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Dangers of All or Part of Your Business Becoming a Probate Asset

 

By: Barry E. Haimo, Esq.

February 4, 2019

Dangers of All or Part of Your Business Becoming a Probate Asset

 

Before you can understand why having your business tied up in probate can be a disaster, you have to first understand what probate is and is not. Catch up about probate using the links below.

Probate page: http://bit.ly/2zdYOUo

Probate sequence of posts (left hand column list of posts): http://bit.ly/2RAzcFv

As you now know, all assets owned by a deceased person in his or her name are included in the estate (and some even not in his or her name). If it’s a business, and regardless of whether or not it’s Apple, Google, Amazon, Netflix, Tesla, Disney or a small mom and pop closely held business called “Uncle Joe’s Restaurant, Inc.”, it’s included in the estate. So what does that mean?

Valuation

The Personal Representative (“Executor” in other states) has the fiduciary obligation to administer the estate. He/She/It must identify all the probate assets, beneficiaries and creditors (we call it the ABCs) and disclose same on the inventory and fiduciary accounting. The beneficiaries and creditors all have an interest in the estate so they are entitled to notice and they are going to  pay special attention to the business. They are entitled to know the date of death value and will certainly have something to say if it’s perceived to be undervalued. Importantly, the Personal Representative has a fiduciary obligation to maximize the value of the estate so he/she/it cannot overlook a potentially undervalued business appraisal or accept an appraisal produced by an unqualified appraiser (or an appraiser chosen by an adverse party). You can expect a few hearings on the subject as this issue slowly gets resolved through the court system. It’s worth noting you should get an appraisal at the time of death for tax purposes even if you avoid probate. The difference is that it’s private and doesn’t involve a lot of parties who have rights.

Settlement

Remember that legitimate creditors are entitled to be paid out of the assets in the estate, which includes the business. If there’s insufficient assets in the estate, then the business will be liquidated and the proceeds derived therefrom may likely be used to settle the deceased’s creditors’ claims. What’s left will be devised to the beneficiaries pursuant to the will or via statute (if there is no will). Consequently, all or part of the business will end up being owned by the beneficiary or beneficiaries, and it’s likely that (i) the beneficiaries have no relationship with the surviving partners in the business, (ii) the beneficiaries are not interested in participating in the business and will likely abandon the interest or want to sell their shares to a third party or (iii) the beneficiaries will not be qualified to work the business and be more of a burden than benefit.

Operation

Good business people execute shareholders agreements or operating agreements which address, among other triggers, a death triggered buy-back in what’s called a “buy-sell” agreement. Even with a buy-sell agreement, while the estate administration is pending, the Personal Representative is effectively acting as the shareholder on behalf of the business interest, and is again, charged with an obligation to maximize the value of the estate. Without a buy-sell agreement, very often your surviving business partners will not have a relationship with the Personal Representative. In addition, similar to the risks of a beneficiary turned partner, it’s likely that (i) the Personal Representative is not interested in participating in the business and will likely abandon the interest or want to sell its shares to a third party or (iii) the Personal Representative will not be qualified to work the business and be more of a burden than benefit.

On one hand, the buy-sell agreement will expedite liquidation of the shares and transfer of shares to the appropriate beneficiaries.  It will also enable the surviving partners to continue to operate the business with less disruption, which is better for them and their families. On the other hand, it does not avoid the probate process or avoid the public nature of the proceedings. There are additional steps to take, which we’ll cover in a different post.

Time Consuming and Expensive Process

This process can take a very long time, sometimes 1-2 years, which cannot possibly be good for the business during that time. It also is quite financially draining. With valuations, hearings and attorneys fee and costs, it could easily be over $10,000.  Further, even if the Personal Representative is very diligent, there are so many other parties that can hold it up: judges, case managers, clerks, judicial assistants, creditors, attorneys to creditors, beneficiaries, attorneys to beneficiaries, etc.

Public

It’s also worth mentioning that the inventory disclosing the value of the business is public record.

Bottom Line

Here’s the bottom line: you don’t want your business going through the probate process and neither do your partners. Nobody’s more qualified to operate it than people who know the business well, and that’s not the Personal Representative and likely not the beneficiaries either. It’s public, time consuming and there’s a lot of parties involved, which makes it very complicated. There are solutions, but an estate planning attorney is not enough. You need an estate and business planning attorney, and that’s what we do.

 

THE INFORMATION CONTAINED HEREIN IS INTENDED FOR INFORMATIONAL PURPOSES ONLY. EACH SITUATION IS HIGHLY FACT SPECIFIC AND REQUIRES A CONSULTATION TO UNDERSTAND SUCH FACTS AND THE CLIENT’S NEEDS AND GOALS. ACCORDINGLY, NOTHING CONTAINED HEREIN CONSTITUTES LEGAL ADVICE.

Author:
Barry E. Haimo, Esq.
Haimo Law
Strategic Planning With Purpose®
Email: barry@haimolaw.com
LinkedIn: http://www.linkedin.com/in/bhaimo
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