Case Study: Why taking out life cover to provide for your business debt is not enough!

Case Study: Why taking out life cover to provide for your business debt is not enough!

Mike ran a logistics company for many years. As the business expanded, he needed additional financing and secured a loan at very favorable rates. Mike had to sign surety for the debt and decided to take out life cover to provide for this liability in the event of his passing. The life cover was secured by the business on Mike’s life and the premiums paid and deducted for tax purposes. The business rapidly expanded and Mike saw an opportunity in a new sector. 

Mike met two entrepreneurs with contacts that could open doors to this sector. So Mike decided to bring these two guys into the business. Together they could achieve so much more. They would be equal shareholders in the business.

But things did not go so well, the economy took a downturn and then Mike unexpectedly passed away.

Jackie, Mike’s wife knew that Mike had always planned and believed that sufficient provisions existed for her and the children from Mike’s considerable insurance portfolio.

The business was the policyholder of the life cover on Mike’s life and the life insurance company let the remaining business partners know to expect the considerable payout. When the two remaining partners realized that a large amount would become payable to the company they decided not the allow the business the pay off the debt that Mike had signed surety for prior to their becoming business partners.

Instead, the two remaining partners declared a large dividend for themselves from the proceeds of the life cover and decided to close the business.

As Mike had signed surety for the debt his estate became liable for the debt. The provisions that Jackie expected were severely reduced. Consequently, Jackie and the children had to adjust their lifestyle and forgo many of the plans they had for the children’s education.

Solution:

·      Mike should have taken out the life cover on his own life not via the business

·      If Mike still decided that the business should take out the cover then there should at least have been a resolution signed by all the shareholders committing the business to paying off the debt at Mike’s passing

·      Mike should have ceded the life policy to the financier to ensure that the debts would have been covered and not paid to the business

For advice on how to properly structure such a contingent liability arrangement, contact me at [email protected]