Collateral Assignment Split Dollar Agreements

A Credit Union may choose to offer a split dollar agreement to an executive as an employment benefit. In a collateral assignment split dollar arrangement, the key components and agreements are:

• The Credit Union makes a loan to the The loan proceeds are used by the executive to acquire a life insurance policy, typically on the executive’s life. The executive is the owner of the policy.
• The loan is secured by the policy, which is collaterally assigned to the Credit Union as security for the repayment of the loan.
• To ensure that the split dollar plan operates as a retention vehicle, the benefits available under the policy (in the form of permitted borrowings and the death benefit) are subject to a vesting schedule.
• The parties enter into a split dollar agreement, which sets forth the rights and obligations of each party, including the distribution timing and availability, vesting schedule, and the treatment of the policy in various separation scenarios, e., termination for cause, resignation, change in control, etc.
• The executive executes a promissory note agreeing to repay the Credit Union for the loan. The note will specify whether the note is interest-bearing, the maturity date, whether the loan is full recourse, limited recourse, or non-recourse, define an event of default, and include standard remedies. The note will also specify whether it is a demand note (payable on demand) or a term note (typically payable upon death of the executive, or earlier if there is an event of default.)
• Most of PARC Street Partners plans utilize “limited recourse” loans, which means that in the event of an event of default or other occurrence causing the note to be due, the Credit Union will first collect from the cash surrender value (or death benefit) of the policy. The Credit Union then has the right to collect any remaining loan balance from the executive. The limited recourse provision simply defines the order in which remedies are to be exercised but does not limit the executive’s responsibility to repay the loan in full.

PARC Street Partners standard form of promissory note is a term note that is due as provided in the split dollar agreement, upon the death of the executive, or upon any event of default. The note defines an event of default as (a) the bankruptcy or insolvency of the executive, (b) the executive’s termination for cause (as defined in the split dollar agreement), or (c) the executive’s breach of the split dollar agreement, the collateral agreement and/or any other collateral document, which breach is not cured within 20 days after notice from the Credit Union. Upon the occurrence of any of these events, the Credit Union would be permitted to exercise its remedies consistent with the limited recourse provision.

PARC Street Partners standard form of split dollar agreement sets forth in detail what happens in the event that the executive separates from service.

• If the executive terminates for cause, the executive forfeits all rights under the The Credit Union may exercise its rights under the collateral assignment and take ownership of the policy, apply the cash surrender value to the loan, and pursue the executive’s personal assets for the remaining loan balance.

• If the executive is terminated without cause or resigns, he/she keeps the vested portion of the plan and forfeits the unvested portion. In a single policy design, the policy is actually split into two policies, if allowed by the insurance company. The executive keeps the vested policy, and the vested portion of the borrowing rights are available at the designated borrowing commencement date. The Credit Union takes ownership of the unvested policy and applies the cash surrender value to the loan. If the insurance company does not allow a policy split, our standard approach is to use multiple identical policies at implementation so the Credit Union can take ownership of unvested policies that are not needed to provide the vested benefit. The remaining loan balance is typically repaid at the death of the executive, however, if an event of default occurs before the date of death, the Credit Union would have the right to exercise its rights under the collateral assignment against the vested policy as well as pursue the executive’s personal assets for any remaining loan balance.

As with any loan, the Credit Union, as lender, will have the right to exercise remedies, collect on the collateral and seek repayment of the loan (including from executive’s personal assets) only as provided in the loan documents (here, the note and the split dollar agreement) and only after the occurrence of an event of default, death or other event permitting the Credit Union to exercise its remedies.

It is critical to carefully review all documents establishing the split dollar arrangement to determine the intent of the parties and the substance of the arrangement. If the agreements clearly state that the Credit Union has the right to pursue the executive for any loan deficiency after realizing on the collateral and the Credit Union has assessed the Executive’s ability to repay, then the Credit Union’s intent is to be repaid in full even if such payment is deferred until the executive’s death. With a recourse or limited recourse loan, the Credit Union Board should take care not to undermine this intent and expectation by making representations to the executive that he/she will not be expected to repay the loan. Another question to consider is who bears the risk if the cash surrender value of the policy is not sufficient to repay the loan. In PARC Street Partners plans, this risk is always on the executive.

• The Credit Union must consent to all policy
• All policy withdrawals are evaluated by PARC Street Partners to make sure that the withdrawal will not impair the policy or cause the Credit Union to be at risk. If the policy has not performed as originally projected, the executive’s borrowing rights will be reduced.
• Borrowings are generally made starting at a predetermined retirement age and paid over a 20-year period which allows the policy time to recover from any underperformance. The executive is generally not allowed to take large lump sum borrowings from the policy at the time of retirement or to take any distributions not written into the agreement.
• Finally, in a recourse or limited recourse design, both the note and the split dollar agreement clearly state that if the policy does not repay the loan in full, the executive is responsible for the balance.

As split dollar arrangements are a highly specialized strategy, it is important for the Credit Union to work with an experienced and knowledgeable team in implementing a split dollar arrangement, which includes the insurance agent/broker who places the insurance and evaluates the performance of the policy and the financial status of the insurer at least on an annual basis; and legal counsel who prepares the governing documents consistent with applicable tax and other laws.

About the Author

Cynthia A. Moore

Member and Division Director at Dickinson Wright PLLC

CMoore@dickinsonwright.com

Reprinted with permission of Cynthia A. Moore, Dickinson Wright PLLC. The views and opinions expressed are those of Cynthia Moore. Any discussion of taxes is for general information purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate.

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