LEGAL OUTLINE FOR CALIFORNIA INSURANCE AGENCIES
INTRODUCTION
This outline is written for the owners of small or medium sized California property and casualty independent insurance agencies, and the broker/agents who own them or produce insurance for them. It is intended to raise practical legal problems facing agents, and to help them find practical answers. The outline is based on California law, but it may be helpful to broker-agents in other states as well. There are some legal areas which are California specific, such as covenants not to compete.
An interest in an agency or a book of business is like a farmer's crop. There is a life cycle, from planting the seed to bringing in the harvest. By planning ahead from the beginning, an agency principal helps both the agency's operation and its ultimate disposition.
Choosing the form of doing business is an important decision. Deciding whether to incorporate requires the agent to weigh the protection of a corporation against its increased cost in time and money. The small producer needs to consider the possible advantages of joining with others. The owner of a larger production agency needs to consider how to grow and to develop new producers. An agent also needs to think ahead about how he plans to sell or transfer his agency or book of business when he retires, and how to structure his business to accomplish his plans.
I feel that an agent with any substantial assets should either be incorporated or join with someone who is.
Important questions of structuring the corporation are whether to elect Subchapter S, whether to hold the stock individually or in a partnership, and whether the expirations should be held by the corporation, an underlying partnership, or the shareholders. These decisions should be taken with an eye to operating and ultimately selling the agency. Deciding these questions at the outset will make the agency's future choices much easier.
Contracts to protect expirations owned by a producer or the agency with anti piracy agreements are important. The terms of employment and independent contractor relationships should be spelled out by written agreements. If the agency has partners or shareholders, it should have an agreement covering how an owner's death or departure will be handled.
I feel that all agencies and producers should have such contracts for everyone's protection.
Litigation exposure can be reduced if the agent understands how the risks arise, and makes plans to avoid them. Major areas of litigation exposure are errors & omissions, and protection of expirations. Proper insurance can reduce but not eliminate exposure. Alternate dispute resolution if properly used may reduce litigation risks and cost.
A producer who is aware of his legal rights is in a better position to protect them without litigation. An established producer who joins a larger agency can lose his expirations if he does not take steps to protect them.
We are all mortal. Selling or otherwise transferring an ownership interest in an agency, such as with sales of stock or assets, corporate mergers, partnership liquidations, or use of Employee Stock Ownership Plans (ESOPs), is something all agency principals will ultimately do. It is important to plan ahead, since otherwise it may be too late to take
important steps when the moment actually arrives.
A wise agent will have a buy-sell contract or similar arrangement in place, and will probably also have a durable power of attorney in place to permit someone to act for him if he becomes disabled. An agency's book of business can be decimated if an agent dies or becomes disabled and no provision has been made to protect it. I have had the experience of trying to arrange for the rapid sale of a deceased agent's book, and it is not a happy situation to be in if no preparations have been made.
In selling the agency, the 1993 Clinton tax law changes make good will and expirations deductible to the buyer, but extend the time for amortizing covenants, expirations and good will to 15 years. Tax rate changes have raised maximum federal ordinary income tax rates to $39.6%, while leaving the maximum capital gains rate at 28%. Existing plans for agency sales should be re-examined to see how they are affected by these changes.
Deferring tax, and diversifying investments, are often important considerations in selling or otherwise transferring a production agency. A merger or other corporate reorganization, a rollover form an ESOP purchase of stock, or a charitable remainder trust, may be used to defer taxes.
Inheritance of the agency by a child who will take over ownership can be done at substantially lower tax cost with advance planning. The agency can be passed to children through normal estate planning devices, such as lifetime gifts, or wills or trusts that take advantage of tax saving opportunities in the death tax laws. Another device is to channel a child's personal new production through that child's separate business.
This outline is designed to help an agency principal plan ahead. It is intended to raise important questions, and suggest some possible answers. It is not intended to be a complete treatise. On complex matters such as mergers and reorganizations, it can only suggest the objectives to be sought, rather than the specifics on how they are accomplished. It cannot deal with specific fact situations. It is no substitute for competent personal advice from the agent's lawyer, accountant, or insurance agency specialty consultant.