Corporations II

One of the reasons that business owners seek legal advice is to implement agreements which change the normal attributes of a traditional corporation. They do this, because the traditional statutory rules simply don't fit the needs of every business enterprise. In the absence of a properly drafted agreement, they wind up with the provisions supplied for them by their state of incorporation's corporate code. Here are some of areas in which business owners commonly seek to change the basic rules.

• A partnership is an association of two or more persons to carry on as co-owners a business for profit and includes a limited liability partnership....

Stock Transfer Restrictions: Because each shareholder has a personalized stake in the operations of the company, shareholders commonly want to restrict who will be involved in the business, in the same way that partners want to restrict membership. There is an additional reason for transfer restrictions: if shares are not restricted, it may be possible for a single existing owner, or an outsider, to acquire a majority intererest in the firm. The new majority shareholder might use his powers as majority owner to redirect the priorities of the company, or to exclude the minority from the benefits of ownership. For this reason stock transfer restrictions are a common component of close corporation agreements. Often they are accompanied by buy-sell agreements. The agreement may require the shareholder to offer his shares to the company first at the proposed selling price, or to the other shareholders in equal proportions. Sometimes shareholders may provide for transferability among family members.

Buy-Sell Agreements: Since there is no ready market for shares in most close corporations, shareholders will want a way to recoup their investment and its gain upon retirement, disability or death. There are a variety of mechanisms to set the buy-out price. Sometimes the shareholders agree to set a new price annually, although many business owners are less than diligent in keeping the agreed price current. As one owner's buyout event approaches, the setting of price can become a matter of controversy. The parties may agree to a formula, to an appraisal, or may simply agree that the corporation has the right to buy at an outsider's offered price. The problem with this latter mechanism, is that an outsider will not offer a fair price, unless the outsider is assured of participating in the benefits of the corporation.

Buy-in Rights: It is not uncommon for a controlling owner to promise future ownership rights to attract a key employee or retain the participation of a next-generation family member. A common source of friction arises when the controlling owner fails to meet the employee's expectations. A written agreement can eliminate some of that friction.

Restriction on Management: Customarily, the board of directors has power to hire and fire, set compensation, and make other decisions. Under traditional corporate law, the courts seldom interfere with those decisions under the "business judgment rule" which requires deference to board of directors decision making. An agreement may establish shareholder veto for certain actions, set supermajorities, establish minimum compensation, require dividends, establish procedures for dispute resolution, and so on.

Restrictions on Issuance of Stock: Issuance of new stock can be an occasion to change the balance of power in a corporation. A majority might increase its majority by attempting to sell stock preferentially to the majority. Pre-emptive rights, the right to acquire stock in proportion to ones interest in the corporation provides some protection against this abuse. I more subtle abuse can occur if the majority chooses to issue stock at a time, or in an amount, inconvenient to the minority. An agreement can provide that issuance of further stock cannot change the minority's veto rights, or may require consent of the minority to issue new stock.

For many years the leading source of information on close corporations has been F. Hodge O'Neal and Robert B. Thompson's book "Close Corporations," published by Callaghan.