The Buy-Sell Agreement That Assumed Insurance That Did Not Exist

The situation

The call came in about a supplier dispute, a fairly ordinary contract disagreement over a late equipment delivery. Near the end of the conversation, almost as an afterthought, Bassam mentioned that he and his business partner had a buy-sell agreement in place, drafted by their accountant's office five years earlier, in case anything happened to either of them. He said it the way people mention insurance they assume is handled and rarely think about. We asked to see it anyway, mostly out of habit.

Bassam had built the shop from a single rented bay doing custom metal fabrication into a business with twenty staff and steady contract work supplying parts to larger manufacturers in the region. It had grown from what he described as a side hustle he ran nights and weekends around a full-time job into something generating roughly $100,000 in its early, smaller years and had since scaled well past that as the real business. His business partner, Gabor, held a minority stake and ran daily operations on the shop floor, while Bassam handled sales and client relationships. Gabor had come up through the trade as a machinist before buying into the company, and his wife, Erzsebet, worked as an early childhood educator, which meant the household depended on the shop for most of its income even though her salary covered the steadier, predictable part of their budget.

The buy-sell agreement itself was short, four pages, and read like a template. It said that if either owner died, the surviving owner would buy out the deceased owner's shares at a formula price based on the company's trailing average earnings, and that the purchase would be funded through life insurance policies held by the company on each owner's life. That last sentence was the one that mattered, and it was also the one nobody had checked in five years.

Bassam's original advisor, an insurance agent who had also handled the company's general liability and property coverage, had discussed key-person insurance with him early on and Bassam believed policies had been put in place around the same time the buy-sell agreement was signed. He had never seen a policy document, never received an annual statement, and had never been asked to complete the medical underwriting that a real life insurance application requires. He had simply assumed it was done, the way a business owner assumes a task he delegated years ago was completed and never resurfaced.

What the documents showed

A short call to the insurance agent's office confirmed what a careful reading of the buy-sell agreement had already suggested: no key-person policies had ever been issued on either owner. The agent recalled discussing the concept with Bassam in a general way years earlier but had no record of an application, no underwriting file, and no policy in force. Whether the ball had been dropped by the agent, by Bassam, or somewhere in between was not something worth spending time reconstructing; what mattered was the gap itself.

The buy-sell agreement, meanwhile, was fully enforceable as a contract regardless of whether the funding it assumed existed. Whether a surviving owner is legally obligated to buy a deceased owner's shares depends on how the agreement is written — some buy-sells make the purchase mandatory on death, others leave it as an option for the survivor or the corporation, or put the obligation to redeem on the corporation itself. This agreement's own wording left no such option: it made the purchase mandatory on either owner's death, at the formula price, which by that point worked out to a mid six-figure amount given how much the business had grown. Without insurance proceeds to fund that purchase, the surviving owner would have had to pay it out of company cash flow, personal savings, or new debt, at exactly the moment the business had also just lost one of its two owners and was least able to absorb a large cash outflow.

The risk ran in both directions and was not symmetrical. Gabor had a young family and, on paper, was the less wealthy of the two; if Bassam died first, his estate would be entitled to the full buyout price, but Gabor would have almost no realistic way to raise that amount without selling the business itself or taking on debt secured against it. If Gabor died first, Bassam faced the same problem in reverse, with the added complication that Erzsebet and their children would be relying on the buyout payment as a major part of their financial security after his death, at a time when Erzsebet's own income as an early childhood educator would not come close to replacing it.

There was also a quieter problem inside the agreement's formula pricing clause. The trailing-earnings calculation it used had not been updated since the company was much smaller, and applying it literally to the business's current financials produced a valuation that both owners, once they saw the number, agreed did not reflect what the company was actually worth. The document had been drafted once, filed away, and never revisited as the business changed, which is a common enough pattern but one that turns a routine planning document into a source of real financial exposure when it is finally tested.

What we did

1. Confirmed in writing that no key-person or buy-sell funding insurance existed on either owner. A phone call had already suggested the gap, but a recollection is not evidence either owner could rely on if a dispute ever arose later, so we requested formal written confirmation directly from the insurance agent's office. That gave Bassam and Gabor a single, documented starting point everyone could agree on, rather than competing memories of what had or had not been arranged five years earlier.
2. Walked both owners through what the agreement actually obligated them to do, separate from what they had assumed it would do. Many owners in this position focus on the missing insurance and overlook that the underlying legal obligation to buy out the shares exists whether or not funding is in place. Making that distinction clear early avoided a false sense that the whole agreement could simply be shelved.
3. Reviewed the formula pricing clause against the company's current financials. The trailing-earnings formula, applied honestly to the shop's current numbers rather than the smaller business it had been written for, produced a buyout price both owners agreed was too low given how much the company had grown since the agreement was signed. Rather than leave a valuation dispute to surface for the first time during a future crisis, we raised it as a second, related issue needing correction alongside the funding gap itself.
4. Coordinated with a new insurance advisor to get updated life insurance underwriting started for both owners. This step was outside our role as lawyers, but it needed to run in parallel with the legal fix, since a revised agreement built around insurance that still did not exist would repeat the same problem. Both owners applied, and Bassam's underwriting came back with a modest premium adjustment tied to a manageable health condition.
5. Drafted an interim funding mechanism to cover the gap while full insurance coverage was being underwritten. Underwriting takes weeks to months, and neither owner wanted to be unfunded in the meantime. The interim provision allowed the surviving owner to pay the buyout price over a defined multi-year period if a death occurred before full coverage was in place, rather than requiring a lump sum the business could not produce.
6. Updated the formula pricing clause to a fairer, more current valuation method. Rather than leave the price tied to an outdated trailing-earnings snapshot that would drift out of date again within a few years, the revised clause tied the price to a formula recalculated annually, with a defined process for either owner to request an independent valuation if they believed the formula no longer reflected what the business was actually worth.
7. Negotiated the balance between the two owners' differing risk tolerances. Gabor wanted the interim payment period as short as possible, given how much Erzsebet and their children would depend on it landing quickly if the worst happened; Bassam, mindful of what a lump-sum obligation would do to the shop's cash flow and its ability to keep paying its remaining staff, wanted more time. The final term split the difference at a payment schedule both owners could accept.

The outcome

Both owners now hold key-person life insurance policies sized to the current, corrected buyout valuation, closing the funding gap that had existed unnoticed for five years. The policies took a few months to underwrite and did not come back with identical premiums, since Bassam's health rating was slightly higher than Gabor's, a difference the two owners agreed the company would simply absorb as a cost of doing business rather than treat as unequal.

The interim funding mechanism remains in the agreement even though full coverage is now in place, because both owners saw value in having a fallback if either policy ever lapsed or a future health change made re-underwriting difficult. It is not a perfect solution; a multi-year payment schedule still puts real strain on a company the size of Bassam's if it were ever triggered, and both owners understand that the insurance, not the interim clause, is what actually protects the business.

What began as a mention at the end of an unrelated call turned into the company's first real review of a document it had been relying on for years without testing. Bassam has since built a habit of asking, whenever a professional tells him something has been taken care of, for the document that proves it — a small change that costs him nothing and would have caught this gap five years earlier if he had asked it then. Gabor has said the whole episode changed how he thinks about Erzsebet's security, too; he had assumed the buy-sell agreement was doing its job simply because it existed, and had never once asked to see the paperwork behind it himself.

What you can learn from this