Using a buy/sell agreement to restrict transfers of partnership interests.

• Author: Ellentuck, Albert B.

A buy/sell agreement is a popular way to establish some parameters for the disposition of a partnership interest while establishing a method that can be used to value the interest and the terms of a potential payout. A buy/sell agreement is a contract among the partners of a partnership that generally provides for the sale of a partner's interest to the other partners or the partnership upon the occurrence of a specified event--usually the death, disability, or retirement of the partner.

Buy/sell agreements for partnerships can be redemption (liquidation) arrangements, cross-purchase arrangements, or a hybrid of the two. A partnership liquidation buy/sell agreement requires the entity rather than the other owners to purchase the interest of an owner at a stated price and under designated terms in the event of the owner's death or certain other circumstances. The same basic considerations apply to a sale of a partnership interest under a cross-purchase agreement as to any other sale of such an interest. In general, the gain or loss on the sale of the interest is capital in nature (Sec. 741).

Buy/sell agreements can restrict transfers of a partner's interest by:

1. Requiring the selling partner to obtain the other partners' consent before transferring the partnership interest. Consent restrictions are generally upheld if the consent is not unreasonably withheld and refusals are based on legitimate business reasons.

2. Granting the remaining partners (or the entity) a right of first refusal. Rights of first refusal are commonly used and are generally held to be enforceable. A right of first refusal usually allows the remaining partners to purchase the interest at the price offered by the third party, the price stated in the buy/sell agreement, or the lower of the two.

3. Specifying (in some manner) the allowable transferees. Although this can ensure that the partner's children will succeed to his or her interest, the partner's estate may be left with inadequate assets to pay expenses since there is no market for the partnership interest. In addition, this method will not establish an estate tax value for the deceased partner's interest.

Restricting Transfers at Death

Another common provision restricts transfers at death. Business partners use these provisions to eliminate the risk that a partner's heirs will disrupt business operations. This is usually accomplished by requiring the mandatory purchase (by the surviving partners and/ or the...