What is a Transfer of Ownership Agreement?
What is a transfer of ownership agreement?
A transfer of ownership agreement is a document that an outgoing owner of a business signs to transfer rights in the business to another individual. The incoming owner then signs the document taking on the specified rights. This three-party system is necessary because the corporation on behalf of the company must consent to the substitution of the old owner for the new one. The document that the parties sign may be called an "Assignment and Assumption Agreement," a "Buy-Sell Agreement," or some other name, but it is often collectively known as a transfer of ownership agreement .
The transfer of ownership agreement is frequently used to amend the ownership of a corporation due to the retirement or incapacity of an owner or in the case of divorce. It can be used in a variety of situations and serves as evidence that a person has transferred an interest that he or she no longer wishes to control or own. However, transfer of ownership agreements are not limited to a change of ownership resulting from divorce. The transfer of ownership agreement frequently is used upon the disqualification or resignation of a partner or corporation shareholder. Moreover, the transfer of ownership agreement, if executed correctly, is valid regardless of whether the underlying business is a partnership, LLC, or corporation.
Essential Elements of the Agreement
Parties: Most often, transfer of ownership agreements are made between individuals, companies, or other entities with a vested interest in the property being transferred. Proper identification of all parties is crucial to ensure that all rights are transferred. When all parties to the agreement are not properly identified, disputes can arise, causing delay or total frustration of the transaction.
Property Information: The agreement will generally describe the property to be transferred, and must specifically identify all items of property being transferred between the parties. If there is any doubt as to whether the description is complete, the transferring party should include a clause that clearly delineates all items of property to be included in the transfer. That way, the scope of the transfer will not be subject to interpretation.
Terms and Conditions: The agreement should include all terms and conditions necessary to make the agreement complete. Common issues to consider are: contingencies (failing to include a contingency for financing can be disastrous if a lender will not approve the financing); closing dates; insurance; representations as to property condition or compliance with local regulations; closing costs; escrows; and other negotiating points.
Other Clauses: Besides the essential clauses, each transaction may have its own specific issues that are unique to the business aspects of the transaction. Those issues are generally addressed in the agreement by adding provisions that either add, subtract, or modify the provisions of the contract with respect to the specific needs of the parties.
How to Create a Transfer of Ownership Agreement
The process to create a Transfer of Ownership Agreement generally includes the following steps:
- Consult with Counsel – Consultation with an attorney can prove to be invaluable. Failure to consult with an attorney may result in an unenforceable agreement as the Internal Revenue Service (IRS) may not recognize the agreement as a bona fide contract, or as a valid transfer in ownership for insurance policy purposes, if the intent sat behind the agreement is not clear. Your attorney will determine if additional legal contracts are necessary so as to ensure future enforcement of the agreement.
- Obtain Insurance Company Approval – After consultation, your attorney drafts the transfer of ownership agreement and addresses any additional contracts which may be necessary. Before the agreement is signed, approval must be obtained from the insurer. Many policies allow the insurer to require evidence that the policy owner received full value for the policy in exchange for the transfer. The policy owner challenging the agreement bears the burden of proof to demonstrate that the sale was fair. A transfer of ownership agreement should not violate the collateral assignment provisions or other restrictions outlined in the policy.
- Finalize Agreement – After the agreement is approved by all necessary parties and all other issues are resolved, the document is executed and copies are provided to the policy owner, the insurer, and all other parties.
The drafting and execution of the Transfer of Ownership Agreement is the easiest step in the process so long as the right guidance is obtained upfront.
Common Forms of Ownership Transfer
There are several common types of ownership transfer, each with unique considerations. One of the most common transfers is the transfer of real property, often by deed, such as a quit claim deed or warranty deed. A transfer may occur incidentally by virtue of the death of an owner, as may happen with a joint tenancy (also known as a tenancy by the entirety, avoiding probate) or the establishment of a living trust. It is also common for ownership to pass in accordance with the terms of a contract, most commonly in business transactions by way of an asset purchase agreement or stock sale agreement. In addition, a transfer of ownership can occur through a corporate reorganization.
A transfer of ownership of business assets (as opposed to the ownership of ownership interests) in an existing company can be accomplished with various agreements that set forth the terms and conditions of the transaction. An asset purchase agreement reflects the sale of the assets of a business, including the related liabilities. The seller of an asset transfers legal title to the buyer in exchange for an agreed upon purchase price. An asset purchase transaction usually involves companies that are not affiliated and usually does not involve the purchase of the selling company’s stock, although the transaction can be structured to functionally accomplish the same purposes as a stock purchase transaction. The specific terms of an asset purchase transaction depend on the business and the transaction so that there is no "one size fits all" document. The most important consideration, however, in an asset purchase transaction is the extent to which the buyer wants to acquire liabilities or leave certain liabilities behind with the selling entity.
In addition, sometimes parent and subsidiary or affiliated companies undergo internal transfers of ownership. To effectuate such transactions, companies have stock purchase agreements. An agreement may also be executed between a partner in a partnership and the remaining partners in the partnership in order to buy-out the selling partner.
Intellectual property rights are generally considered to be transferred when the ownership of the intellectual property right is transferred to someone else. Copyrights are transferred by assignment or license while trademarks can be transferred separately from the ownership of the goods to which they are related, such as through trademark licensing agreements. Finally, when the creator or author of copyrightable material dies, the copyright passes to his heirs and is subject to probate proceedings.
Legal Considerations and Effects
It is critical for both parties to a transfer of ownership agreement to understand the legal implications of the agreement pursuant to the Internal Revenue Code ("IRC") and other applicable laws and regulations. Specifically, the parties must be careful when structuring the transaction so that it does not fall into an IRS "trap." First, the parties must determine whether the transfer is subject to gift tax. For example, if Stephen transfers one-half of his residence to Phoebe, it is considered a gift from Stephen to Phoebe and may be subject to gift tax if Stephen has used up or is choosing to allocate any available gift tax exemption before making the transfer. The transfer may also be subject to gift tax if the residence is then placed back in joint titling. Further, if Stephen provides Phoebe with a limited right to use the residence for sliding scale consideration, the transfer may be subject to gift tax. The IRC provides many exceptions and exclusions but unfortunately, many individuals are unaware of these and they simply assume that the transfer is not subject to gift tax. As such, the parties to a transfer of ownership agreement should consult with their tax advisors to determine if the transaction is subject to gift tax.
In addition, the transfer may result in the immediate realization of gain for the grantor. Under the IRC, exceptions apply in the case of the trust-to-trust transfer or the spouse-to-spouse transfer. However, other transfers may be subject to present income tax and future income tax . For example, let’s say that Stephen owned the residence prior to the marriage and transfer. On the date of transfer, the fair market value of the property increase, resulting in a built-in gain. If Stephen transfer the property to a trust for Phoebe, Phoebe’s interest in the trust will not have its basis stepped up. Instead, the basis will remain the grantor’s. That is, the transfer will be a deemed sale which may result in the recognition of realized gain at the time of transfer and the future recognition of income at the trust level.
Finally, the transfer of real estate interests in Pennsylvania are subject to realty transfer tax. Specifically, under the Pennsylvania Real Estate Tax Law, 72 PS ยง8101-b – 8202-e, et seq., the purchaser is liable for the payment of realty transfer tax. The tax is calculated at a rate of 2 percent for deeds conveying title to one or more parcels of real estate situated in the Commonwealth of Pennsylvania. Furthermore, all deeds not exempted under the act are subject to 1 percent local tax incurred by the local taxing jurisdiction.
As a result, each transfer of ownership decisions is very fact specific and the outcome is subject to the immediate and long-term goals of both the parties. Moreover, since the structure of each transaction presents a unique set of facts and circumstances, the parties should consider engaging the services of a qualified tax advisor to evaluate their specific situation and provide comprehensive guidance on the transfer of real estate interests.
Ownership Transfer Pitfalls
- Not thinking it all the way through – Yes, it is easy to sit down and write up a basic Transfer of Ownership Agreement, but this is an area that needs to be looked at from many angles to be sure speed bumps or even boulders are avoided. There can be all types of liability issues that might arise during the life of the agreement, as well as some beakers that need to be cleared in order to ensure a smooth transition from one owner to another or the other way around.
- Not writing it down – Many will believe that as long as two people have an oral agreement, they should be safe. Others think that an email will suffice. Nothing is further from the truth. When you don’t have something written down, there is no proof and therefore no legal recourse if needed. Don’t be stupid and just think it will all work out!. Put it on paper and get it dated and signed.
- Think it is their problem and not yours – Since you are done with the company, you do not have any responsibility for how things run, or do you? No matter how big or small, you will always be responsible in some manner for the ownership. This is why an Ownership Transfer Agreement should be signed by multiple parties as the legal liability will never be completely done with. Covering yourself is extremely important and should be a priority.
Summation and Recommendations
The purpose of this article has been to shed more light on transfer of ownership agreements in the context of construction contracts, considering that they have become more common in recent years. Given their prevalence, it is important to fully understand what these agreements can do and why they should be carefully considered before signing any agreement with transfer of ownership clauses. In essence, a transfer of ownership agreement is a legal mechanism that will allow building owners and developers to move the title of the previous owner to a new owner before the building is complete. This will typically be used as a tax-improvement vehicle to transfer the liability for an unfinished building from the previous owner to the new owner. Although it may not be possible at first to determine the details surrounding the future use of the property, an agreement in principal may be established that could provide a clear indication of the intentions of the parties involved, while keeping the necessary flexibility at the same time . The primary areas that must be dealt with carefully when drafting a transfer of ownership agreement are: keeping the objectives of the builder in mind and getting the inspector to sign off on several key tests; making sure that the building is inspected by a certified professional; has all the appropriate systems in place; has no significant defects in major components; and is free from work orders or regulatory violations. Best practices for creating and executing a successful transfer of ownership agreement include: pre-agreeing on the expectations of the parties; establishing the timeline for changes that will be made; and determining who is going to bear the costs associated with complying with any deficiencies found in the building. Real estate development is fraught with risks both for developers and all professionals involved in construction. As such, care must be taken to ensure that there is a clear understanding of the relationship between the parties and the property in question. The successful transfer of ownership agreement will help to ensure that there is no room for interpretation when it comes to the conditions that will be imposed on the new owner of the property.