If Your Firm’s CEO Suddenly Dies, What Happens?

Editor’s Note: The death of Progress Energy Chairman and Chief Executive Officer Bob McGehee has raised the awareness of corporations about the need for succession planning. WRAL Local Tech Wire asked law firm Ward and Smith to examine the importance of anticipating and planning for sudden change. Stuart B. Dorsett, a member of the Trusts and Estates Section of Ward and Smith, P.A., stresses that private and public firms need such a plan.

RALEIGH — The business world is saddened by the unexpected death of Bob McGehee, the chief executive officer of Progress Energy. However, while Progress Energy will undoubtedly feel the loss of its charismatic leader, the company’s business is unlikely to suffer in a material way, largely because Progress Energy had a succession plan in place.

Most non-publicly held companies do not have a succession plan, but one is just as critical for closely held businesses. Any such succession plan should address at least the following issues:

How Will an Immediate Need for Funds Be Handled?

It is frequently said that money is the "mother’s milk of politics"; the same is true for a closely held business. If the key person or executive in the business (the "key executive"), who may well be the business owner, dies, the business is likely to need an immediate influx of cash for several reasons:

1. The company may need to hire one or more replacement managers to carry out the tasks handled by the deceased key executive.

2. The deceased key executive may have been a substantial owner of the company and a guarantor of company loans. Those loans may contain a provision that they become immediately payable in full if there is a change in ownership of the company or if a guarantor dies. The company may need cash immediately to pay the existing loans, and banks or other lenders now may be reluctant to make replacement loans in the absence of the key executive.

3. Additional funds may be necessary to carry the business through any temporary business downturn resulting from the absence of the key executive’s experience in acquiring new projects for the company and the distraction of the remaining or new owners of the company resulting from the loss, which may well be personal in nature.

4. The deceased key executive’s estate may need cash to pay estate taxes in order to avoid the necessity of a sale or liquidation of the company.

Most owners of closely held businesses reinvest cash in the business itself, so generally there are no substantial reserves of cash available to meet these needs.

Accordingly, life insurance is likely to be an important solution to this problem. Use of life insurance may be combined with an Irrevocable Life Insurance Trust in order to prevent the insurance proceeds from being included in the taxable estate of the deceased key executive.

How Will the Management of the Company Be Continued?

The company’s business succession plan needs to address the identity of the person or persons who will run the company after the death of the key executive. Frequently, the business owner’s children are involved in the business, and, if two or more children are involved, the business succession plan should make it clear which child will step in as head of the company. The business owner also must address a difficult question: are his or her children truly qualified to run the business, or does the company need to look outside of the family for succeeding managers?

How Will Licensing Issues Be Handled?

The company needs to ensure that someone other than the key executive holds the necessary licenses to operate the business. For example, I represented the estate of the deceased owner of a heating and air conditioning contractor. Unfortunately, the decedent was the only employee at the company who held the necessary contractor’s license. Accordingly, the moment the decedent died, the company’s business was essentially shut down. Fortunately, another manager with the appropriate licenses was located within a short period of time, but the absence of additional licensees within the company could have proved disastrous.

How Will the Ownership of the Company Change?

If, as a result of the business owner’s death, multiple family members (for example, two or more children) are going to co-own the business, the succession plan needs to address the relationship among those successor owners. The business owner needs to recognize the inevitable tensions that will exist between the family members who are actively engaged in the operation of the business and those family members who are passive owners. It would be advisable for the family to enter into an agreement which contains "buy-sell" and dispute resolution mechanisms to deal with subsequent ownership of the company, which may be a very personal and emotional issue.

Most owners of closely held businesses and key executives are too busy dealing with the day-to-day demands of their business operations to focus on the development of a business succession plan. However, the creation of such a plan, in conjunction with an overall estate plan, is of critical importance to the continued viability of the business operations and the preservation of family harmony.

Ward and Smith, P.A. provides a multi-specialty approach to the representation of technology companies and their officers, directors, employees, and investors. Stuart B. Dorsett practices in the Trusts and Estates Section, where he concentrates his practice on estate planning, estate administration, business succession planning, and asset protection planning. Comments or questions may be sent to sbd@wardandsmith.com.

This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.