In this interview, Paul Hood, an expert in buy/sell agreement planning, sheds light on the common deficiencies found in these agreements and the misconceptions that surround them. Hood emphasizes the importance of thorough review and drafting, as many agreements are poorly written and lack clarity. He highlights the need for business owners to understand the intricacies of their agreements, including valuation procedures, payment terms, and potential ambiguities. Hood’s extensive experience in the field and his role as a consultant and expert witness provide valuable insights into the complexities of buy/sell agreement planning.

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Who are your clients, and how do you assist them?

 Our clients are mainly business owners seeking assistance with the creation of buy/sell agreements, as most existing agreements tend to be inadequate. Typically, it’s either the business owner themselves or one of their advisors, such as a lawyer, CPA, bank trust officer, or specialized life insurance agent. There’s a diverse range of professionals in this field whose clients are seeking to evaluate the effectiveness of their current agreements.

Around 90% of the time, these agreements have significant flaws and lack clarity. Many lawyers struggle to draft them effectively, as it requires expertise in entity or corporate law and tax law, which often falls into a gap area. Larger firms usually rely on either an estate planner or a corporate lawyer to handle the drafting, but they may not fully grasp the intricacies of the situation.

In my capacity, I primarily work as a consultant, helping clients evaluate and enhance their buy/sell agreements. Additionally, I am proficient in writing the agreements myself.

How do you assist your clients in drafting improved buy/sell agreements?

 To aid my clients in drafting better buy/sell agreements, I initiate the process by inquiring about their contingency plans for events like death or divorce. Surprisingly, many of them are unaware of the specifics outlined in their agreements. After signing, these agreements are often stowed away and seldom revisited. However, it is crucial to have a clear response outlined in the buy/sell agreement for each triggering event. For instance, in the event of death, there may be provisions for mandatory buy-and-sell or the option to transfer ownership to a family member. These agreements require meticulous examination from start to finish.

I encourage my clients to thoroughly read the agreement and consider various aspects. They should ascertain if there are mandatory buy or sell provisions and determine who determines the price and the associated rules. Evaluating the payment terms, such as whether it will be in cash or through an installment note, and examining provisions for interest or security, like a stock pledge or mortgage, is also crucial.

Regrettably, based on my extensive review of over a thousand agreements, I can confidently state that 90% of them have significant flaws. While most lawyers accurately address the triggering events, their mistakes often lie in the selling procedure. They may include unnecessary provisions, such as requiring the appraiser to produce a valuation within an impractical 30-day timeframe. In reality, gathering all the necessary information for an accurate appraisal within such a short period is highly unlikely. This valuation delay then affects the rest of the agreement, leading to procedural defects or ambiguities that can result in legal disputes.

My role is to identify these defects and ambiguities within the agreements, guiding my clients toward crafting more comprehensive and effective buy/sell agreements.

Why are many buy/sell agreements inadequate?

 Numerous buy/sell agreements suffer from inadequacy primarily due to poor drafting and a lack of coherence. These agreements are often crafted by individuals who lack the necessary experience and expertise to create effective agreements. In my case, I was fortunate to have worked in a 30-lawyer firm that possessed strong tax and business planning knowledge. However, being a smaller firm, we didn’t have a dedicated corporate department, so the tax section also handled corporate matters. This allowed me to develop a comprehensive understanding of both tax and corporate aspects, leading me to write a book on the subject in the early 90s. I have also extensively spoken on the topic and served as an expert witness in related cases.

I frequently find myself being hired by malpractice insurance companies when an insured lawyer faces lawsuits stemming from issues within these agreements. It’s a recurring pattern where poorly drafted agreements are signed, triggering events occur, and ambiguities arise between the partners. Eventually, one party files a lawsuit against the drafting lawyer for malpractice. In such cases, I often advise the insurance company to prepare for a settlement conference since taking the case to trial would likely result in a loss. The drafting lawyer involved often fails to meet the prevailing standard of practice in their jurisdiction, and in some cases, they are certified tax lawyers who should be held to an even higher standard. Unfortunately, they fall short of meeting that standard, making them liable for malpractice. The insurance company then needs to assess its exposure since they insured the lawyer’s work. More often than not, I have the unfortunate task of informing them that their lawyer did not fulfill their obligations, potentially leaving them liable.

What are the misconceptions and obstacles regarding buy/sell agreement planning?

 One of the major misconceptions is that business owners often place sole reliance on their lawyers for buy/sell agreement planning. They assume that since they haven’t encountered any issues thus far and have an agreement in place, it must be sufficient. The main obstacle lies in persuading them to have their agreements reviewed, as they typically assume, albeit mistakenly, that their agreement is solid.

However, upon reviewing these agreements, I frequently discover various problems and obstacles that were overlooked. For example, they may have failed to specify who will be responsible for valuing the business or overlooked the need for specialized expertise in business appraisal. There are four recognized certifications for business appraisers, and being a CPA does not automatically qualify someone unless they have specific training and experience in valuation. Sometimes, the agreements are drafted by general practitioners or individuals unfamiliar with the complexities of the matter. They may have simply copied and pasted an agreement from someone else, and the client signs it without recognizing potential deficiencies.

Until a triggering event occurs, business owners often assume that everything is in order. However, I emphasize the importance of preparing for potential scenarios, using the analogy of a fire drill. By conducting a hypothetical fire drill and thoroughly examining their agreements, they may begin to feel uneasy and question whether their agreement falls within the 90% with significant flaws. This story about fire drills has proven highly effective in raising awareness among both professionals and clients.

The reality is that poorly drafted or ambiguous buy/sell agreements often result in litigation. In such cases, it’s important to note that in litigation, only the lawyers tend to benefit, as they can defend clients until their resources are depleted.

How can people learn more?

To learn more, people can visit my website at www.paulhoodservices.com. On the website, under the Resources tab, there are various podcasts, articles, and other informative content. I have articles that cover topics such as the psychology of estate planning, the human side of estate planning, buy/sell agreements, and more.