What are the shareholders expectations in a close corporation? (3)
- Shareholders generally serve as directors and officers and expect to work for the corporation
- Shareholders expect to receive money from close corporations (salary or dividends)
- Shareholders expect to have management rights
What are the characteristics of a close corporation? (3)
- Not publicly traded – no liquidity of investments and no check on those in control
- Small number of shareholders
- Lack of separation between ownership and control
What is the New York “No Harm, No Foul” Approach to shareholder agreements limiting board discretion?
- No separate registration required for statutory close corporations
- If it has the characteristics of a close corporation, courts will treat it as such
What is the majority rule on limiting board discretion from Clark v. Dodge?
“A shareholder agreement that restricts board discretion is valid if the restrictions are so slight as to be negligible and there is not damage suffered or threatened to anybody”
What is the test for the New York Approach for shareholder agreements limiting discretion?
- Does the agreement sterilize the board (if YES, struck down)
- Will creditors and other shareholders be harmed? (if YES, struck down)
What is the Delaware Approach to shareholder agreements limiting board discretion?
No special rules/protections for closely held businesses unless they are registered as such in the C/I
What are the three characteristics a corporation must have to be a statutory close corporation under DGCL § 342?
- No more than 30 shareholders of record
- Stock certificates must have restrictions on transfer
- No public offering of stock
When does Delaware law allow contracts to limit board discretion?
- The corporation registers as a close corporation in its C/I
- The corporation specifies in the C/I that such agreements are allowed?
What is the danger of shareholders entering into agreements to ensure they are employed by the corporation or receive a salary?
Violating DGCL § 141 - provides that the business and affairs are to be managed by the board of directors except as otherwise provided in this chapter or in the C/I
What are the three ways to ensure board representation?
- Cumulative voting (DGCL § 214)
- Different classes of stock - each class elects a different board member
- Vote pooling agreements
What is a vote pooling agreement?
Shareholders agree in advance of a vote to vote their shares a certain way to ensure they will be on the board
What are the (3) characteristics of ownership and control of stock in a vote pooling agreement?
- You still own your stock
- You still receive dividends on your stock
- You still vote your stock
What are the requirements of a vote pooling agreement as laid out in DGCL § 218(c)?
- Has to be an agreement between 2 or more shareholders
- In writing
- Signed by the parties
What are shareholders two options for enforcement of vote pooling agreements?
- Breach provision in the contract
2. Irrevocable proxy (DCGL § 212(e))
What is a “freeze out?”
- Shareholder loses job
- Shareholder receives little or no economic return on investment (no job, no salary, no dividends)
- Shareholder not elected to or removed from board
What is the traditional approach to freeze outs?
Courts defer to the majority’s decision. See Zidell v. Zidell (applying business judgment rule)
What is the modern approach to freeze outs laid out in Donohue v. Rodd Electrotype Co.?
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.
What is the balancing test of the modern approach laid out in Wilkes v. Springtide Nursing Home, Inc.
- Control group demonstrates a legitimate business purpose
- Burden shifts to the minority shareholder to demonstrate same objective could be achieved through less harmful alternative
- If P makes the showing, court will weigh the legitimate business purpose against the practicability of the less harmful alternative
What are the additional factors in Wilkes?
- Was the action in disregard of a long-standing policy
- Was the shareholder a founder of the corporation?
- Would the action mean that the shareholder would receive no return at all from the corporation?
How does the NY involuntary dissolution statute work?
Allows the holders of shares representing 20% or more of the outstanding votes of the corporation to petition for dissolution b/c the directors or those in control have been guilty of illegal, fraudulent, or oppressive actions toward the complaining shareholders.
How does the MBCA allow defendant corporations to avoid court-ordered involuntary dissolution?
By electing to repurchase the complaining minority’s shares at a fair value.
What makes the acts of directors “oppressive”?
- Violates the minority shareholders’ reasonable expectations
- Burdensome, harsh, or wrongful
What are the three judicial options in a dissolution action?
- Court has the DISCRETION to dissolve the corp
- Court can grant alternative relief: buyback or payment of dividends
- Court can make dissolution conditional on a majority buyback first
What is a share repurchase agreement?
Agreement to repurchase stock held by a minority shareholder when certain triggering events occur since there is no market for shares available
