Closely Held Entities

• Author: James D. Cox/Thomas Lee Hazen
• Profession: Professor of Law at Duke University/Professor of Law at the University of North Carolina, Chapel Hill
• Pages: 350-367

§ 14.1 Close Corporations: Definitions

and Distinctive Needs

“Close corporation” (or “closely held corporation”) is defined in a num-

ber of ways. The term is often used to refer to a corporation with only

a few shareholders to distingu ish a corporation of that kind from a

publicly held company. Summing up the characteristics of a close cor-

poration, a Massachusetts court commented that such a corporation is

typif ied by: “(1) a small number of stockholders; (2) no ready market for

the corporate stock; and (3) substantial majorit y stockholder participa-

tion in the management, di rection and operations of the corporations.”1

A number of states have enacted special legislation to define and

govern the close corporation. In Delaware and several ot her states, for

example, this special st atutory regulat ion states that a close corporation’s

charter must provide that (1) its stock shall be held by not more than a

specified number of persons; (2) its stock is subject to transfer re strictions;

and (3) it shall not engage in public offerings of its stock.2 In a few states,

the special close corporation statute defines “close corporation” simply

as any corporation that elects close corporation stat us for purposes of

the statute.3 As discussed throughout this chapter, courts recognize the

special needs of close corporations even in the absence of statute. Th is

special treatment applies even if a corporation elects not to incorporate

under a state’s special close corporation statute. However, there is author-

ity in Delaware that corporations desiring to be treated as close corpora-

tions must elect to do so under the Delaware Close Corporation Act.4

A person taking a minority position in a close corporation may

desire and therefore bargain for protection against t he power of those

holding a majority of a corporation’s voting stock to make decisions

that will prejudice minority interests. Part icipants may use some kind

of contractual ar rangement to set up a control pattern for the corpo-

ration that differs f rom the traditional corporation control struct ure.

The arrangement may take t he form of a pre-incorporation agreement

among the participa nts, a shareholders’ agreement after the corporat ion

has been organized, a voti ng trust, special charter and bylaw provi sions,

irrevocable proxies, or employment contracts between the corpora-

tion and the shareholder-employees of the corporation. Most of these

arrangements and the laws applicable to them are discussed briefly in

the sections that follow.

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§ 14.2 Shareholders’ Agreements: Contents

Participants in close corporations frequently enter into agreements

a mo ng t he m s el ve s to p ro v id e pr ot e c ti o n t o mi n or i t y s h ar e ho ld e rs a ga i n st

the principle of majority rule or to tailor the corporate struct ure to the

participants’ par ticular desires and the needs of the enterprise. M inority

shareholders often seek agreements that will provide them with repre-

sentation on the board of directors or will otherwise give them input

in the management of the corporation.5 A lthough board membership

may give the minorit y access to information on some decisions being

made for the corporation, membership alone provides t he minority with

very little protection against the power vested in the majority by the

principle of majority rule. Consequently, the minority may bargain for

power to veto some or all corporate decisions or for some other effective

participation in corporate af fairs. The majority may agree to share their

power with the minorit y in order to encourage potential shareholders

to invest in the enterprise, bring into the enterprise valuable patents or

know-how, or provide needed executives or scientifically skilled employ-

ees as key members of the company. Shareholders’ agreements to which

minority shareholders are parties typically cover selection of the mem-

bers of the board of directors, t he naming of corporate officers, employ-

ment of shareholders and their salaries, and the amount of ti me each

participant is to devote to the business.6

§ 14.3 Forms and Execution

of Shareholders’ Agreements

A shareholders’ agreement may take a number of forms. In a simple

shareholders’ pooling agreement, the part ies agree to vote their shares

in the manner set forth in the agreement. The shareholders retain title

to their shares and t he right to vote them; however, they are contractu-

ally bound to vote pursua nt to a prearranged plan. A pool ing agreement

is to be disting uished from a shareholders’ management agreement, in

which the parties attempt to control corporate decisions that otherwise

would be made by the board of directors, such as determ ining corporate

policy, selecting officers, fi xing salaries, and declaring dividends.

An agreement among shareholders may involve more than a si mple

contract binding the par ties to vote their shares in a specified way. It

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