Cross Purchase Agreement

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Cross Purchase Agreement

A Brief Introduction About the Cross Purchase Agreement

A cross purchase agreement is an agreement between the partners or shareholders of a company whereby they can purchase the ownership interest or shares of a partner who has died, retired, or has become incapacitated. This agreement lays down how the shares of such partners will be divided amongst the remaining partners. The shares will either be distributed in the proportion of the shareholding of the other partners or in some manner that has been previously decided. Such an agreement may also be known as a “cross-purchase buy-sell agreement.” This agreement provides a method of transferring an ownership interest in a company easily. It helps to ensure that the business of the company will continue even if one of the owners or partners dies. 

Who Take the Cross Purchase Agreement – People Involved

A cross purchase agreement is entered into between the partners or shareholders of a company. There is no specific buyer or seller in this agreement. 

Purpose of the Cross Purchase Agreement – Why Do You Need It?

The purpose of this agreement is to lay down in writing the terms under which the cross-purchase plan will be carried out. This buy-sell agreement is triggered when a partner dies or retires, and his shares become available. Usually, under such agreements, each partner buys life insurance policies for all the other partner(s) and names himself as the beneficiary. Thus, the money that is received from the insurance policy is used to buy out the shares of the deceased partner. 

This agreement is essential to make sure that the ownership of the company remains with the surviving partners. Once this agreement has been created, the partners are not allowed to transfer their shares to any other person. Also, the heirs of the deceased person are legally obligated to sell the shares to the other partners. 

Ideally, this agreement should be used when there are a few numbers of partners (3-4 partners is considered an ideal number) who are of the same age. In case there are multiple partners of varying ages, this agreement can become very complicated.

Contents of the Cross Purchase Agreement

A cross purchase agreement must include the names of the parties who are involved, the date on which it is created and the territory in which the agreement shall be operative.

The most important clause in the agreement is the buyout clause that provides the events in which the buyout provision will come into effect. The most common event is when a partner dies. It may also contain buyout provisions for other events such as retirement, a partner becoming disabled, a partner declaring bankruptcy and other events as the partners may mutually decide. 

It must also contain a fixed purchase price of the shares, or it must provide a formula through which the price can be determined. The agreement may also require the partners to evaluate the company every year.

The procedure for carrying out the buyout must be mentioned in detail. How the payment is to be made, and the time within which the entire process is to be completed should be laid down. 

How to Draft the Cross Purchase Agreement

The following are the steps to follow while drafting a cross purchase agreement: 

  • Negotiations must be conducted to decide how the purchase price of the shares will be determined and how the funding for such purchase will be taken care of.
  • The agreement must be well-drafted while providing for all outcomes.
  • It should then be reviewed carefully and signed by both parties.

Negotiation Strategy

  • Under a cross-purchase method, all the negotiations will revolve around how the shares are to be distributed amongst the remaining partners.
  • The easiest way to do this is to distribute the shares according to the existing shareholding percentage of the partners.

Benefits and Drawbacks of the Cross Purchase Agreement

The following are the benefits and drawbacks of having a cross purchase agreement:

  • One of the major benefits of having this agreement is that it provides a method for the other partners to purchase the shares of the partner who is leaving the company or who dies.
  • It is a relatively easy way of transferring an ownership interest in the company. It also ensures the stability of the business.
  • A drawback of this agreement is that it can only be used when there are a limited number of partners, as mentioned previously; otherwise, it can be a very complicated and expensive procedure.

What Happens in Case of Violation of the Cross Purchase Agreement?

The agreement must have a clause that states that any transfer of shares that is against the terms of this agreement will be deemed to be void. In case a party to the agreement breaches any of its obligations, the other parties may institute a case in court for specific performance of the terms of the agreement. In such a case, the breaching party will be compelled to perform his duties and obligations. This is done in cases where damages are not deemed to be a sufficient remedy or where the damages cannot be measured in money. 

Most agreements also have a mandatory arbitration clause in case any dispute arises between the parties.

In conclusion, a cross purchase agreement can be beneficial as a method of transferring the ownership interest in a company. It helps to ensure that the owners continue to hold an undivided ownership interest in the company.