Ownership Succession for Family-Owned Banks: Building the Right Estate Plan

For a number of community banks, the management and ownership of the institution is truly a family affair. For banks that are primarily controlled by a single investor or family, these concentrated ownership structures can also bring about significant bank regulatory issues upon a transfer of shares to the next generation.

Unfortunately, these regulatory issues do not just apply to families or individuals that own more than 50 percent of a financial institution or its parent holding company. Due to certain presumptions under the Bank Holding Company Act and the Change in Bank Control Act, estate plans relating to the ownership of as little as 5 percent of the voting stock of a financial institution may be subject to regulatory scrutiny under certain circumstances. Under these statutes, “control” of a financial institution is deemed to occur if an individual or family group owns or votes 25 percent or more of the institution’s outstanding shares. These statutes also provide that a “presumption of control” may arise from the ownership of as little as 5 percent to 10 percent of the outstanding shares of a financial institution, which could also give rise to regulatory filings and approvals.

Upon a transfer of shares, regulators can require a number of actions, depending on the facts and circumstances surrounding the transfer. For transfers between individuals, regulatory notice of the change in ownership is typically required, and, depending on the size of the ownership position, the regulators may also conduct a thorough background check and vetting process for those receiving shares. In circumstances where trusts or other entities are used, regulators will consider whether the entities will be considered bank holding companies, which can involve a review of related entities that also own the institution’s stock. For some family-owned institutions, not considering these regulatory matters as part of the estate plan has forced survivors to pursue a rapid sale of a portion of their controlling interest or the bank as a whole following the death of a significant shareholder.

To preserve the institution’s value, significant shareholders should consider the regulatory and tax consequences associated with their estate plans. Here are some issues to consider:

• Combined family ownership interests. A significant shareholder should consider not only her own stock ownership, but also that of her immediate family, when determining if any bank regulatory issues may apply. For purposes of the various statutory thresholds for determining control, ownership of immediate family members, including grandparents, siblings, and children, can be aggregated, leading to unexpected presumptions of control.
• Types of estate planning entities. For many larger estates, a variety of estate planning vehicles can be involved, including revocable and irrevocable trusts, testamentary trusts, family partnerships, charitable trusts and other charitable entities, such as private foundations. However, federal regulations only provide a narrow “safe harbor” from the requirements of the Bank Holding Company Act, which has led to a number of estate planning structures being unexpectedly classified as bank holding companies.
• Impacts to S corporations. Many family-controlled banks have elected to be taxed as S corporations in order to allow the institution’s earnings to be distributed to shareholders more directly. Estate planners should consider any barriers to transfer under an applicable shareholders’ agreement, especially if the owner contemplates transferring stock to an entity that is an ineligible shareholder under S corporation rules.
• Corporate governance issues. Individuals that own a controlling interest in a financial institution should consider the impact of his or her death on the governance of the institution until the estate is settled and the shares transferred to new owners. If the controlling shares are unable to be voted due to an estate or trust dispute, governance tasks for the bank, such as holding an annual meeting or approving a merger, can be held in limbo. As a result, the appointment of capable and responsible executors and trustees is a critical step in any estate plan.
• Strategic planning. Significant shareholders should consider the desires of the next generations when formulating an ownership succession plan. While some family members may have a desire to manage the bank in the future, others may simply desire liquidity or have other investment goals. Considering these desires and determining how an estate plan may affect the strategic plan of the institution can preserve value for the controlling family, the institution, and minority shareholders.

Family-owned financial institutions are built over a lifetime and the regulatory and tax issues associated with an ownership transfer can be mitigated with careful planning. Regardless of whether a family intends to transition active management to the next generation or to simply pass down the full value of their shares to their relatives, constructing a plan that considers the family’s goals, in addition to regulatory and tax matters, is essential.