Closely Held Corporations
DE deadlock statute -the custodian shall...?
(b) A custodian appointed under this section *shall have all the powers and title of a receiver* appointed under § 291 of this title, but *the authority of the custodian is to continue the business of the corporation and not to liquidate its affairs and distribute its assets*, except when the Court shall otherwise order and except in cases arising under paragraph (a)(3) of this section or § 352(a)(2) of this title. . . .
(c) If not able to get the 50% of voting power? →
(c) Notwithstanding any provision in the certificate of incorporation, *any holder of shares entitled to vote at an election of directors of a corporation, may present a petition for its dissolution on the ground that the shareholders are so divided that they have failed, for a period which includes at least two consecutive annual meeting dates, to elect successors to directors whose terms have expired OR would have expired upon the election and qualification of their successors.*
NY has a more extreme remedy for DEADLOCK! * BUT NY courts are reluctant to order dissolution* → Wollman v. Litman
(i) *Irreconcilable differences even among an evenly divided board of directors do not in all cases mandate dissolution* (ii) *We affirm the appointment of a Receiver (custodian)* (a) His function, however, should be limited to the necessities indicated, namely, to the orderly functioning of the regular course of business of the corporation until the further order of the court. = *NY courts in equitable powers may order a custodian in the meantime* (like DE!)
FBI Farms Inc. v. Moore -validity of transfer restrictions?
(i) virtually all jurisdictions, allows corporations and their shareholders to impose restrictions on transfers of shares. (ii) *Transfer restrictions are treated as contracts either between shareholders or between shareholders and the corporation* (a) Because they are restrictions on alienation and therefore disfavored, the terms in the restrictions are not to be expanded beyond their plain and ordinary meaning (= *NARROWLY CONSTRUED!*)
FBI Farms Inc. v. Moore 3. Restrictions on Transfer Except to "Blood Members of the Family" 4. Restrictions as Applied to Involuntary Transfers → sheriff seizing the shares and selling them! *Will the restrictions STOP that involuntary transfer?*
3. = REASONABLE designation when adopted 4. NO → the transfer restrictions would NOT apply for creditors & involuntary transfer situations! *BUT NOTE → the creditors or recipients of the stock of the involuntary transfer receive the stock WITH the restrictions on their transferability of the shares!*
D. Classified stock can also be used to control shareholder voting. -How?
For example, a given company could have Class A and Class B common stock authorized in its charter. (a) *Class A shares could have voting rights while Class B shares do not*. (b) Thus, those who own the Class A shares are entitled to nominate and elect all the directors to the company's board. They also control the outcome of any vote on a significant corporate transaction (e.g., a merger), a proposed charter amendment, etc. *Alternatively, each of the two classes could entitle their holders to elect a specified number of directors to the board*
Would this irrevocable proxy/interest be valid in NY?
NOTE → this would NOT be valid in NY b/c Hebert would not be on the laundry list of qualifying persons who have interests in the shares!
A. → Voting provision in a shareholders agreements -provision allowed? -remedy for breach?
allowed in NY and DE. → Voting provision in a shareholders agreements and bind them to vote as they promise to vote for each other nominees to the board (1) Ex: 2 shareholders agree that each will get to nominate 3 people to the board to the 6 person board, and both will vote for the others nominees (a) What is the appropriate remedy if they don't? (i) SPECIFIC PERFORMANCE
Most states, including Delaware and New York, have so-called deadlock statutes → typically call for ?
either *an appointment of a receiver to run the business until the deadlock is resolved (Delaware)* or *the involuntary dissolution of the business (New York)*
FBI Farms Inc. v. Moore *Indiana Statute (MODELING the MBCA 6.27)* -where do the transfer restrictions need to be? - notice of the restriction? -restrictions allowed to prevent? (2)
→ (a) *Restrictions Need to be in the "The articles of incorporation, bylaws, an agreement among shareholders, or an agreement between shareholders and the corporation "* → (b) Need Proper notice! (b) Without it, such a provision is unenforceable (c)(1) = to prevent a transfer that would RUIN a S election for tax purposes! (c)(2) = to ensure the "private placement transaction"
Given this vulnerability....we hold? -this applies when...?
→ we hold that stockholders in the close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another = * UTMOST GOOD FAITH AND LOYALTY!* (a) We stress that the strict fiduciary duty which we apply to stockholders in a close corporation in this opinion *GOVERNS ONLY their actions relative to the operations of the enterprise and the effects of that operation on the rights and investments of other stockholders.* (i) We express *NO OPINION as to the standard of duty applicable to transactions in the shares of the close corporation when the corporation ITSELF is not a party to the transaction.*
New York's oppression statute → "Shareholder oppression" → standard?
"Shareholder oppression" → *Reasonable Exceptations Standard* → "considered oppression to *arise when "those in control" of the corporation "have acted in such a manner as to defeat those expectations of the minority stockholders which formed the basis of [their] participation in the venture."* = Expectations that are *REASONABLE and CENTRAL to their investment decision* → 1. *conduct that substantially defeats the "reasonable expectations" held by minority shareholders in committing their capital to the particular enterprise* → 2. AND *must investigate what the majority shareholders knew, or should have known*, to be the petitioner's expectations in entering the particular enterprise.
B. By Irrevocable proxy *discussed before!* (1) What happens to an irrevocable proxy when the shareholder shows up to the meeting (having already given away their irrevocable proxy)?
(1) - *A stockholder who executes an irrevocable proxy grants the right to vote his shares to a third party for the time period stated therein or otherwise as provided by statute.* (a) The *third part, rather than the stockholder, is entitled to vote his shares as she sees fit.* (2) *For a proxy to be irrevocable, it must state on its face that it is irrevocable and essentially be coupled with an interest.* (a) Under the Delaware corporation law (§ 212(e)) an interest sufficient to support an irrevocable proxy must be either "an interest in the stock itself or an interest in the corporation generally." 8 Del.C. § 212(e). (b) NY ONLY a Laundry List of People that may hold an irrevocable proxy = (a) They can show up to the meeting to hear what's going on, but can't vote. If they do vote, then their vote won't count (unless they're voting in Philly).
C. Voting Trust! -how do they work? -how made? -how long do they last?
(1) Here, shares are deposited into a trust. (2) The trust is the "record" owner of the shares and thus is entitled to vote all the shares through its TRUSTEE. (a) The beneficiaries of the trust, however, retain the right to receive dividends with respect to the shares they have deposited in the trust. (3) Voting trusts, like shareholders' agreements, allow voting control to be allocated in a manner other than pro rata. (4) They are also used to preserve the voting solidarity of a group of shareholders. (5) Agreements evidencing voting trusts must be filed with the corporation (a) →Need to file a copy of the agreement with the corp. (6) Last for specified time period (a) NY can last only up to 10 years, but can get multiple extensions (7) Valid in NY and DE
Donahue v. Rodd Electrotype Co. (b) In 1955, after Mr. Rodd had become president and general manager of business, the company repurchased 750 of the 1,000 outstanding shares of its stock → "RODD ELECTROTYPE" (i) Thus, Rodd and Donahue became the company's only shareholders, owning 80% and 20% of the company's outstanding shares, respectively. (ii) Shortly thereafter, Mr. Rodd's two sons, Charles and Frederick, were hired by the corporation. Charles succeeded his father as president and general manager in 1965. (a) Just prior to 1967, Mr. Rodd decided to distribute 117 of his 200 shares of stock (c) 1970 Mr. Rodd turned 77 years old. (i) Charles negotiated with his father for the purchase of 45 of his father's shares for $800 per share. (Charles later testified that this price reflected both the book and liquidating value of the shares). (ii) Later, the corporation's three-member board (consisting of the two Rodd brothers and a lawyer) voted to have the corporation consummate the purchase of the 45 shares at the agreed upon price. → BUY BACK THOSE SHARES! (a) *NOTE - RODD HAD A controlling block of shares, and therefore they did what he said!* = *Could argue this was like the Sinclair case of "self-dealing" → benefit conferred to a majority stockholder that is not given to the minority stockholders too* (b) Mr. Rodd thereafter sold two shares to each of his three children for $800 per share while also gifting them 10 shares each (d) By this time, Mr. Donahue had passed away. (i) His wife and son inherited his 50 shares of stock in the corporation. (ii) Once they learned that the corporation had purchased some of Mr. Rodd's shares for $800 a piece, they offered to sell their shares to the corporation based on the same terms. (iii) After the corporation rejected Mrs. Donahue's offer, they commenced this lawsuit. *We deem a close corporation to be typified by: 3*
(1) a small number of stockholders; (2) no ready market for the corporate stock; and (3) substantial majority stockholder participation in the management, direction and operations of the corporation. → *bears striking resemblance to a PARTNERSHIP* → Just as in a partnership, the *relationship among the stockholders must be one of TRUST, CONFIDENCE AND ABSOLUTE LOYALTY if the enterprise is to succeed.*
Relief in this case ? (2)
(a) 1. judgment may require Harry Rodd to remit $36,000 with interest at the legal rate from July 15, 1970, to Rodd Electrotype in exchange for forty-five shares of Rodd Electrotype treasury stock. (b) Or 2. In the alternative, the judgment may require Rodd Electrotype to purchase all of the plaintiff's shares for $36,000 without interest.
The minority is vulnerable to a variety of oppressive devices, termed "freeze-outs," which the majority may employ. . Freeze outs?
(a) : "The squeezers . . . *may refuse to declare dividends; they may drain off the corporation's earnings in the form of exorbitant salaries and bonuses to the majority shareholder-officers and perhaps to their relatives*, or in the form of high rent by the corporation for property leased from majority shareholders . . . ; they may deprive minority shareholders of corporate offices and of employment by the company. . . . " Minority can't just sell their shares on the market!!! Thus, in a close corporation, *the minority stockholders may be trapped in a disadvantageous situation. No outsider would knowingly assume the position of the disadvantaged minority. The outsider would have the same difficulties.*
NY deadlock statute -what? -on what grounds? (3)
(a) Except as otherwise provided in the certificate of incorporation under section 613 (Limitations on right to vote), the *holders of shares representing one-half of the votes of all outstanding shares of a corporation entitled to vote in an election of directors may present a petition for DISSOLUTION on one or more of the following grounds:* (1) That the *directors are so divided respecting the management of the corporation's affairs that the votes required for action by the board cannot be obtained.* (2) That the *shareholders are so divided that the votes required for the election of directors cannot be obtained.* (3) That there is *internal dissension and two or more factions of shareholders are so divided that dissolution would be beneficial to the shareholders.*
Legislation for CLOSELY HELD CORPS NY 620: *Allows closely held corps to operate like reg corps → via shareholder agreements!* - for instance, those agreements can ----(2)
(a) can say how the shares will be voted! (b) may restrict their ability to manage / what managerial authority means, IF: (1) *If all the incorporators or holders of record of all outstanding shares*, whether or not having voting power, *have authorized such provision in the certificate of incorporation or an amendment thereof* and (2) If, subsequent to the adoption of such provision, *shares are transferred or issued only to persons who had KNOWLEDGE OR NOTICE thereof or consented in writing to such provision.*
Typical events that trigger forced resales include: (3)
(i) • *Termination of employment*. The shareholder in question is allowed to retain her shares so long as she remains an employee of the company. Once she leaves (either voluntarily or involuntarily), she must sell her shares back to the company. (ii) • *Death of a shareholder*. The estate of a deceased shareholder must sell the decedent's shares back to the company. Often, the company receives the funds necessary to repurchase the shares from the proceeds of a life insurance policy that the company took out on the decedent. (iii) • *Incapacity of a shareholder.* Because a closely-held company typically relies on its owner-managers to run it, the incapacity of a shareholder could prove deeply problematic. Indeed, the incapacitated shareholder's inability to contribute to the company's operations could have a materially adverse effect on that company. Thus, when a shareholder becomes incapacitated, she must sell her shares back to the company. Thereafter, the company can use those shares to entice a prospective owner-manager to take the place of the incapacitated shareholder.
Closely-held companies share 4 key attributes.
*1. First, they have a limited number of shareholders, most of whom are individuals.* * 2. Second, these companies are generally run by MANAGERS (owner-managers) who are also shareholders.* (a) These shareholder-managers typically receive compensation from their companies in the form of salaries and other perquisites, rather than through the receipt of cash dividends. *3. Third, no secondary trading market exists for shares of closely-held companies.* (a) Thus, shareholders have a difficult time cashing out of their investments. *4. Lastly, formal (i.e., contractual) restrictions (typically in a "shareholders' agreement") often influence their corporate governance and their shareholders' ability to transfer shares to third parties.*
MATTER OF KEMP & BEATLEY NOTE → why didn't the duty of care and loyalty apply here?
*Sad reality is = board of Ds can comply with their fiduciary responsibilities and STILL engage in oppressive conduct* (i) Won't get caught up in the duty of care, because none of the actions were grossly negligent, but rather purposeful (ii) MAY get caught in the duty of loyalty here if the corp can't show what they did was in any way for the best interests of the corp, but rather, just to screw these guys over
(i) 1) "No stock of said corporation shall be transferred, assigned and/or exchanged or divided, unless or until approved by the Directors thereof;" (ii) 2) "That if any stock be offered for sale, assigned and/or transferred, the corporation should have the first opportunity of purchasing the same at no more than the book value thereof;" (iii) 3) "Should said corporation be not interested, and could not economically offer to purchase said stock, any stockholder of record should be given the next opportunity to purchase said stock, at a price not to exceed the book value thereof;" (iv) 4) "That if the corporation was not interested in the stock, and any stockholders were not interested therein, then the same could be sold to any blood member of the family. Should they be desirous of purchasing the same, then at not more than the book value thereof."
1. = consent restriction! 2. = right of first offer TO THE CORP! 3. = right of first offer FOR REMAINING STOCKHOLDERS! 4. = group restriction!
*The 2 biggest issues to CONTRACT about when it comes to Closely Held Corps?*
1. Control Of voting 2. Ownership of Shares
FBI Farms Inc. v. Moore 1. Right of first offer? 2 . Restrictions on Transfer with Board Approval
1. HERE - not enforced (a) While the sellers did NOT first offer the corp to buy the shares (b) → NOT an effective defense by the corp. because the corporation and its shareholders were aware of the sheriff's sale and did nothing to assert the right of first refusal. 2. *LOOK at the legality of it AT THE TIME OF CREATION* (a) → *restriction is reasonable if it is designed to serve a legitimate purpose of the party imposing the restraint and the restraint is not an absolute restriction on the recipient's right of alienability.* (i) *BUT MAY NOT be permitted to unreasonably withhold or delay* (a) reasonable here when first adopted? Yes, and all stockholders voluntarily agreed to it at that time
A. →Restrictions on Transferability (4 types)
1. right of first refusal 2. right of first offer 3. consent restraint 4. group restriction
*A. →Restrictions on Transferability (4 types)* 3. consent restraint. DE? NY?
= *A consent restraint prohibits a shareholder from transferring her shares unless she first obtains the permission of the company's board of directors and/or other existing shareholders.* (i) Section 202(c)(3) of the *DGCL specifically authorizes the use of consent restraints.* (ii) *Allowed by NY in common law → so long as it cannot be exercised unreasonably/ unreasonably withheld or delayed* (a) Rafe v. Hindin→ need a provision that the stockholder may NOT unreasonably withhold his consent.
*A. →Restrictions on Transferability (4 types)* 2. right of first offer. (i) IF the corp has both 1.right of first refusal And 2. right of first offer→ ?
= *If a shareholder desires to sell her shares, she MUST FIRST offer them for sale to the company, other existing shareholders or both on terms previously agreed upon and set forth in the shareholders' agreement(= a pricing formula for determining the price that the offerees must pay)* (i) → *ONLY IF* the offerees reject that offer, or the offer simply lapses, may the shareholder thereafter offer her shares for sale to a third party. (i) IF the corp has both 1.right of first refusal And 2. right of first offer→ *party desiring to sell HAS to offer to corp first, as in #2*
*A. →Restrictions on Transferability (4 types)* 1. right of first refusal
= *If a shareholder receives an offer from a third party to buy her shares, she MUST, prior to selling them to that third party, offer her shares for sale to the company, other existing shareholders or both on substantially the same terms (including, without limitation, the exact same price) as the third party is offering.* (i) → *ONLY IF* the offerees decline her offer, or the offer simply lapses, the shareholder can then sell her shares to the third party. (ii) If the offer by the 3rd party is modified, re-triggers this requirement and need to offer it back to the company first!
*A. →Restrictions on Transferability (4 types)* 4. group restriction -DE? *Restrictions on Transferability exceptions* (2)
= *Pursuant to it, a shareholder can freely transfer her shares, but only to designated persons or classes of persons (e.g., family members)* (i) Under Section 202(c)(5) of the *DGCL, group transfer restrictions are legal so long as the group designation is not "manifestly unreasonable."* *Restrictions on Transferability exceptions* (a) Despite a shareholders' agreement to the contrary, transfer restrictions are generally inapplicable to transfers made by operation of law. (b) Transfer restrictions also are ineffective against third party buyers UNLESS the certificate representing the shares in question contains a conspicuous legend (NEED TO PUT THEM ON NOTICE OF THE TRANSFER RESTRICTIONS! (i) IF NOT MENTIONED → THEY TAKE FREE AND CLEAR OF THOSE RESTRICTIONS)
If selling shares back to the corp!→ To meet this test, if the stockholder whose shares were purchased was a member of the controlling group, the controlling stockholders must .....?
= *cause the corporation to offer each stockholder an equal opportunity to sell a ratable number of his shares to the corporation at an identical price.*
Legislation for CLOSELY HELD CORPS DE *(1) Can have a shareholder's agreement* *BUT also→ set of provisions that allow you to transform the closely held corp into a STATUTORY CLOSE CORP*
= ALLOWS IT TO BE RUN MORE LIKE A PARTNERSHIP -DE 342 → requirements include: no more than 30 shareholders, etc. -Need to be labeled as such in the charter "STATUTORY CLOSE CORP" But Haas said he's never come across a "statutorily close corp"
*Dissolution for Oppression = Shareholders in a Closely Held Corp → NOT GETTING ALONG* 1. Deadlock (2 forms) -way to avoid?
= is the term used to describe a stalemate between two or more opposing factions. * Deadlock can occur at either the shareholder or board of directors level.* (1) Two or more opposing shareholder groups can prevent the election of the new board members necessary to replace those leaving the board. (2) On the board of directors level, directors for and against a given issue may be evenly divided. Thus, the board is not able to make important business decisions and the business, therefore, simply treads water. a) Way to avoid this? Pick a board of ODD # of directors
B. Forced Resale Provisions
= prevents shares from falling into the "wrong hands." (a) *Upon a triggering event→ in the context of a forced resale, the shareholder must sell her shares back to the company even if she (or her estate) wants to continue holding them* (i) Often made into an option the corp. may take, rather than an obligation because the corp may not have enough $ to buy back the shares! (a) Or maybe a payment plan
*1. Control Of voting* - 4 methods of control
A. → Voting provision in a shareholders agreements B. By Irrevocable proxy C. Voting Trust! D. Classified stock can also be used to control shareholder voting.
*2. Ownership of Shares* - 2 methods
A. →Restrictions on Transferability (4 types) B. Forced Resale Provisions
Closely-Held Corps?
All companies that are not reporting companies under the Exchange Act are, by definition, privately-held companies.
"His participation in that particular corporation is often his principal or sole source of income. As a matter of fact, providing employment for himself may have been the principal reason why he participated in organizing the corporation." (a) Statutory remedy?
Assuming the petitioner has set forth a* prima facie case of oppressive conduct, it should be incumbent upon the parties seeking to forestall DISSOLUTION* to demonstrate to the court the existence of an adequate, alternative remedy . . . . *Still, courts are reluctant to order dissolution* → *Every order of dissolution, however, must be conditioned upon permitting any shareholder of the corporation to elect to purchase the complaining shareholder's stock at fair value*
DE deadlock statute -in what circumstances? (3)
DE 226 → (a) The Court of Chancery, *upon application of any stockholder, may appoint 1 or more persons to be custodians*, and, if the corporation is insolvent, to be receivers, of and for any corporation when: (1) At any meeting held for the election of directors the *stockholders are so divided that they have failed to elect successors to directors whose terms have expired or would have expired upon qualification of their successors*; or (2) The *business of the corporation is suffering or is threatened with irreparable injury because the directors are so divided respecting the management of the affairs* of the corporation that the required vote for action by the board of directors cannot be obtained and the stockholders are unable to terminate this division; or (3) The *corporation has abandoned its business and has failed within a reasonable time to take steps to dissolve, liquidate or distribute its assets.*
Evangelista v. Holland (a) the shareholders' agreement in question allowed the corporation to buy out the estate of any deceased shareholder for $75,000. (i) When the estate of a deceased shareholder refused to sell the decedent's shares back to the corporation for that amount, the corporation brought suit to enforce the agreement. (ii) Evidence was presented indicating that the decedent's stock was worth at least $191,000. -found for who? why?
In finding for the corporation, the Court stated the following: (i) That the *PRICING FORMULA established by a stockholder's agreement MAY BE LESS than the appraised or market value is unremarkable.* (ii) *When the agreement was entered into* in 1984, the order and time of death of stockholders was an unknown. *There was a mutuality of risk."* (a) → *it was reasonable at the time entered into and agreed by all THEN, so it is enforceable now*!
*Dissolution for Oppression = Shareholders in a Closely Held Corp → NOT GETTING ALONG* 2. *SHAREHOLDER OPPRESSION* MATTER OF KEMP & BEATLEY (1) The company's stock consists of 1,500 outstanding shares held by 8 shareholders. (2) Petitioner Dissin had been employed by the company for 42 years when, in June 1979, he resigned. (a) Prior to resignation, Dissin served as vice-president and a director of Kemp & Beatley. (b) Over the course of his employment, Dissin had acquired stock in the company and currently owns 200 shares. (3) Petitioner Gardstein, like Dissin, had been a long-time employee of the company. Hired in 1944, Gardstein was for the next 35 years involved in various aspects of the business including material procurement, product design, and plant management. His employment was terminated by the company in December 1980. He currently owns 105 shares of Kemp & Beatley stock. (a) *Of particular concern was that they no longer received any distribution of the company's earnings. Petitioners considered themselves to be "frozen out" of the company* (4) Gardstein and Dissin, together holding 20.33% of the company's outstanding stock, commenced the instant proceeding in June 1981, seeking dissolution of Kemp & Beatley pursuant to NY section 1104-a of the Business Corporation Law (a) Their *petition alleged "fraudulent and oppressive" conduct by the company's board of directors such as to render petitioners' stock "a virtually worthless asset."* (b) Also found was the company's "established buy-out policy" by which it would purchase the stock of employee shareholders upon their leaving its employ. (i) → REPEALED by the corp. To prevent doing it for these 2 guys New York's oppression statute →?
NY 1104-a = *stockholders holding at least 20% of a NY corp's shares can petition the court for corporate dissolution based on "oppressive" conduct by the majority or controlling stockholder or stockholder group.*
Haft v. Haft (a) [Herbert Haft was the founder and CEO of Dart Group Corporation. He transferred 172,730 shares of Dart Class B common stock to his son, Ronald Haft. (i) Class B stock was the company's only class of voting stock. Class A stock had no voting rights (ii) The shares that Ronald received constituted 57% of the outstanding shares of Class B stock. Therefore, it carried the power to nominate and elect the entire Dart board of directors. (iii) Ronald gave his father a promissory note and granted him a lifetime irrevocable proxy to vote the transferred shares as the father saw fit. Later, Ronald sought to revoke the irrevocable proxy. (iv) However, the court determined that the father's interest in the company by virtue of his CEO position was enough to render the proxy irrevocable.] (v) = *son trying to revoke the proxy!*
Under the *Delaware corporation law (§ 212(e)) an interest sufficient to support an irrevocable proxy must be either "an interest in the stock itself or an interest in the corporation generally."* (a) I am required to express the opinion that such an interest—the interest that Herbert Haft had and retains *as the senior executive officer of Dart—is sufficient under our law to render specifically enforceable the express contract for an irrevocable proxy. . .*
