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

BUSINESS ASSOCIATIONS II – Hecker, Spring 2015

CLOSE CORPORATIONS

I. Generally

a. Definitions

i. Close Corporation – A term of art, a close corporation is a statutorily qualified corporation which elects to be treated as such.

1. DGCL Subchapter XIV Rules – “Unless a corporation elects to become a close corporation under this subchapter in the manner prescribed in this subchapter, it shall be subject in all respects to” the DGCL except for the special rules for close corporations in this subchapter.

2. DGCL § 341. Law Applicable to Close Corporation

(a) This subchapter [Subchapter XIV] applies to all close corporations, as defined in section 342 of this title. Unless a corporation elects to become a close corporation under this subchapter in the manner prescribed in this subchapter, it shall be subject in all respects to the provisions of this chapter, except the provisions of this subchapter.

(b) All provisions of this chapter shall be applicable to all close corporations, as defined in section 342 of this title, except insofar as this subchapter otherwise provides.

3. DGCL § 342. Close Corporation Defined

(a) A close corporation is a corporation organized under this chapter whose certificate of incorporation contains the provisions required by section 102 of this title and, in addition, provides that:

(1) All of the corporation’s issued stock of all classes, exclusive of treasure shares, shall be represented by certificates and shall be held of record by not more than a specified number of persons [shareholders], not exceeding thirty; and

(2) All of the issued stock of all classes shall be subject to one or more of the restrictions on transfer permitted by section 202 of this title;

(3) The corporation shall make no public 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, as it may be amended from time to time.

4. Formation of New Corp as Close Corp – DGCL § 343 requires that the COI contain a statement that the corp is a close corp, and that the COI include the provisions required above.

5. Election of Existing Corporation – If a corporation already exists (either as a small corporation or a closely-held corporation) and wishes to elect to become a close corporation, it merely needs to do so under DGCL § 344 which merely requires amending the COI to reflect the requirements of § 343. Requires a two-thirds vote of each class of outstanding stock.

ii. Closely-Held Corporation – Not interchangeable with the above, this refers to a small corporation that is:

1. Not qualified or, if it is, then

2. It has not elected to be treated as a close corporation

II. Cumulative Voting – Allows a shareholder to distribute among his nominees for the board, in any way he pleases, a number of votes equal to the number of shares they own multiplied by the number of director seats up for election.

a. Formula 1: Minimum Number Shares – Minimum Number of Shares Needed to Elect A Particular Number of Directors; question is “do they have enough?”

X = minimum number of shares needed

S = total number of shares that will be voted at the meeting (total outstanding if all shares represented)

N = number of directors desired to elect

D = total number of directors to be elected

EXAMPLE – 1000 shares outstanding, 7 board seats up for election. Minority shareholders group wants to elect 2 directors. Estimated that 800 of the 1000 outstanding shares will be voted at the meeting.

X = 201, so the minority shareholders group must have ownership or control of at least 201 shares in order to elect the two directors they want.

b. Formula 2: Max Number Directors – Number of Directors That Can Be Elected By A Group Controlling A Particular Number of Shares; question is “how many can they get?”

N = number of directors that can be elected

X = number of shares controlled

D = total number of directors to be elected

S = total number of shares that will be voted at the meeting

EXAMPLE – 7 directors to be elected, 800 shares to be voted, the minority shareholders group has control of 201 shares between them.

N = 2.01. Rounding down to the nearest whole number, the minority shareholders group has enough votes to elect 2 directors in the upcoming election.

III. Shareholder Agreements (Restricting Shareholder Action)

a. Focus On Close Corporations – If Shareholders A and B want to gang up on Shareholder C (in their shareholder capacity), they can agree to team up and throw all their weight in the same direction – whether it be on particular business matters or votes for directors. Shareholders are presented with two different options:

b. Statutes Important to Voting Trusts

DGCL § 212. Voting Rights of Stockholders; Proxies; Limitations

(e) A duly executed proxy shall be irrevocable if it states that it is irrevocable and if, and only as long as, it is coupled with an interest sufficient in law to support an irrevocable power. A proxy may be made irrevocable regardless of whether the interest with which it is coupled is an interest in the stock itself or an interest in the corporation generally.

DGCL § 218. Voting Trusts and Other Voting Agreements

(a) One stockholder or 2 or more stockholders may by agreement in writing deposit capital stock of an original issue with or transfer capital stock to any person or persons, or entity or entities authorized to act as trustee, for the purpose of vesting in such person or persons, entity or entities, who may be designated voting trustee, or voting trustees, the right to vote thereon for any period of time determined by such agreement, upon the terms and conditions stated in such agreement. The agreement may contain any other lawful provisions not inconsistent with such purpose. After the filing of a copy of the agreement in the registered office of the corporation in this state, which copy shall be open to the inspection of any stockholder of the corporation or any beneficiary of the tru

in the trustee’s name. A voting trust is valid for not more than 10 years after its effective date unless extended under subsection (c).

(c) All or some of the parties to a voting trust may extend it for additional terms of not more than 10 years each by signing an extension agreement and obtaining the voting trustee’s written consent to the extension. An extension is valid for 10 years from the date the first shareholder signs the extension agreement. The voting trustee must deliver copies of the extension agreement and list of beneficial owners ot the corporation’s principal office. An extension agreement binds only those parties signing it.

MBCA § 7.31 Voting Agreements

(a) Two or more shareholders may provide for the manner in which they will vote their shares by signing an agreement for that purpose. A voting agreement created under this section is not subject to the provisions of section 7.30.

(b) A voting agreement created under this section is specifically enforceable.

c. Basic Types of Shareholder Agreements:

i. Pooling Agreements – Where the parties to the agreement retain all rights to their share, both control and benefits, and they agree to vote their own shares a certain way.

ii. Voting Trusts – Where the parties to the trust divide the proprietary interests in their shares. They transfer the legal title/control interest to another person who “votes the other party’s shares” for the benefit of the original holder-in-fee.

iii. Which Type Determined By Substance – Whether an agreement will be treated as a pooling agreement or a voting trust will be determined by the substance of the voting agreement, not the title. It doesn’t matter what it is called, it only matters what it acts like.

1. If Voting Trust – If it is determined that the agreement, regardless of what it is called, is actually a voting trust, then the agreement must both be (1) expressly authorized by statute i.e. state recognizes voting trusts as valid; and (2) the agreement must conform to the voting trust statute of the jurisdiction.

2. Ringling – Shareholders in a close-corporation attempted to create a voting trust, but it failed for several reasons:

a. Prior Pooling Agreement – There had existed, in the past, pooling agreements between shareholders, but never a voting trust – they voted their own shares to their own benefit, not to the benefit to somebody else

b. Attempted Voting Trust – In this case, shareholders tried to establish a voting trust