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Cross-Option Agreement

Also known as: Double Option Agreement, Buy-Sell Agreement

Definition

A cross-option agreement is a legal contract between business shareholders that gives surviving shareholders the right to buy—and the deceased's estate the right to sell—shares when a shareholder dies or becomes critically ill.

This dual-option structure protects business continuity while ensuring the deceased's family receives fair financial value rather than illiquid shares in a company they may know nothing about.

What Does Cross-Option Agreement Mean?

A cross-option agreement creates a two-way safety mechanism for business shareholders. Under a 'call option,' surviving shareholders have the right to purchase the deceased shareholder's shares at an agreed price. Under a 'put option,' the deceased's estate has the right to require survivors to buy those shares. Either party can trigger a sale, but neither is forced to transact—preserving Business Property Relief under the Inheritance Tax Act 1984, Section 113, by avoiding classification as a 'binding contract for sale' under HMRC rules (SVM111120).

The structure is critical for tax efficiency. Options must run consecutively—the call option exercisable first (within 6 months), followed by the put option (months 6-12). If options run concurrently, HMRC may treat this as a binding obligation, destroying 100% Business Property Relief and triggering 40% inheritance tax on the full share value.

Implementation requires three elements. First, shareholders enter into the legal agreement defining options, triggering events (death or critical illness), and valuation mechanisms. Second, each takes out life insurance written in trust for fellow shareholders. Third, the company's Articles must permit share buybacks. Sarah and James each own 50% of a software company worth £2 million. When James dies, Sarah exercises her call option to purchase his shares for £1 million. The insurance pays out, enabling the purchase. James's widow receives £1 million cash, and Sarah retains full control.

Common Questions

"What's the difference between a cross-option agreement and a shareholders' agreement?" A shareholders' agreement covers all shareholder relationships including voting rights and dividends. A cross-option agreement is more specific, dealing with what happens when a shareholder dies or becomes critically ill. Think of the shareholders' agreement as the rulebook for running the business, and the cross-option agreement as the exit strategy for death or illness.

"Do I need life insurance to make a cross-option agreement work?" While not legally required, life insurance is essential for practical implementation. Without it, surviving shareholders may have the right to buy shares but lack the funds. Typically, each shareholder takes out a policy on their own life, written in trust for other shareholders, ensuring funds are available when needed.

"Will a cross-option agreement affect Business Property Relief on my shares?" If structured correctly, it preserves 100% Business Property Relief because HMRC treats it as an 'option,' not a binding contract for sale. The options must run consecutively and give both parties the right but not the obligation to transact. Poor drafting that creates a binding obligation will destroy Business Property Relief and trigger substantial inheritance tax.

Common Misconceptions

Myth: A cross-option agreement forces surviving shareholders to buy the deceased's shares

Reality: Cross-option agreements grant both parties the right to transact, not the obligation. This 'choice' structure preserves Business Property Relief under UK tax law. If the agreement forced a sale, HMRC would treat it as a binding contract for sale under Section 113 of the Inheritance Tax Act 1984, destroying BPR and triggering 40% inheritance tax.

Myth: I don't need a cross-option agreement because my Articles of Association already restrict share transfers

Reality: While Articles may include pre-emption rights requiring shares to be offered to existing shareholders first, these don't create the dual protections of a cross-option agreement. Pre-emption rights give 'first refusal' but don't give the estate power to force a sale. With a cross-option agreement, the estate has a put option—the right to require shareholders to buy at a fair price. Without this, the estate could hold illiquid shares indefinitely. Pre-emption rights also don't address funding or tax efficiency.

  • Business Succession Planning: A specific legal tool within broader succession planning, addressing unplanned transitions due to death or illness.
  • Shareholders' Agreement: Often incorporated within shareholders' agreements or created as standalone documents working alongside them.
  • Key Person Insurance: Different purposes—key person insurance protects company finances while shareholder protection insurance funds share purchases.
  • Company Shares: Determines what happens to shares when triggering events occur, unlike other assets that simply pass to your estate.
  • Partnership: Similar arrangements exist for partnerships using option agreements to handle partner exits upon death.

Need Help with Your Will?

If you're a business owner, your will is just one part of protecting your legacy. While cross-option agreements require specialist corporate legal advice, your personal will is equally important.

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Legal Disclaimer:

This article provides general information only and does not constitute legal or financial advice. WUHLD is not a law firm and does not provide legal advice. Laws and guidance change and their application depends on your circumstances. For advice about your situation, consult a qualified solicitor or regulated professional. Unless stated otherwise, information relates to England and Wales.