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Partnership protection is concerned with maintaining and continuing
the partnership in the event of one or more of the partners ceasing
to act as a partner, due to illness, injury or death.
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It is essential that partners make sure that in the event of the
death of one of them, the remainder are in a position to buy out
the deceased's share in the partnership from the estate. The first
step in securing this situation is to draw up a formal partnership
agreement specifying what is to happen in the event of death, and
giving the surviving partners the legal right to buy the deceased's
share.
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Similar considerations apply on the retirement or ill health of
a partner, or withdrawal from the partnership for any other reason.
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A partnership is formed whenever two or more people are in business
together where they choose not to form a limited company. Partners
share in the risk of the operation and in the capital, goodwill
and profits, so it is important, although not obligatory, that a
formal partnership agreement is in place.
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The partnership agreement will prevent the partnership from being
dissolved automatically in the event of death, retirement or resignation.
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In the event of death, for example, the deceased's share of the
business would pass into the estate. This may pose problems as the
partner's dependants generally will neither be willing nor able
to contribute to the business, and indeed may wish to withdraw their
share of the capital.
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Planning is essential, therefore, to ensure the partnership share
passes to the surviving partners for suitable value.
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Life assurance policies are an ideal planning tool in these circumstances;
to provide funds to be available and in the right hands and enable
the necessary cash to be used to purchase the partnership share.
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The Double Option agreement is a flexible form of 'buy and
sell agreement' (see below), which states that in the event of the
death of a partner, the estate has the option to sell and the other
partners have the option to buy the shareholding usually, but not
always, in the proportions in which they already hold the balance
of the partnership shares.
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When one option is exercised, the other must follow. The partners
may have to exercise the option within a fixed period from the partner's
death and during this period the estate may not sell to anybody
else.
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The agreement will also specify that each partner must take out
a life policy to produce the necessary funds. A suitable trust will
be used, having the other partners as co-trustees. Under the trust,
the surviving partners only retain their interests in the proceeds
of the policy if the option to purchase under the agreement is exercised.
Thus each partner will take out a policy in their own name (usually
a whole of life policy, term assurance, or pension term assurance)
with the policy written in trust for the benefit of surviving partners,
the proceeds being in accordance with the current balance of shareholding.
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As the makeup of the partnership is likely to change over time,
it is important that a flexible trust is used with suitable powers
of appointment, permitting the addition and deletion of potential
beneficiaries
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The 'buy and sell agreement' states that in the event of
the death of a partner, the estate is obliged to sell and the other
partners are obliged to buy the deceased's shareholding in the proportions
in which they already hold the balance of the partnership shares.
This is the major advantage of using this route.
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The disadvantage lies in the loss of IHT business property relief.
Such a binding contract is viewed by the Revenue as excluding the
value of the business share, because at the point of death it is
no longer business property, having been sold and bought immediately
(Ref S113 IHT Act 1984).
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Arrangement of trusts and policies will be similar to that mentioned
above.
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Where Automatic Accrual is used, each member of the partnership
enters into an agreement with the other partners that, in the event
of death, the deceased's interest in the business passes to the
surviving partners automatically without payment.
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It is usual, however, for life policies to be written in trust
so that the family of the deceased does receive some cash, effectively
in payment for the deceased's interest in the business.
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At retirement the question arises as to the ability of
remaining partners to buy out those retiring.
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Any of the above forms of agreement may be used for this purpose,
but suitably worded to provide rights or options on retirement as
well as death, and with a date of retirement being specified.
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In practice, a 'suite' of policies - protection and investment
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provide cash on death, and also cash on surrender, or maturity.
Whilst surrender is not entirely satisfactory, it does provide an
extra element of flexibility for periods of less than 10 years.
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Personal Pensions might also feature as part of the planning, part
funded by additional drawings. It might be agreed that the cash
element from a PPP will be deemed full compensation or if there
is a discrepancy, loans can be taken out against the future cash
value for those remaining.
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Leaving for any other reason could be looked at as 'early retirement'
and dealt with in a similar way to retirement, if necessary