parent nodes: closely held corporation | control of corporation | corporation law | directors | piercing the corporate veil | specific performance | voting control
closely held corporation
(a) A close corporation is a corporation organized under this chapter whose certificate of incorporation contains the provisions required by § 102 of this title and, in addition, provides that:
(1) All of the corporation's issued stock of all classes, exclusive of treasury shares, shall be represented by certificates and shall be held of record by not more than a specified number of persons, not exceeding 30; and
(2) All of the issued stock of all classes shall be subject to 1 or more of the restrictions on transfer permitted by § 202 of this title; and
(3) The corporation shall make no offering of any of its stock of any class which would constitute a "public offering" within the meaning of the United States Securities Act of 1933 [15 U.S.C. § 77a et seq.] as it may be amended from time to time.
(b) The certificate of incorporation of a close corporation may set forth the qualifications of stockholders, either by specifying classes of persons who shall be entitled to be holders of record of stock of any class, or by specifying classes of persons who shall not be entitled to be holders of stock of any class or both.
(c) For purposes of determining the number of holders of record of the stock of a close corporation, stock which is held in joint or common tenancy or by the entireties shall be treated as held by 1 stockholder. (8 Del. C. 1953, § 342; 56 Del. Laws, c. 50; 64 Del. Laws, c. 112; § 59.)
DGCL § 342
The certificate of incorporation of a close corporation may provide that the business of the corporation shall be managed by the stockholders of the corporation rather than by a board of directors. So long as this provision continues in effect:
(1) No meeting of stockholders need be called to elect directors;
(2) Unless the context clearly requires otherwise, the stockholders of the corporation shall be deemed to be directors for purposes of applying provisions of this chapter; and
(3) The stockholders of the corporation shall be subject to all liabilties of directors.
Such a provision may be inserted in the certificate of incorporation by amendment if all incorporators and subscribers or all holders of record of all of the outstanding stock, whether or not having voting power, authorize such a provision. An amendment to the certificate of incorporation to delete such a provision shall be adopted by a vote of the holders of a majority of all outstanding stock of the corporation, whether or not otherwise entitled to vote. If the certificate of incorporation contains a provision authorized by this section, the existence of such provision shall be noted conspicuously on the face or back of every stock certificate issued by such corporation. (8 Del. C. 1953, § 351; 56 Del. Laws, c. 50.)
DGCL § 351
Contracts
Generally, shareholders of closely held corporations face lower transaction costs in dealing with each other.
Shareholders can make binding contracts to vote as shareholders, [Ringling Brothers Barnum and Bailey v Ringling] (upholding voting arrangement to vote for certain directors), but not to bind themselves as directors. [McQuade v Stoneham] (striking down agreement by shareholders to vote a particular manager into office). All agreements among shareholders binding the actions of directors are void. [McQuade v Stoneham]. Once a person becomes a director, they take on a fiduciary duty to the corporation that they did not have as shareholders; they are thus called upon to exercise an independent judgment as to running the corporation's specific affairs. Furthermore, allowing directors to bind their actions creates too much risk of oppressing minority voters, who face high transaction costs in selling or transferring ownership, and often have human capital invested in the firm.
However, if there are no third-party minority shareholders that will be harmed, an agreement to bind director actions may be valid in the case of closely held corporations with low transaction costs. [Clark v Dodge]. Shareholder agreements are binding if unaminous. [Clark v Dodge]. Courts may also use a lower standard allowing shareholders to bind each other's actions as directors in closely held corporations, even where "technically violat(ing)" statute or case law, where there is an "absence" of an "objecting minority" or "public detriment" and the agreement is reasonable. [Galler v Galler]; cf the Coase Theorem for legal rules and transaction costs. Allowing contractual voting agreements that bind shareholders in closely held corporations reduce the transaction costs and uncertainty of setting up a closely held corporation and deciding how it will be run, and give shareholders the potential for employment contracts, which is a major form of returns from closely held corporations. Note that some states have statutes generally authorizing voting agreements without Galler's restrictions, IBC § 7.70, and provide that a shareholder agreement is effective against shareholders who have notice of the transaction. IBC v MBCA. Shareholders may also bind themselves to be penalized for their actions as directors, even where the corporation is not necessarily a closely held corporation, at least where the shareholders are sufficiently sophisticated. [Ramos v Estrada] (upholding buy-out penalty for member of shareholder voting bloc).
Note that minority shareholders can also resort to cumulative voting, buy-sell agreements, voting trusts, or statutory close corporations. See also shareholder voting.
Note also that courts may decree specific performance to restore minority shareholders to their previous or rightful place within the firm, often forcing warring parties to stick with each other.
Duties
See also abuse of control
Shareholders of a close corporation owe a duty of "utmost good faith and loyalty" in dealing with each other, so that they may not act with avarice, self-dealing, or expediency. [Wilkes v Springside Nursing Home]. The law of fiduciary duties applied to closely held corporations comes from a modified form of partnership law. Minority shareholders can thus claim a right to reasonably expected practices among themselves that form a "long-standing corporate policy," such as an agreement of promoters to maintain themselves as directors or hire themselves as officers. [Wilkes v Springside Nursing Home]. DISCLOSURE. Note the problem Wilkes creates of blurring the lines between partnerships and closely held corporations, reducing the choices of promoters., who could contract into greater protections under a corporate form. However, minority shareholders gain no extra protection from the at-will employment rule from their minority status. [Ingle v Glamore Motor Sales].
Conversely, a minority shareholder may not act as a holdout to cause losses to the majority shareholders. [Smith v Atlantic Properties] (awarding damages against a minority shareholder who used an effective veto to expose the corporation to tax penalties).
In order to defeat a claim that the fiduciary duty of shareholders of a closely held corporation was breached, the shareholders must show a "legitimate business purpose;" the burden is then on the plaintiff minority shareholders, who can defeat the business judgment rule by showing that a "less harmful" alternative means would have reached the same legitimate objective. [Wilkes v Springside Nursing Home].
Ho
Cases
[Ringling Bros Barnum and Bailey v Ringling] (upholding agreement by shareholders of closely held corporation either to agree on how to vote their shares or to submit to third party arbitrator to decide for them, by holding that the arbitrator's function was permissible, but that "no decision of the arbitrator could ever be enforced if both parties ... were unwilling that it be enforced," that the agreement was not a delegation of voting power, but an agreement by each of the parties to vote in a certain way, that "a group of shareholders may, without impropriety, vote their respective shares so as to obtain advantages of concerted action," that an agreement to vote together forms a valid contract, so that a failure to vote as the agreement prescribed was breach)
[McQuade v Stoneham] (invalidating an agreement with shareholders requiring them to use their "best endeavors" to elect certain officers, including the plaintiff, by refusing to extend "the power to unite" to "limitations on the power of directors to manage the bvusiness of the corporation by the selection of agents at defined salaries")
[Clark v Dodge] (upholding contract by two owners (one 25% owner, another 75%) of closely held corporation to continually vote each other as directors, despite the rule of [McQuade v Stoneham], on the grounds that "the directors are the sole stockholders," and that "the enforcement of (such a contract) damages nobody")
[Galler v Galler] (upholding agreement to make payments to widow of stockholder of closely held corporation, declare dividends even where in excess of profits, and requiring shareholders to vote for certain directors, where the agreement would be void under [McQuade v Stoneham], on the grounds that the shareholders of closely-held corporations faced low transaction costs vis-a-vis each other, even where the agreement did not have a clear termination date, again in violation of normal case law)
[Ramos v Estrada] (upholding agreement to pool voting shares of closely held corporation held by majority group of shareholders and requiring good faith effort to achieve voting "consensus," including buy-out penalty for noncompliant shareholders, even where the corporation did not qualify as closely held under state law, where the stock was not "readily marketable")
[Wilkes v Springside Nursing Home] (holding that the shareholders of a closely held corporation owe a duty of "utmost good faith and loyalty" to each other, and holding that the duty had been breached where the majority had failed to pay a minority shareholder salary as an officer, against "long-standing" and reasonably expected corporate policy)