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Business Associations II
University of Kansas School of Law
Hecker, Edwin Webb

BA II Outline – Spring 2014

Professor Hecker

Close Corporations

Agreements restricting S/H action

Voting Trust agreement

i. A Voting Trust requires:

1. Execution of a written trust agreement between participating S/H and voting trustees

2. A transfer to the trustee, for a specified period, of the S/H stock certificates and legal title to the stock

3. The trust separates legal title (right to vote) from economic rights

a. If dividends paid out, they are paid to the trustee. But, trustee must transfer them to beneficiary.

ii. Ringling Bros.

1. Ringling’s and Haley’s had a voting agreement. There was a disagreement and Haley’s breached.

2. This was a “pooling agreement” instead of a voting trust

a. Why not a voting trust? Because there was no power to “enforce” the agreement.

b. As such, it didn’t have to comply with voting trust statute

3. To enforce the agreement, there should have been express irrevocable proxies. Court won’t imply them.

4. The Ringling’s remedy was limited to throwing out the Haley’s votes, as opposed to forcing them to vote according to the agreement. If agreement had an express irrevocable proxy, the court would have required specific performance.

iii. Abercrombie

1. 3 S/H (A,B, and C corp) appoint an agent to represent their shares. Agree the shares will be voted IAW majority of the group with irrevocable proxies

2. But, court held it to be voting trust and invalid b/c it didn’t comply with statute

3. Court elevates substance over form

4. If you have what you call a “voting agreement” with an irrevocable proxy, the court will hold it invalid unless it complies with the 218(a), because it is actually a voting trust in substance.

iv. Proxies

1. S/H can vote by proxy.

2. But, directors are fiduciaries and can’t give away discretion to vote.

3. To make a proxy irrevocable, it must be “coupled with an interest”

4. DGCL § 212(e)

a. Proxy shall be irrevocable if:

i. It states it is irrevocable AND

ii. It is coupled with an interest

b. The interest may be in the stock itself or in the corp generally. THUS, if you give a proxy to someone else who is in the corporation which says it is irrevocable, then it’s irrevocable. Conversely, if you give a proxy to someone else who is not apart of the corporation, it is revocable. If you have a pooling agreement, make it an irrevocable proxy! If you simply have a pooling agreement, and a disagreement occurs, you have to go to court.

c.

§ 218 – Voting trusts

i. (a) May enter into a voting agreement and give a trustee the right to vote for any period of time

1. Filing

a. Must file with the state

b. “Open to inspection of any S/H”

2. Stock certificates shall state they are subject to a voting agreement

3. Manner of voting the stock shall be determined by a majority of the trustees

a. If equally divided, vote can be equally divided

4. Purpose of filing

a. To ensure other S/H know the trust exists

i. “Open to inspection of any S/H”

b. If there is a stock certificate, it shall say it is subject to a voting trust

ii. (c) An agreement between S/H

1. If in writing and signed, may provide

2. The shares shall be voted IAW the agreement

3. Or as parties agree

4. Or IAW a procedure agreed upon by them

a. This is the holding of Ringling, so 218(c) codifies Ringling.

iii. (d) This section won’t invalidate any other voting agreement or irrevocable proxy among S/H that is not otherwise illegal

1. Intended to overrule Abercrombie

2. Infers you don’t have to comply with the voting trust statute

3. Remedy? Throw votes out like in Ringling, or specific performance?

Reconciling Ringling, Abercrombie, 218, Oceanic (see pg. 470 bottom)???

– The only thing we know for sure is if you comply with the statute, you’re good.

Agreements restricting BOD action

Case law

i. McQuade v. Stoneham (NY 1934)

1. 2500 outstanding shares in the NY Giants. Stoneham has 1306.

2. Stoneham agrees to sell McGraw and McQuade 70 shares each. His shares reduced to 1166.

3. Agreement:

a. To vote each other as directors

b. To elect each other as officers

c. To pay each other salaries

d. There shall be no changes without unanimous consent

4. The agreement to vote each other as directors ok, but agreement invalid to elect each other as officers and pay each other salaries

a. Agreements for S/H functions okay

b. Agreements to control BOD functions NOT okay

c. Manice v. Powell

i. BOD power is original and undelegated. S/H can’t control the judgment of the BOD.

d. § 141(a) BOD shall manage the company

e. It’s a breach of a director’s fiduciary duty to contract away his discretion [for changing officers, salaries, policies], unless directors who are contracting constitute 100% of shares or provided in COI (see 141(a)).

ii. Clark v. Dodge (NY 1936)

1. Clark (25% stock) knew secret formula of drug company. Dodge (75%) got him to tell the secret in return for always getting 25% salary and no unreasonable salaries to other employees

2. Agreement valid

a. There were no minority S/H who were not parties to the agreement

i. That was the problem in McQuade

iii. Galler v. Galler (Ill 1964)

1. 2 brothers run a close corporation. Agreement called for salary continuation if one brother died in order to take care of surviving spouse

2. Agreement held valid

a. So long as there is no complaining minority interest (100% shareholder participation or non-participating shareholders are neutral), no prejudice to creditors, no public injury, it doesn’t have to be in COI.

3. In a close corporation, it’s identical personnel at the S/H and director level

a. The only real protection you have in a close corp is a detailed S/H agreement

iv. Reconciling McQuade, Clark & Galler, 141(a): Questionable situation: 3 or more directors/shareholders (i.e. A, B, C), 2 of which make an agreement (A & B) that one breaches, and those two are in an action against one another (A v. B), and the other directors/shareholders are neutral. The breaching party would assert C’s rights as a defense because he would want the contract to be invalid. Here, there is not 100% participation, but C is neutral, so it does not really matter. However, if C were not neutral, the contract would be invalid re McQuade.

– If COI says BOD can contract away BOD functions (salaries, electing as officers, policies), then they can (b/c 100% s/h participation is required to develop/amend COI). However, if no COI provision, it will only be ok to contract away Bod functions if there is no complaining minority interest (100% shareholder participation or non-participating shareholders are neutral), no prejudice to creditors, no public injury.

Examples of prejudice to creditors/public injury?

KS case law

i. In KS and Del, you can completely sterilize the BOD so long as 100% of S/H agree

1. Even if they don’t agree, might be ok so long as the S/H aren’t complaining

ii. KS Supreme Court has said parties who enter into an agreement

iii. (3) Corp has abandoned its business

1. De facto dissolution

3. (b) Custodian has power and title of a receiver, but authority is to continue the business rather than liquidate it. Court shall order custodian to become a receiver and liquidate if:

a. Corp is insolvent

i. De facto corporate dissolution

ii. Corp has abandoned the business, but taken no steps to liquidate it

b. Corp has in effect discontinued the business, or cases under 352(a)(2) for close corporations

i. 355 – COI can give S/H right to dissolve corp at will

ii. 352(a)(2) – If S/H have that right under 355, S/H can seek judicial appointment of a custodian

iii. 226 – The custodian’s job would then be to liquidate the business, not run it

c. Court orders it

i. E.g. If business isn’t insolvent and not a close corp, but a custodian is appointed and months pass and no solution reached. Court might just order the business dissolved.

Close corporations

i. § 352 – Appointment of custodian

1. (a) Standing

a. Upon application of any S/H (doesn’t apply to large corps),

2. (a) Grounds for appointment

a. In addition to 226 reasons, court may appoint a custodian when:

i. (1) Business is managed by S/H, they are deadlocked, irreparable injury is occurring, and remedies provided in the COI or by-laws have failed, or

ii. (2) Petitioning S/H has the right to dissolution under the COI

3. (b) Instead of appointing a custodian (the more drastic remedy), court may appoint a provisional director (the less drastic remedy) under §353

4. Note: §352 differs from §226 in that the stockholders running the corporation are not deadlocked on electing directors, but rather running the biz in general

ii. § 353 – Appointment of provisional director

1. (a) Grounds for appointment

a. BOD divided, vote required for action can’t be obtained, business can’t be conducted to the advantage of the S/H (milder than § 352)

2. (b) Standing

a. Application for relief may be filed by

i. (1) ½ of directors, or

ii. (2) at least 1/3 of S/H, or

iii. (3) >2/3 of any class of stock if there are multiple classes entitled to vote for directors.

iv. COI may provide for lesser numbers

3. (c) Provisional director

a. Shall be impartial. Not a receiver.

b. Not the same power as a custodian. Same power as any other director.

c. On the BOD until removed by court, majority of all shares vote to remove, 2/3 of any class which voted to appoint him vote to remove

4. (d) If not enough votes under this section to appoint, court may appoint provisional director under § 352(b)

5. Note: The appointment of a provisional director may enable one faction to make changes in control structure of corp. whose effects will persist even after the provisional director is gone, i.e. amend COI to allow for more directors.