(15) Close Corporations

What is a close corporation?

A corporation combining features of a corporation and a partnership in which the owners manage the day-to-day operations.

How many shareholders does a close corporation usually have?

Usually fewer than 30 shareholders.

Who typically manages the day-to-day operations of a close corporation?

The owners (shareholders).

Does a close corporation generally make public offerings of its stock?

No.

What restrictions commonly apply to stock in a close corporation?

Restrictions on the transferability of shares.

What two business forms does a close corporation combine?

A corporation and a partnership.

Who is liable when shareholders assume the roles of directors and officers in a close corporation?

The shareholders acting as directors and officers.

Why are shareholders liable in a close corporation?

Because management authority is delegated back to the shareholders.

What fact pattern commonly indicates shareholder liability in a close corporation?

Substantial management and control by the majority shareholders.

Are shareholder agreements permitted in close corporations?

Yes.

What is the purpose of shareholder agreements in close corporations?

To allow shareholders to control corporate policy and management matters traditionally handled by the board of directors.

What corporate matters may shareholder agreements control?

Detailed corporate policy and management issues normally left to the board.

What is required for a valid shareholder agreement?

Unanimous approval.

Must a shareholder agreement be in writing?

Yes.

Who must sign a shareholder agreement?

All persons who are shareholders at the time of the agreement.

Where must a shareholder agreement be filed?

With the corporation.

What fairness requirement applies to shareholder agreements?

They must be fundamentally fair to both majority and minority shareholders.

What types of agreements may be included in a shareholder agreement?

Voting agreements, proxies, shareholder voting agreements, and voting trusts.

Why are transfer restrictions permitted in close corporations?

To control who may become a shareholder.

When is a transfer restriction valid?

When it is reasonable and serves a legitimate purpose.

When is a right of first refusal enforceable?

When the selling shareholder can receive a reasonable price.

May a corporation refuse to transfer shares if a valid restriction is violated?

Yes.

Are absolute restrictions on transferring shares valid?

No. They are void.

How must a transfer restriction appear to be enforceable?

It must be conspicuous in the agreement.

What fiduciary duty issue commonly arises between majority and minority shareholders?

The fiduciary duty owed by the majority to the minority.

What is a common example of majority shareholder misconduct?

A minority freeze-out or unfair repurchase of minority shares.

Why may a minority shareholder seek involuntary dissolution?

Because the minority shareholder cannot sell shares on an open market.

Who may bring an involuntary dissolution action in a close corporation?

An individual shareholder.

Testable Issue:What characteristics identify a close corporation?

Few shareholders, shareholder management, restricted stock transfers, and no public stock offerings.

Testable Issue:Who is liable when shareholders manage a close corporation?

The shareholders acting as directors and officers.

Testable Issue: What are the requirements for a valid shareholder agreement?

Unanimous approval, written agreement, signatures of all shareholders, filing with the corporation, and fundamental fairness.

Testable Issue:When are stock transfer restrictions enforceable?

When they are reasonable, serve a legitimate purpose, are conspicuous, and are not absolute.

Testable Issue:What fiduciary duty exists between majority and minority shareholders?

The majority owes fiduciary duties to the minority.

Testable Issue:When may a minority shareholder seek involuntary dissolution?

When the minority cannot sell shares because no public market exists.

Essay Rule:How do you analyze a close corporation issue?

Determine whether the corporation qualifies as a close corporation, identify whether shareholders have assumed management responsibilities, analyze the validity of any shareholder agreement, determine whether transfer restrictions are enforceable, evaluate any fiduciary duty owed by majority shareholders to the minority, and consider whether involuntary dissolution is an available remedy.

Master Synthesis:What is the framework for analyzing close corporation issues?

Identify the corporation as a close corporation, determine who manages the business and bears liability, analyze shareholder agreements and transfer restrictions for statutory validity, evaluate fiduciary duties between majority and minority shareholders, and determine whether remedies such as involuntary dissolution are appropriate.