Privately-held companies may have restrictions in their shareholder agreements regarding the transfer of company shares to others. This includes the transfer of stock by a recently deceased shareholder through his will. How these agreements influence the distribution of stock through a will to a beneficiary depends on the content of the specific agreement. Please note that laws governing the distribution of property vary by state. Consider hiring a professional to help you interpret your state’s probate laws and the relevant shareholder agreement.
A will is a legal document created by someone in contemplation of death that details how he wants his property, such as stock in a small business, to be distributed. Only property placed in a probate estate can be distributed by will. The requirements for a valid will vary by state. Generally, the will must be drafted by a competent person of his own free will. The drafter must sign the will in the presence of two or three witnesses, depending on the state. The witnesses must also sign the document.
Probate property are assets the decedent owned at the time of his death. However, any property the decedent owned subject to immediate transfer upon his death is excluded from probate. This transfer can be due to either operation of law or the terms of a contract. An example of an asset that is transferred due to operation of law is jointly-owned real estate subject to a right of survivorship. An example of an asset that is transferred due to contract would be a life insurance policy or individual retirement account.
A shareholder agreement is a contract between the owners of a corporation, agreed to when the business is formed. While a shareholder agreement can be used to address a variety of possible situations, normally these contracts focus on the exchange of the business’s stock. The restrictions imposed by a shareholder agreement are to ensure ownership is restricted to individuals the other stockholders can work with. In addition to restricting who may own stock, shareholder agreements generally outline an established process regarding what to do when a shareholder dies.
Wills & Shareholder Agreements
If a will leaves stock to a beneficiary subject to a shareholders' agreement, what happens next depends on the contract. One possibility is the corporation’s ownership will accept the beneficiary as a shareholder, allowing him to keep the stock. Another possibility is the corporation will immediately buy back the shares when the shareholder dies. If the corporation buys the shares, the shareholder agreement will generally provide a method to determine the value of the shares. Depending on the terms of the shareholders’ agreement, this may mean the stock is not considered probate property. Therefore, the beneficiary has no rights to the stock.
Ademption vs. Avoidance
If a court determines the stock subject to an agreement is probate property, it may evaluate the beneficiary’s rights in one of two ways. Under ademption theory, the court will assume the decedent intended to revoke the gift of stock since he agreed to transfer the shares to the corporation when he died. If the decedent had wanted the beneficiary to get the stock, the court will assume he would not have agreed to the stock transfer. Therefore, the beneficiary conveyed the stock in the will would get nothing. Under avoidance theory, the court will assume the shareholder agreement merely changed the form of the gift from stock to cash. As a result, the beneficiary will get the proceeds from the buyout by the corporation.