generally sign the agreement twice. Once representing the business as an owner or officer and once personally to personally guarantee the business loan.

The first potential area of conflict occurs when the partners realize they are jointly and severally liable for the loan. This means that the partner with the most assets will be called on to make good on the loan if the other partner or partners can not pay their share. In a scenario where there are two equal shareholders in a business that borrows $1,000,000 and where one partner has $3,000,000 of personal assets and the other $500,000, clearly the wealthier of the shareholders is at greater personal risk than his less wealthy partner.

A much more severe potential conflict exists when the business owners and loan guarantors do not understand the loan agreement they sign with their bank. Most loan agreements define "default" in the body of the agreement. An obvious default would be non-payment of the interest or principal when due. A not so obvious default is discussed in the body of a recently reviewed loan agreement: "the loan shall be considered in Default if the borrower dies or is declared judicially incompetent or files for personal bankruptcy." In other words, the loan could be in perfect order in terms of its pay status; but the bank can declare the loan in default if a partner dies, is declared incompetent or declares personal bankruptcy. Things actually get even worse. In the same loan agreement, it says, "In the event of Default, the Note and any and all other indebtedness of Borrower to Bank shall immediately become due and payable, both as to principal and interest."

Things really get bad when you read the paragraph in the agreement dealing with "set off." It says:

"Upon the occurrence and during the continuance of any Event of Default, Bank is hereby authorized at any time and from time to time, without prior acceleration, demand or notice of any kind to Borrower, to set off and apply any and all deposits at any time held and other Indebtedness at any time owing by Bank to or for the credit or the account of Borrower or any Guarantor against any and all of the obligations of Borrower now or hereafter existing under this Agreement or the Term Note irrespective of whether or not Bank shall have made any demand under this Agreement or the Term Note and although such obligations may be unmatured. The rights of Bank are in addition to all other rights and remedies which Bank may have”.

With this as background, let's look at a business that has executed and funded an entity buy-sell agreement. This is being used as the example because it generates the most extreme adverse result. If the agreement is a cross purchase or trusteed cross purchase agreement, the results are bad, but not quite as bad.

You are sitting in an appointment with the owners of a business and are told that they are "all set" with their planning and certainly all set with their life insurance. They have a buy-sell agreement and have funded it with life insurance that is owned by and payable to the business. You can fold up your tent and leave or ask the following question, "I think it’s great that you’ve had the foresight to set up and fund your buy-sell agreement; but may I ask you a question? Does your business borrow money?" If the answer is yes, your next questions are, "did you carefully read your loan agreement before you signed it? Do you understand the definition of technical default? Was the bank’s right of offset explained to you?"

Unless the people you are meeting with are very unusual, this line of questioning will open up an opportunity to explain their loan agreement and the fact that it actually negates the buy-sell agreement.

Picture this scenario, shareholder A dies in an accident. The business has an open $1,000,000 line of credit that is in full use. Shareholder B as the sole survivor and representative of the business files a claim with the life insurance company for the $1,000,000 death benefit purchased to fund the buy-sell agreement. The Bank declares the loan in default and exercises its right of offset. The proceeds are paid to the company and immediately seized by the bank. The widow of shareholder A arrives with her attorney and her inherited stock in the business and requests payment. Shareholder B has a serious problem!

He can't pay the widow because the bank took the insurance proceeds to satisfy the loan obligation. How could this have been prevented?

First of all, the buy-sell agreement should have been established as a cross purchase or trusteed cross purchase agreement. This would have eliminated the possibility of the proceeds being attached. It would not have eliminated the bank from declaring the loan in default. The business should also have purchased key-man coverage on each shareholder to cover the loan obligation as well as traditional key-man indemnity issues.

Understanding these issues can turn what seems like a wasted meeting into a great sales opportunity.