Employee Ownership Trusts – Insurance Cover for Trustees
The number of companies that are owned by employee ownership trusts (“EOTs”) continues to grow along with the size of companies; many EOT owned companies have multi-million pound turnover and profits. In this article, co-written with Thomas, Carroll (Brokers) Limited and Thomas, Carroll Independent Financial Advisers Limited, we examine a couple of insurance products that EOTs may wish to consider.
Directors’ and officers’ liability insurance
D&O cover is often arranged by organisations as it provides personal liability cover for company directors, officers and managers from claims that may arise from their actions and decisions within their role putting their personal finances at risk.
The core purpose of a D&O policy is to cover “wrongful acts” this could include a breach of trust, breach of duty, negligence, error, misleading statement or wrongful trading when acting within the scop of their duty. A comprehensive package also includes, company insurance, employment practices and certain crimes.
When a change in ownership takes place such as happens when an EOT is established, any existing D&O policy will automatically enter “run-off”. Employee ownership trusts need protection and a new policy must be arranged.
Although the role of the EOT trustee in one of protecting the interests of the employee beneficiaries and oversight of the business, there could still be risks associated with being a trustee or a director of a company trustee (a “trustee director”). Directors’ and officers’ liability insurance (“D&O cover”) may be appropriate to provide an element of protection to the individuals taking on the appointment of a trustee or trustee director. Not all D&O policies are the same and not all insurance policies include cover for “trustees” in their policy.
It is important that the new D&O policy includes cover for the trustees of the EOT. The new policy should be set up to reflect the new ownership structure and the coverage suitable for this new structure. There are policies available on the market which are tailored to the EOT structure.
All policies vary, D&O cover will not provide protection for a director who has acted fraudulently or dishonestly. However, the policy should provide protection for a trustee director who has made a mistake or who has been caught up in a wider dispute involving the EOT. In the context of an EOT, a director, acting in their capacity as a trustee director could inadvertently create a tax liability.
In any event, the trading company should inform its insurers of the change of control of its shareholders as the change of control will invalidate any existing D&O policy.
Warranty & Indemnity and Tax Liability Insurance
When buying or selling a company, warranty and indemnity and tax liability insurance should also be a consideration. These policies are designed to protect against financial loss from inaccuracies in the warranties and indemnities made in a share purchase agreement. Warranty and Indemnity policies are available to both buyers and sellers although typically bought by the buying party. When a breach of warranty occurs such as misrepresentation, the buyer can claim on the Warranty and indemnity policy rather than pursuing the seller. W&I policies may be appropriate for some EOT transactions where the sellers will have no on-going relationship with the EOT and trading company and receive all the consideration on completion and therefore will have no deferred consideration which could be at risk from a warranty claim.
Life assurance for ex-shareholders
In most EOT transitions, the shareholders have sold their shares for an initial lump sum with a large amount of the consideration being paid on deferred terms out of the future profits of the company. The death of an ex-shareholder will not accelerate the payment of the deferred consideration which will become payable to the deceased’s estate and beneficiaries. The amount of the outstanding deferred consideration is extremely likely to be liable to inheritance tax which would be charged at 40% of the amount due.
The company may wish to consider taking out a life assurance policy on the life of the ex-shareholder to ensure that the company can make a contribution to the EOT to pay the outstanding deferred consideration. The life assurance policy can be a for term linked to the deferred consideration payments and on a reducing balance on the assumption that the company will be able to pay the deferred consideration.
The company will be unlikely to be able to obtain a corporation tax deduction for the insurance premiums because HM Revenue & Customs (“HMRC”) will very likely claim that the premiums are not being paid wholly and exclusively for the purposes of the trade. The upside is that the policy payment will very likely be received tax free by the company. There is a risk that the payment by the company to the EOT could be treated by HMRC as a distribution by the company; this risk applies to all future payments by the company to the EOT. Hopefully, any tax clearance obtained before the sale of the shares to the EOT will have covered this risk.
Thomas, Carroll has been providing advice for businesses, business owners and key people for more than 50 years.
Applications for life cover are subject to medical and financial underwriting and sometimes can take 2 or 3 months to arrange.
Directors and officers insurance can be arranged relatively quickly once all the information has been provided for the new company including insurance proposal forms, business plan and funding arrangements and company structure. Some sectors and more complex company structures will take longer, it is best to engage with your insurance broker early.