Managing closely held corporations: a legal guidebook
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Traditional Roles of Directors
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Section 1: Basic Concepts
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A. Corporation, Articles of Incorporation and Bylaws
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B. Directors, Officers and Shareholders
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C. Closely Held Corporation
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1. Shareholders Frequently Are Also Directors, Officers
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2. Management Structure and Corporate Governance Rules
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3. There Is Little Liquidity of Investment
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4. The Value of Shares Is Not Readily Determined
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5. Financial and Other Information Is Generally Not
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7. Limited Resources and Other Practical Constraints
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May Result in Inattention to Corporate Formalities
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D. Types of Closely Held Corporations
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1. Incorporated Proprietorships
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2. Incorporated Partnerships
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4. Subsidiary Corporations
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5. Corporate Joint Ventures
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6. Outside-Investor-Backed Corporations
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E. Tax Attributes of Closely Held Corporations
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Section 2: The Structure of Corporate Action
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A. Traditional Roles of Directors, Officers and Shareholders
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B. Board Structure and Action
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b. Action without Meeting
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c. Committees of the Board
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C. Establishing the Agenda for Board Action
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D. Quality of Information
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d. Attendance by Electronic Means
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g. Conduct of the Meeting
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3. Action without Meeting
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G. Joining the Board as an Outside Director
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H. Honorary Directors, Advisory Boards, Board Observers
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Section 3: Director and Officer Duties and Rights
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1. Board Responsibilities
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2. Individual Responsibilities
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b. The Need to Be Informed
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c. The Right to Rely on Others
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c. Fairness to the Corporation
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d. Documentation of Conflicts
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7. The Duty of Disclosure or Candor
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B. The Business Judgment Rule
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E. Responsibilities in Special Situations
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F. Representative Directors
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Section 4: Shareholder Duties and Remedies
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A. Duties of the Controlling Shareholder
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B. Rights and Remedies of Minority Shareholders
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2. Dissolution and Judicial Intervention Statutes
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Section 5: Modifying Traditional Roles and Structure
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D. Multiple Classes of Shares
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F. Other Protective Provisions
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Section 6: Buy-Sell Agreements
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A. Restriction on Transfer
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B. Right of First Refusal
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C. Repurchase Rights in the Event of Shareholder Death
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D. Repurchase Option if Shareholder Terminates Employment
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H. Put and Drag-Along Rights
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I. Restrictive Legend on Share Certificates
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Section 7: Raising Money, Issuing Shares and Distributing Assets
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A. Financing the Corporation
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1. Strategic and Practical Concerns
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2. Corporation Law Concerns
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3. Securities Law Concerns
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B. Dividends and Stock Repurchases
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1. Strategic and Practical Concerns
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C. Giving Employees an Ownership Interest
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Section 8: Liability Concerns
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A. Director and Officer Liability
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2. Liability under Other Laws
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B. Shareholder Liability–Piercing the Corporate Veil
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C. Limitations on Liability for Money Damages
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Section 9: Corporate Books, Records and Reporting
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A. Minutes, Written Consents, Articles and Bylaws
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B. Financial Records and Statements
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D. Right to Inspect Books and Records
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This Guidebook, prepared by the Committee on Corporate Laws of the Section of Business Law of the American Bar Association, provides a concise, practical overview of important legal principles governing directors, officers and shareholders of closely held corporations. It is intended primarily for nonlawyers. There are other excellent books and articles for corporate directors, officers and shareholders as well as for owners and managers of businesses organized in noncorporate forms, such as limited liability companies (LLCs). A bibliography at the end of this Guidebook lists some of the materials most relevant to the closely held corporation.
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This Guidebook is different from other available sources in a number of ways:
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* It deals with the special concerns and challenges involved in closely held corporations–those with relatively few shareholders and no public trading market for their equity securities. Although LLCs have become the entity of choice for many closely held businesses since they came on the scene in the 1990s, the closely held corporation remains the most common form of business organization in the United States. There is a staggering diversity in the types and sizes of businesses operating as closely held corporations, but many of the legal issues facing directors, officers and shareholders are the same, from the smallest closely held corporation operating at a local or even neighborhood level to the largest operating across the globe.
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* It covers legal concerns of directors, officers and shareholders. In publicly held corporations, most shareholders are passive investors with little connection to, or control over, management and little occasion to deal directly with the corporation. There may be little or no overlap between the decisionmakers (management) and the risk-takers (shareholders). In closely held corporations, on the other hand, much greater congruency of decision-making and risk-taking exists. Most of the directors and officers are also significant shareholders. Consequently, a guidebook addressing closely held corporations needs to address all three roles.
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* It focuses on the law of corporate governance–the legal rules relating to the respective powers and duties of directors, officers and shareholders. This Guidebook does not purport to summarize all the various bodies of law relevant to closely held businesses. It focuses instead on crucial, common-denominator corporate law issues relating to structure, management and decision-making. Who has the power to approve which corporate actions? How are those actions taken? What fiduciary duties of care, loyalty, good faith, fairness or disclosure do directors, officers and shareholders owe each other? What liabilities may result from breaching those duties?
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Section 1 of this Guidebook outlines some of the most basic and important concepts involved in the closely held corporate form. The next three Sections discuss the rudiments of corporate governance: Section 2 focuses on the structure of corporate action
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As noted, closely held corporations come in a great variety of types and sizes. Many of the concepts discussed in this Guidebook apply with equal importance to all closely held corporations
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A number of the concepts discussed in this Guidebook have close analogs in the world of noncorporate forms of organization, such as partnerships and LLCs. Choice of entity is an extremely important decision for those organizing a closely held business, involving a complex balancing of tax and other important considerations. Organizers of a closely held business need expert advice to make an informed choice. This Guidebook, however, takes choice of the corporate form as a given. The characteristics of noncorporate forms of organization and the considerations involved in choice of entity are beyond the scope of this Guidebook.
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Every state in the United States has its own corporation statute available for business corporations. (1) Most closely held corporations are incorporated under the laws of the state in which they are headquartered or under the laws of a widely accepted corporate “home-away-from-home,” such as Delaware. Although the differences in corporation statutes from state to state are not enormous, there are some differences that may be important at times for closely held corporations. Unless specifically provided to the contrary, the terminology and legal rules discussed in this Guidebook conform to the Model Business Corporation Act (the “Model Act”). (2) Readers should be aware that the state statute applicable to their corporation in a particular state may differ from the Model Act. When faced with a specific problem, directors, officers, shareholders and counsel should examine the particular state statute governing the corporation.
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SECTION 1: BASIC CONCEPTS
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This section explains a few basic legal concepts that all directors, officers and shareholders of closely held corporations must understand.
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A. CORPORATION, ARTICLES OF INCORPORATION AND BYLAWS
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A corporation is an entity separate from its directors, officers and shareholders, having the legal attributes provided in the state corporation statute under which it is created. Unlike the sole proprietorship and general partnership forms of business organization, a corporation comes into being only if specific acts are taken: articles of incorporation (known in some states, including Delaware, as a certificate of incorporation) containing required provisions must be filed with the appropriate government office (normally the secretary of state) in the state of incorporation, and a fee must be paid. Once the corporation is properly formed, it will continue in existence until it is dissolved.
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In addition to being the “birth certificate” of the corporation, the articles of incorporation also serve as a basic public record of legally required information about the corporation. Corporation statutes typically require that the articles of incorporation contain, at a minimum: (1) the corporate name, (2) the name of the corporation’s agent for service of process and its registered office in the state of incorporation, (3) the type and amount of authorized capital stock of the corporation and (4) the name and address of the incorporator (the person who caused the articles to be filed). In addition to required information, the articles are also the place in which the corporation may opt in or opt out of very important elective provisions under the governing corporation statute, such as:
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* pre-emptive rights of the shareholders to subscribe for shares (see Section 7).
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* cumulative voting for election of directors (see Section 2).
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* limitations on director liability (see Section 8).
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In addition, corporation statutes permit inclusion of practically any other provisions desired in the articles of incorporation. Typically, however, participants in closely held corporations prefer to keep the content of the articles sparse because the articles are available to the public and because provisions in the articles generally require a shareholder vote to change. The articles of incorporation or certificate of incorporation are sometimes referred to as the “charter” of the corporation.
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The bylaws are a set of more detailed rules of corporate governance that are required by most corporation statutes. Corporate bylaws usually lay out rules for shareholder and board meetings (e.g., when, where, who can call, notice, quorum and voting requirements), officer titles and duties, indemnification of directors and officers and other important matters. Unlike the articles of incorporation, the bylaws are not required to be filed with the state government and are a private document typically kept in the minute book. The bylaws may generally be amended by action of either the board or the shareholders.
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B. DIRECTORS, OFFICERS AND SHAREHOLDERS
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Shareholders or stockholders are the owners of the corporation. Unlike partners in a general partnership (who participate equally in the management of the partnership business unless agreed to the contrary), shareholders of a corporation are, by law, given the right to vote on only certain enumerated items of corporate business: election of directors, amendments to the articles of incorporation and bylaws and certain fundamental transactions (mergers, statutory share exchanges, major sales of corporate assets and dissolution). The board of directors has the unilateral authority to approve all other corporate actions. The Model Act and most state corporation statutes permit shareholders in a closely held corporation to vary this vesting of residual authority in the board of directors (and even to dispense with the board of directors altogether) through a control agreement. Shareholders in closely held corporations frequently customize voting control to ensure desired board composition or balance of power on key corporate actions through use of multiple classes of stock with differing voting rights, voting agreements or voting trust arrangements (see Section 5).
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Directors are elected by the shareholders. Modern corporation statutes have generally eliminated requirements that directors be shareholders or meet any other statutory qualifications. Most corporation statutes permit as few as one director to make up the board.
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Officers of the corporation are elected by the board of directors and have the authority and responsibilities delegated to them either in the bylaws or by specific board resolutions. Officers may also have implied authority by virtue of their positions, at least with respect to ordinary business transactions. The Model Act and most state corporation statutes permit the board great latitude in deciding what officers the corporation should have, what titles those officers should have and what responsibilities and duties they should have. Most corporations have an officer who serves the chief executive function (typically called President, Chief Executive Officer or CEO) and the chief financial and accounting function (typically called Vice President-Finance or Treasurer or Chief Financial Officer or CFO). The Model Act and nearly all state corporation statutes require that one officer be in charge of corporate records. That officer is generally called the Secretary. The Model Act and most state corporation statutes permit one person to serve more than one, or even all, officer functions.
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C. CLOSELY HELD CORPORATION
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A closely held corporation is most commonly defined as a corporation that has a relatively small number of shareholders and no active trading market for its securities. (3) The term is frequently used to refer to any corporation that is not a publicly held corporation. A publicly held corporation has an organized, separate trading market for its equity securities and may have thousands of shareholders. Closely held corporations include a very diverse range of business associations from one-shareholder corporations to family-owned businesses to wholly owned subsidiaries to corporate joint ventures. Although closely held corporations are often small businesses, closely held status has nothing to do with size. A number of the largest corporations in the world, in terms of assets and revenues, are closely held.
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Although closely held corporations come in many types and sizes, they share common attributes. These attributes include:
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1. Shareholders Frequently Are Also Directors, Officers and Key Employees
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In publicly held corporations, most shareholders are passive investors with little connection to, or control over, management and little occasion to deal directly with the corporation. In closely held corporations, on the other hand, there is typically much greater overlap. Directors and officers are generally also significant shareholders and active participants in the day-to-day business of the corporation. They all know each other and know each other’s skills as managers and employees. Some important consequences flow from this attribute.
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* Who becomes a shareholder is important. Shareholders in closely held corporations generally want to control transfers of equity securities so that unwanted outsiders do not become participants in the business. This is usually done through contractual restrictions on transfer (see Section 6).
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* Conflicts of interest may be frequent. The overlapping roles of shareholder, officer, director and employee mean that transactions involving the corporation frequently involve conflicts between the interests of a director, officer or shareholder and those of the corporation. These conflict-of-interest transactions pose special problems for the board of directors (see Sections 3 and 8).
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* Difficulty of multiple roles. When a shareholder serves as a director or officer, the self-interest of the shareholder may conflict with the interests of the other shareholders or the corporation as a whole. Even though a shareholder is free to vote and otherwise act in his or her own interest, a director or officer owes loyalty to the corporation. A shareholder who serves as director or officer must remember that a director or officer has fiduciary responsibilities to the corporation (see Section 3 for a further discussion of the director’s and officer’s duty of loyalty in conflict-of-interest situations).
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The officer of a corporation who serves as a director also has a dual role. In matters involving compensation or other employment arrangements, the officer may have a personal interest that conflicts with the interests of the corporation. As employees, officers also have heightened duties to the corporation that differ from the supervisory duties of directors (see Section 3).
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Customers, suppliers, bankers, lawyers and other people with relationships to the corporation may be asked to become directors. Inherent conflicts of interest may exist when a person with a business relationship with the corporation serves as a director. A lawyer for the corporation who also serves as a director faces special concerns.
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2. Management Structure and Corporate Governance Rules May Be Customized
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Management structure and corporate governance rules are frequently customized in closely held corporations through the use of shareholder agreements, multiple classes of stock with differing voting rights, voting agreements or voting trust arrangements. These arrangements may be used to ensure desired board composition or desired balance of power on decisions regarding key corporate actions. Shareholders forming a closely held corporation often have preconceived expectations regarding structure and governance that do not conform to the basic default rules under the relevant corporation statute (e.g., a desire that all shareholders must be directors or must approve expenditures over $50,000). Various techniques can be used to customize structure and governance to meet these expectations. Using arrangements to ensure expectations are met can be a crucially important part of the planning and organization for closely held corporations, especially where investors include factions or constituencies (e.g., branches of a family, venture capital investors) whose self-interests may clash. Directors of closely held corporations involving such customized balancing must learn to operate within the customized rules the corporation adopts (and the political realities they represent) and must be ready to deal with difficult cross-allegiances and conflicts that may arise when directors attempt to represent the interests of a faction or constituency while fulfilling their fiduciary duties to the corporation and to all shareholders.
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3. There Is Little Liquidity of Investment
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Because a closely held corporation has no active trading market for its shares, a shareholder who wants to sell shares may have little ability to find a buyer. Sales of stock frequently must be made at a substantial discount to value as a proportionate share of the business when a buyer can be found. A shareholder who has a falling out with other shareholders in a closely held corporation may find that the only market for his or her shares consists of those other shareholders with whom he or she is at odds. The economic pressure on an outcast shareholder in a closely held corporation may be even greater if the outcast’s primary income has been derived as an employee of the corporation.
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* Buy-sell agreements are substitutes for market liquidity. Liquidity concerns of individual shareholders, as well as concerns of all shareholders regarding who can invest with them, can be at least partially addressed by putting contractual buy-sell mechanisms in place at the outset. Consideration of such agreements is an essential part of corporate planning and organization and can help reduce the risk of hardship and disputes. Buy-sell arrangements can provide for purchase of shares upon changes in circumstances, such as death, disability or termination of employment (see Section 6 for a discussion of the types of provisions found in buy-sell agreements).
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* Buy-sell agreements are no guarantee against disputes, litigation and liability. Even well-conceived buy-sell agreements may not anticipate all problems arising from a falling out among shareholders. Courts in some jurisdictions have not viewed themselves as constrained by the terms of buy-sell agreements in fashioning remedies (such as shareholder buyouts) under judicial dissolution or intervention statutes.
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4. The Value of Shares Is Not Readily Determined by a Market Price
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Holders of stock in publicly traded corporations can determine the current market value of their shares by opening a newspaper. Without an active trading market, valuing shares in a closely held corporation is much more difficult and prone to dispute. Widely accepted valuation techniques may produce very different results. Disputes over valuation typically result in costly battles among valuation experts. Valuation disputes can arise in many different contexts and can pose very difficult problems for directors.
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5. Financial and Other Information Is Generally Not Publicly Available
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Publicly held corporations are subject to: (a) the audit requirements, periodic reporting obligations, proxy rules and other ongoing disclosure requirements of the Securities and Exchange Commission (SEC)
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Because of the relatively small group that typically makes up the directors, officers and shareholders of a closely held corporation, deadlocks are possible in management and among shareholders. Deadlock is a special concern where ownership of a corporation is evenly divided between two segments of a family or two investor groups, each with equal representation on the board of directors. State corporate statutes provide that, upon deadlock that severely interferes with the functioning of the corporation, a shareholder may petition a court for dissolution of the corporation or other relief aimed at breaking the impasse. To avoid the potential for deadlock, some closely held corporations include an additional neutral director on the board. Others include arbitration provisions in their articles of incorporation or bylaws or in a shareholder agreement. The benefits and problems relating to these and other dispute resolution mechanisms should be explored with counsel before adoption. There is no standard mechanism for resolving deadlocks.
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7. Limited Resources and Other Practical Constraints May Result in Inattention to Corporate Formalities
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The majority of closely held corporations are small businesses with very limited resources to spend on lawyers and corporate formalities. An important challenge for directors is to fulfill their fiduciary duty of care to the corporation and its shareholders and to preserve limited liability for corporate participants in spite of these limited resources. Shareholders and directors in many closely held corporations may fall into the habit of taking actions in an informal manner or not recording actions in corporate minutes on a current basis. Although the law might recognize the effectiveness of such informal actions for some purposes, if an action is challenged, the burden to prove that the action was legally approved will be on the party seeking to bind the corporation. Directors may also find it difficult to establish that they were adequately informed and duly deliberate in making a corporate decision if the decision and the process leading to it have not been adequately documented in the minutes.
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Informality in corporate actions, failure to keep current minutes, inattention to corporate separateness of assets, books and records and confusion with respect to corporate payments to shareholders can have dire legal consequences to the corporation and its shareholders (see Section 8 on piercing the corporate veil and other liability concerns).
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D. TYPES OF CLOSELY HELD CORPORATIONS
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Closely held corporations come in a tremendously broad range of types, sizes and contexts. Although they all share the common traits of relatively few shareholders and no active public trading market for their securities, their remarkable diversity in other respects makes it difficult to discuss common legal problems and issues in a meaningful way. Some of the most common recurring types of closely held corporations include:
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1. Incorporated Proprietorships
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The one-person corporation in which the proprietor is the sole shareholder and director and wears all the officer hats is one of the most common types of closely held corporation. Conflict-of-interest and corporate governance problems, which may be of central importance in closely held corporations with multiple shareholders, are largely irrelevant to these one-celled corporate organisms. With only one shareholder, buy-sell agreements and voting arrangements are also irrelevant. However, documenting corporate action and otherwise respecting the formalities of corporate separateness are at least as crucial for these as for any other corporation.
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2. Incorporated Partnerships
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Another common type of closely held corporation is one with a handful of shareholders, all of whom are actively involved in the business as employees and managers. Conflict-of-interest and corporate governance issues are normally a very important focus in this setting. Customization of standard corporate governance structures may be very important. Buy-sell and voting arrangements must normally be part of the organizational process in order for the expectations of participants to be met.
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A variation on the incorporated partnership is the family corporation in which the shareholders are also family members. Family corporations have the potential for all the conflict-of-interest and corporate governance issues as other incorporated partnerships on top of the tensions and succession planning issues inherent in families. Here, too, customized corporate governance may be important, and buy-sell and voting arrangements may be valuable.
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4. Subsidiary Corporations
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The closely held corporation is the basic building block of corporate family groups. Subsidiaries in corporate families range from operating units in complex holding company structures to special-purpose financing subsidiaries to merger subsidiaries created solely to effect acquisition or disposition transactions. Although wholly owned subsidiaries may present none of the corporate governance or conflict-of-interest problems inherent in corporations with multiple owners, complex subsidiary structures create other concerns. Documenting corporate action and otherwise respecting the formalities of corporate separateness are, again, at least as crucial for these as for any other corporation.
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5. Corporate Joint Ventures
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Businesses frequently join forces to pursue certain opportunities or projects as joint ventures. Often, the joint venture will be structured as a new jointly owned corporation. Corporate joint ventures often embody highly complex and heavily negotiated balances of power and countervailing contractual rights and obligations. They may involve extreme customization of corporate governance and difficult conflict-of-interest issues. They may also involve specific identification of, and procedures for handling, corporate opportunities.
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6. Outside-Investor-Backed Corporations
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When outside investors, including venture capital funds, provide financing to closely held corporations, they do so with an expectation that the corporation may “go public” or be sold in the foreseeable future. Venture-backed start-ups are typically a transitional form of closely held corporation: closely held today, but with a possibility of becoming publicly held. Venture capital investors typically require a customized corporate governance balance of power through a combination of preferred or other stock rights and contractual veto powers. These custom elements must be put in place, however, in ways that do not impede anticipated future actions.
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E. TAX ATTRIBUTES OF CLOSELY HELD CORPORATIONS
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Corporate taxation under federal and state law is beyond the scope of this Guidebook. Management should ensure that the closely held corporation has appropriate tax advice from counsel and accounting professionals. Difficult income taxation issues relating (among other things) to compensation and other expenses paid to shareholders (or on their behalf) frequently arise in closely held corporations. In addition, important issues relating to corporate and shareholder income taxation are often closely entwined with issues relating to estate and gift taxation and estate planning by principal shareholders of closely held corporations. These issues can become quite complex and require expert advice in the planning stages.
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A few basic concepts regarding federal corporate income taxation are, however, essential for managers to understand. Corporate income is normally subject to dual taxation: (1) the corporation pays corporate tax on its income, and (2) shareholders pay individual income tax on corporate earnings distributed to them in the form of dividends. Noncorporate forms of business organization, such as partnerships and limited liability companies, do not have dual taxation (although they can elect to be taxed like a corporation). Instead, partners of a partnership or members of an LLC are taxed directly on their allocable shares of partnership or LLC income, without regard to whether any earnings are actually distributed to them by the partnership or LLC. Whether dual taxation or this flow-through taxation is more advantageous for a business and its owners depends upon a balancing of many factors, such as prevailing corporate, individual and capital gains tax rates, projected income or losses as well as the ability to “zero-out” income at the entity level by making deductible expense payments to owners instead of nondeductible dividend distributions. Consideration of these factors as well as a variety of nontax factors is crucial in deciding whether a business should be organized in corporate or noncorporate form.
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Some closely held corporations are eligible to become subject to a modified version of flow-through taxation by making an “S election” under the federal Internal Revenue Code. Shareholders of “S corporations” are taxed directly on their proportionate share of corporate income and may deduct directly their proportionate share of corporate losses. S corporations do not pay income tax at the entity level. However, S corporate taxation differs in other ways from flow-through taxation of noncorporate forms and is not appropriate for many types of businesses. In order to qualify for S election, a corporation must file an appropriate election with the Internal Revenue Service and must meet certain criteria, including having no more than seventy-five shareholders, no more than one class of stock and no stock ownership by anyone other than individuals resident in the United States and some trusts. In all respects relating to state corporation law and to the powers and duties of directors, officers and shareholders, S corporations are no different than corporations that have not elected this special tax treatment (often referred to as “C corporations”).
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Although in many cases state income tax treatment of closely held corporations will parallel federal tax treatment, there can be significant differences. Management should consult with the company’s accountant and legal counsel to determine applicable state income tax law.
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In addition to federal and state income tax, a corporation may be required to pay annual franchise tax for the privilege of being a corporation under the laws of its state of incorporation. Some states have no franchise tax. Others require annual franchise tax payments that may be quite substantial depending upon the amount of corporate assets, income, authorized shares and other factors used in the formula for calculating the tax in a particular state. Although most closely held corporations can effectively limit their franchise tax through proper planning, consideration of state franchise tax may still be a factor in choosing a state of incorporation.
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SECTION 2: THE STRUCTURE OF CORPORATE ACTION
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Corporate governance is the term frequently used to refer collectively to the legal rules relating to the respective powers and duties of directors, officers and shareholders: Who has the power to approve which corporate actions? How are those actions taken? What fiduciary duties of care, loyalty, good faith, fairness or disclosure do directors, officers and shareholders owe each other? What liabilities may result from breaching those duties?
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The more mechanical rules of corporate governance (Who decides what? How are decisions made?) are generally laid out in the corporation statute itself. Some of those rules are absolute and invariable, but most are default rules that can be varied in the articles of incorporation or bylaws or by contract (see Section 5). The corporate governance rules regarding fiduciary duties are more the product of judge-made caselaw and generally less variable than the mechanical rules.
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This Section discusses the more mechanical, structural rules of corporate governance. The next two Sections discuss the duties owed.
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A. TRADITIONAL ROLES OF DIRECTORS, OFFICERS AND SHAREHOLDERS
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Traditional corporate governance vests the residual authority to manage the corporation in the board of directors. Shareholders elect the directors. Shareholders must also approve certain other types of significant corporate action, including amendments to the articles of incorporation and certain fundamental transactions (mergers, statutory share exchanges, major sales of corporate assets and dissolution), but the board of directors has the authority to approve all other corporate actions.
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The Model Act expresses this vesting of residual authority in the board as follows: “All corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation managed under the direction of, its board of directors.” This language emphasizes the responsibility of the directors to oversee management of the corporation, which is carried out on a day-to-day basis by the officers. The board carries out this oversight responsibility through a combination of (1) making decisions regarding key corporate actions, plans, strategies and directions and (2) monitoring the performance of the officers in day-to-day management.
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The corporation statute explicitly requires that the board approve certain types of corporate actions, such as issuance of stock, grant of options or rights to purchase stock, amendment of the articles of incorporation and the fundamental transactions (mergers, statutory share exchanges, major sales of corporate assets and dissolution) that also require shareholder approval. In addition to decisions that require board approval under the specific provisions of the corporation statute, the board’s oversight responsibility also includes considering and acting upon other significant corporate actions, such as major debt financing, important contracts, contracts with officers and officer compensation. The board’s oversight responsibility also entails:
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* reviewing and monitoring fundamental operating, financial and other corporate plans, strategies and objectives
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* developing, approving and implementing succession plans for management
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* evaluating the performance of the corporation and its management and taking action, such as changing corporate plans, strategies and objectives or changing management, when appropriate
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* adopting policies of corporate conduct and monitoring compliance with those policies and with applicable laws and regulations as well as the adequacy of accounting, financial and other internal controls
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* reviewing and evaluating the process of providing appropriate financial and operational information to decision-makers (including directors) and shareholders.
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The officers carry out the day-to-day management of the corporation. They are appointed by the board of directors and have the authority and responsibilities delegated to them by the board either in the bylaws or by specific board resolutions. Officers may also have implied authority by virtue of their titles, at least with respect to ordinary business transactions. The CEO has great implied authority to enter into contracts and take actions on behalf of the corporation in the ordinary course of business. Other officers may have significant implied authority in their particular areas of responsibility
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Frequently, questions arise regarding the actual authority of an officer to sign a particular contract or take a particular action on behalf of the corporation. In such cases, legal counsel may recommend that the board approve the contract or action and give specific authorization to the officer to avoid any uncertainty. Sometimes the other party in a major transaction or financing will require specific board approval in order to eliminate any uncertainty.
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As noted, the traditional roles of director, officer and shareholder may, and frequently do, vary in closely held corporations. Section 5 discusses modification of traditional roles and structures.
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B. BOARD STRUCTURE AND ACTION
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The size and composition of the board depend upon the nature of the corporation. In determining optimal size and composition in the context of a particular corporation, consideration should be given to: effective performance of the board’s oversight and decision-making responsibilities
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Other factors that might influence board size and composition are the need of the corporation to maintain a community presence, to maintain relationships with customers or other constituencies and to respond to other factors that may be special to the corporation or its industry. In accommodating these needs, board size should not be expanded to the point that size interferes with effective functioning.
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The Model Act and most state corporation statutes permit as few as one director to make up the board and impose no qualification requirements (such as share ownership or state residency) on who can be a director. The Model Act and all state corporation statutes also permit a director to hold any and all officer positions in a corporation. In a one-person corporation (a so-called incorporated proprietorship), the sole shareholder will typically serve as the sole director and have all officer titles as well. This is legally permissible and may be a practical necessity. In corporations with a handful of shareholders, all of whom are active in the business (so-called incorporated partnerships), all of the shareholders typically serve on the board and hold officer positions.
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As any closely held corporation matures, it is often desirable to expand the board’s composition to include individuals with varying backgrounds, abilities and access to resources that will benefit the corporation. Many closely held corporations have recognized the benefit of having one or more outside directors. These outside directors, who are not involved in the management of the corporation, can provide independent advice, perspective and monitoring over the affairs of the corporation and the performance of its management.
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In some types of closely held corporations, board composition reflects a precisely negotiated balance of power among investors. The board of directors of a corporate joint venture, for example, may be made up of negotiated numbers of representatives of each of the joint venturers. The board of some family corporations may reflect negotiated numbers of representatives from each branch of the family. In corporations financed by venture capital investors or other outside investors, the terms of the financing typically include a number of board seats for representatives of the investors and a limitation on the total number of board seats. Venture capital investors also frequently negotiate the ability to elect the majority of board seats in the event the corporation defaults on certain promises. Desired board composition in these balance-of-power situations is ensured through voting agreements or use of different classes of stock, each having the right to elect the appropriate number of directors. In these balance-of-power situations, one or more outside directors–unaffiliated with any particular faction or constituency–may often provide helpful mediation of differences.
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The board of directors takes action by approving resolutions or otherwise indicating consensus with respect to matters presented to the board. Resolutions may be approved, or consensus recorded, at a meeting of the board or by written action in lieu of a meeting.
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Meetings are referred to as “regular” meetings if they occur on a date and at a time designated in the bylaws or by a schedule reflected in board minutes. “Special” meetings are those called without such prearrangement. Meetings may be held either in or outside the state of incorporation. Special meetings may be called by anyone authorized to do so in the articles or bylaws but are generally called by the board chair or the CEO. Notice must generally be given to board members in advance of a special meeting. The notice need not describe the purpose of the special meeting, unless required by the articles or bylaws. Under the Model Act, notice generally may be in writing, by telephone or by other electronic means, including e-mail.
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In order for the board to take action at any meeting, a quorum must be present. Unless the articles or bylaws provide otherwise, a majority of the total number of directors in office constitutes a quorum. In order for an action to be taken at a meeting, a majority of the directors present must vote in favor of it, unless the articles or bylaws require a greater number. Directors may not “give their proxy” to another person or, in other words, have another director or designee vote for them (in part because directors have duties and responsibilities that cannot be delegated).
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Directors may participate in any meeting by conference telephone or any other means of communication by which all participating directors are able simultaneously to hear each other. A director participating by such electronic means is deemed to be present at the meeting for all purposes, including calculation of a quorum.
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The number of meetings a board finds necessary or useful varies with the circumstances, but meetings should be held as often as is needed to adequately carry out the directors’ oversight responsibility. Some boards prefer more frequent and shorter meetings, whereas others prefer fewer but lengthier meetings. Many closely held corporations have regular board meetings at least quarterly.
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Written materials to be considered, discussed or acted upon at a meeting should be distributed to board members a sufficient time before the meeting to permit a thorough review.
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Time at board meetings should be budgeted carefully. There are no required formal rules of procedure dictated by statute for board meetings, and it is generally inadvisable to adopt complex rules of procedure, such as Robert’s Rules of Order, for board meetings. So long as fairness is observed, each board may generally conduct its business as it wishes. For boards with more than a few members, it is generally advisable to designate one of the directors as the chair to preside at meetings and to determine the pace and order of proceedings.
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b. Action without Meeting
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In lieu of holding a meeting, the board may act by written consent. Under the Model Act and most state corporation statutes, action by written consent must be unanimous. Directors may all sign the same written consent, or they may each sign a counterpart copy of the same consent.
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c. Committees of the Board
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The board may create committees of directors and delegate to such committees (with some limitations) the authority of the full board. Committees of the board are a legal and practical necessity for publicly held corporations, which typically have an audit committee, a compensation committee and a nominating or corporate governance committee. Standing committees such as these are rare in closely held corporations.
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In addition to standing committees, boards may also create temporary committees for specific purposes. For example, a committee of disinterested directors may be formed to pass on a conflict-of-interest transaction between the corporation and a director, officer or controlling shareholder. Committees of disinterested directors may also be formed to pass on the advisability of bringing suit in the name of the corporation against a director or officer when a demand for such a suit has been made by a shareholder. Special committees such as these are less common in closely held corporations than in publicly held corporations but may serve useful purposes in either.
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Committees of the board take action by approving resolutions at meetings or by written action without a meeting under basically the same rules as the full board.
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C. ESTABLISHING THE AGENDA FOR BOARD ACTION
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The agenda setting forth matters to be discussed and acted on by the board is typically determined, in the first instance, by the CEO. However, individual directors should have an opportunity to place items on the agenda. Further, the board should satisfy itself that there is an overall annual agenda of matters that require recurring and focused attention.
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Typically, a board will consider the following sorts of matters annually:
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* annual financial results
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* capital expenditure budget
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* management performance review
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* status of financing arrangements
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* corporate systems and controls
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* selection of auditors, if necessary or desired
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* agenda for annual shareholder meetings
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* annual tax and corporate filings
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* designation of signing authority pertaining to financial and other matters
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* nomination of directors and election of officers
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* compensation of officers
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Items that may be considered at quarterly or other periodic meetings include:
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* minutes of prior meetings
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* progress on operational and financial plans
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* quarterly financial results
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* budgeting, financing arrangements and funding of operations
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* transactions between the corporation and its shareholders, officers or directors
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* litigation involving the corporation
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* proposals to amend articles or bylaws
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* establishing fair market value of the corporation’s stock for purposes of option grants or buy-sell agreements
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* corporate policies and practices related to employee safety and health, environmental protection and product safety
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* employee issues, such as equal opportunity and nondiscrimination policies, retirement and pension issues and privacy concerns (including corporate policies and procedures relating to maintenance and safeguarding of computer and corporate records and monitoring employee communications)
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* philanthropic activities of the corporation
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* long- and short-range planning
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Management may bring specific operational or personnel matters to the board’s attention at any meeting or at another appropriate time in order to keep the board apprised of potential issues or to gain the board’s advice and perspective.
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D. QUALITY OF INFORMATION
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The quality of information made available to directors will significantly affect their ability to perform their roles effectively. Although directors who are involved day to day with the corporation may already have the necessary information, nonmanagement directors must make sure that they are adequately informed. Information submitted to the directors should be relevant, concise (but complete), timely, well-organized, supported by any background or historical data necessary to place the information in context and designed to inform directors of material aspects of the corporation’s business, performance and prospects. Data that allow the board to make comparisons to other corporations in the same industry group, or with similar characteristics, are also important.
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Information should be provided sufficiently in advance of board meetings to provide time for careful review and thoughtful reflection, which will better lead to meaningful participation by the directors.
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Unless otherwise provided in the relevant corporation statute or in the articles of incorporation, (a) each share of stock is entitled to one vote on each matter voted on by shareholders, and (b) all shares vote together as one voting group on each such matter. If a corporation has more than one class of stock (e.g., Class A and Class B common stock or common stock and preferred stock), the articles of incorporation must spell out when and how each share votes and whether the classes vote together or separately on particular matters.
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The Model Act and state corporation statutes offer great flexibility with respect to the voting rights that may be specified for various classes of shares in the articles of incorporation. For example, the articles may provide that a particular class of stock has 100 votes per share or no vote at all, or no vote except with respect to certain designated matters. The articles may also provide that a particular class of stock votes along with all other classes with respect to certain matters but votes by itself with respect to others. Corporation statutes provide that, regardless of what the articles of incorporation say, individual classes of stock vote by themselves on certain amendments to the articles of incorporation that would adversely affect the rights of the class (see Section 5 for more discussion of multiple classes of stock).
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Shareholders take action by voting their shares to approve resolutions either at meetings or by written consents in lieu of meetings.
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Corporations hold an “annual” meeting of shareholders each year to elect directors and transact such other business as may be presented. “Special” meetings may be held to take actions at other times. The annual and special meetings may be held either in or outside the state of incorporation.
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Under the Model Act, special meetings of shareholders may be called by the board of directors or by holders of at least ten percent of the outstanding shares (which may be decreased or increased to a percentage not exceeding twenty-five percent in the articles of incorporation). The articles or bylaws may designate anyone else as being eligible to call a special meeting of shareholders, but it is generally advisable to keep that authority as limited as possible under the relevant corporate statute.
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Notice must be given to shareholders in advance of each annual and special meeting unless such notice is waived in writing. Notice must be given no less than ten nor more than sixty days before the meeting date under the Model Act. Notice must be in writing and delivered by mail, in person or by electronic means, such as e-mail. Notice is given at the time it is mailed with proper postage or when an e-mail is transmitted (if the shareholder has consented to e-mail notice). Notice of an annual meeting need not generally describe the purpose of the meeting, unless required by the articles or bylaws. Notice of a special meeting must, however, describe the purpose of the meeting, and the meeting may conduct only such business as is described in the notice.
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Unlike a director, a shareholder may appoint a proxy to attend the meeting and vote his or her shares. Shares represented at a meeting by proxy are treated as being present for all purposes, including calculation of a quorum.
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d. Attendance by Electronic Means
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Under the Model Act and many state corporation statutes, shareholders may not attend meetings by conference call or other means of communication. Delaware and other states, however, have begun to permit attendance by certain types of remote communication. In fact, Delaware permits shareholder meetings that are entirely by remote communication and have no physical location.
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In order for shareholders to take action at any meeting, a quorum must be present. Unless the articles provide otherwise, a majority of the votes entitled to be cast on the matter constitutes a quorum. For example, if a corporation has 1,000 shares outstanding and entitled to vote on a matter, each entitled to one vote per share, a quorum would be present if shareholders owning at least 501 shares were present.
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Under the Model Act, if a quorum exists, a matter (other than the election of directors) is approved by shareholders if the votes favoring the matter exceed the votes opposing the matter. Many corporation statutes require the affirmative vote of a majority of the shares present at a meeting (or, in some cases, a majority of the shares outstanding) in order to approve a matter. Under such statutes, abstaining from voting on a particular matter at a meeting has the same effect as voting against the matter. Under the Model Act and the corporation statutes in states that follow it, an abstention is really an abstention, not the equivalent of a negative vote. For example, if the 501 shares present at the meeting described in the previous paragraph voted as follows: FOR-200
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Directors are elected by a plurality of the votes cast at a meeting at which a quorum is present. This means that, if a quorum is present, the directors receiving the highest number of votes up to the full number of board seats being filled are elected, even if one or more directors do not receive a vote equal to a majority of a quorum. This rule ensures continuity and avoids hold-over directors resulting from an inability to get a majority vote for new board members.
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Normally, shareholders are entitled to vote their shares with respect to each board seat being filled. If a shareholder owns 100 shares and five board seats are being filled, the shareholder is entitled to vote no more than 100 shares for each nominee for the five board seats. This means that shareholders owning a majority of outstanding shares are able to elect all the directors if they so desire (by voting their majority shares in favor of each nominee they desire).
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Cumulative voting is an alternative method of voting that is designed to permit minority shareholders some ability to elect directors to the board. Under the Model Act and most state corporation statutes, cumulative voting is permitted only if the articles of incorporation explicitly opt in. In a minority of states, however, cumulative voting is permitted unless the articles of incorporation explicitly opt out.
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If a corporation permits cumulative voting, a shareholder may take all the votes he or she could cast for directors collectively (e.g., 100 shares x five board seats = 500 votes) and cast them all for one director. How many shares it takes to ensure the election, through cumulative voting, of one board member turns on a complex formula dependent upon the number of shares present and voting, the number of board seats open for election and other factors. Every time the number of outstanding shares or the number of directors on the board changes, the minimum number of shares required to elect one director also changes. In order for minority shareholders to use cumulative voting to their benefit, they must give timely notice of intent to vote cumulatively and must cumulate their votes in exactly the right manner
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g. Conduct of the Meeting
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As in the case of meetings of the board, time at meetings of shareholders should be budgeted carefully There are no required formal rules of procedure. For corporations with more than a handful of shareholders, it is highly advisable that the board chair or another person be designated to preside at the meeting and to determine the pace and order of proceedings.
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3. Action without Meeting
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Shareholders may act by written consent instead of holding a meeting. Under most state corporation statutes, action by written consent must be unanimous. The Delaware corporation statute and an increasing number of other states permit less-than-unanimous written action by shareholders. In either case, shareholders may all sign the same written consent, or they may each sign a counterpart of the same consent.
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The Model Act and all state corporation statutes require that minutes be kept reflecting in writing the actions taken by the board and the shareholders. Minutes of all meetings and all written actions are compiled in the minute book. A copy of the articles of incorporation and bylaws are also generally kept in the minute book (see Section 9 for a description of required corporate record-keeping).
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G. JOINING THE BOARD AS AN OUTSIDE DIRECTOR
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Outside directors have become an increasingly important part of governance of public companies in recent decades. In closely held corporations, where there is substantial overlap between the owners and management, outside directors have played a much less significant governance role. Individuals who are neither officers nor employees are often asked to serve on closely held corporate boards because they bring special expertise (e.g., legal, accounting or technical), because they represent important investors, customers, suppliers, distributors or other business partners of the corporation (or otherwise help cement an important relationship) or because they offer some other perceived advantage to the corporation. Outside directors who are not affiliated with particular investors or business partners of the corporation can be especially useful to boards of closely held corporations as objective observers of management and business operations. The role of the outside director may be especially important and challenging in the context of a closely held corporation dominated by a controlling shareholder or group of related shareholders (see Section 4).
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An individual considering an invitation to join the board of a closely held corporation as an outside director should study both the corporation and the board and should accept a directorship only if confident of the competence and integrity of both the management and the directors of the corporation, as well as his or her own ability to monitor and add value to the enterprise. An individual asked to be a director should consider the following steps:
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* meet the CEO and other top executives as well as major shareholders to review board organization and procedures, discuss the principal issues facing the corporation and determine the attitude of management and controlling shareholders toward board activity–principally, whether independent judgment is truly desired
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* confer with any other outside directors currently or previously serving on the board
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* review the corporation’s financial statements for at least the last two years
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* review corporate minutes for the last two years to become familiar with the corporation’s business, important issues addressed by the board as well as the corporation’s attention to corporate record-keeping and other necessary formalities
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* become familiar with the roles of the corporation’s accountants and counsel
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* review examples of information regularly provided to directors
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* review and discuss with the CEO and other top executives the current forecasts and plans of the corporation
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* review press reports about the corporation to determine how it is viewed in the investment community and the business world generally
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* if serving at the request of an employer, become familiar with the employer’s indemnification policies relating to service on boards at the request of the employer
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* become familiar with the corporation’s director indemnification bylaw provisions, director and officer liability insurance coverage, if any, director indemnification contracts, if any, and pending litigation that (1) is material to the corporation, (2) involves the activities of the board of directors or (3) involves as a party an entity with which the individual is affiliated
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* consider whether the individual has any present or potential conflicts with the corporation. An outside director serving as a representative of a customer, supplier, distributor or other business partner of the corporation may constantly be facing conflict-of-interest problems by serving on the board of the corporation.
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H. HONORARY DIRECTORS, ADVISORY BOARDS, BOARD OBSERVERS AND MONITORS
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Recognizing that not all individuals are willing or able to assume full responsibilities as directors, some corporations appoint valued advisors as “honorary directors” or make them members of an “advisory board.” It has also become increasingly common for lenders, venture investors and other financial or commercial partners with substantial interests in a corporation to negotiate to have a representative sit in on the corporation’s board meetings as an observer or monitor rather than serve as an actual member of the board.
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Honorary directors, members of advisory boards, observers and monitors are not real directors and are not entitled legally to vote on matters considered by the board. Their rights and duties relating to obtaining board information, attending board meetings and participating in board deliberations depend completely upon what the corporation has agreed to permit or require.
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* Honorary directors are typically asked to attend meetings, given board information in connection with meetings and encouraged to contribute to the deliberative process.
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* Members of advisory boards usually do not attend board meetings, receive related information or participate in deliberations. Instead, the advisory board has its own meetings and formulates advice to be given to the board of directors on areas of designated interest or concern.
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* Observers or monitors generally have the right to receive board information in connection with meetings and attend without participating in deliberations.
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Clear demarcations must be made between the roles of actual directors and honorary or advisory directors or observers or monitors. Special care is needed to assure that an honorary or advisory director, or even an observer or monitor, does not act as a director and unintentionally assume director responsibilities and liabilities. In addition, if a matter subject to attorney-client privilege arises, the privilege may be lost if the meeting includes nondirectors in attendance.
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Because honorary or advisory directors and observers and monitors may not be bound by the same fiduciary duty of confidentiality as actual directors with respect to information learned in connection with meetings or otherwise, the corporation should also ensure that appropriate confidentiality agreements are in place.
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SECTION 3: DIRECTOR AND OFFICER DUTIES AND RIGHTS (4)
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As a general matter, a business corporation’s core objective is to conduct its business activities to create and increase corporate profit and shareholder gain. Directors’ activities in providing leadership toward these economic ends can be described as comprising two basic functions: decision-making and oversight. The decision-making function generally involves both the formulation with management of corporate policy and strategic goals and actions taken respecting specific matters. Some matters–such as changes in charter documents, authorization of dividends, election of officers, mergers with other enterprises or corporate liquidation–may require board action (as well as shareholder action, in some cases) as a matter of law. The oversight function does not, in general, involve specifically required decisions or approvals but rather concerns periodic attention to corporate systems and controls, policy issues and other recurring attention to matters suggesting a need for inquiry. In pursuit of both their decision-making and oversight activities, corporate directors have, individually or collectively, various duties, responsibilities and rights, which are more fully described below.
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1. Board Responsibilities
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Stated broadly, the principal responsibility of a corporate director is to promote the best interests of the corporation by providing general direction for the management of the corporation’s business and affairs. The director should bring advice to the corporation based upon the director’s business experience and public and professional relationships. In bringing experience and judgment into the boardroom, a director should not be shy. Indeed, to be a “director” is to “direct”–which means to become informed, to participate, to ask questions and to apply considered business judgment to matters considered by the board.
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The director should give primary consideration to the corporation’s economic objectives. However, a director should also be concerned that the corporation conduct its affairs with due appreciation of public expectations, taking into consideration applicable law, public policy and ethical standards. Furthermore, pursuit of the corporation’s economic objectives will often include consideration of the effect of corporate policies and operations on the corporation’s employees, the public and the environment. Several states have adopted legislation expressly confirming that corporate directors may consider, in the various decisions that they make, the effect of corporate action on constituencies other than shareholders, including employees, local communities, suppliers and customers. Nevertheless, as a general rule, the law does not hold the board directly responsible to constituencies other than shareholders in the formulation of corporate policy. Constituency considerations are best understood not as independent corporate objectives but rather as factors that may be taken into account in pursuing the best interests of the corporation.
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2. Individual Responsibilities
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To be effective, a director should become familiar with the corporation’s business, including the economic and competitive environment in which it operates. This knowledge should enable the director to make an independent evaluation of management performance and allow the director to join with other directors to make changes and to challenge, support and reward management as warranted. Accordingly, a director should have a basic understanding of:
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* the principal operational, financial and other plans, strategies and objectives of the corporation
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* the results of operations and financial condition of the corporation and its significant business segments for recent periods
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* the relative standing of the corporation’s significant business segments vis-a-vis its competitors.
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In addition, a director should be satisfied that an effective system is in place for periodic and timely reporting to the board on the following matters:
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* corporate objectives and strategic plans
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* current business and financial performance of the corporation and the degree of achievement of the board-approved objectives and plans
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* financial statements, with appropriate segment or divisional breakdowns
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* systems of controls designed to promote compliance with law and corporate policies
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* material litigation and regulatory matters.
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Directors should do their homework. They should review board meeting agendas and related materials sufficiently in advance of meetings to enable them to participate in an informed manner. They should receive and review minutes of board meetings and keep abreast of the activities of any board committees.
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Because of their important oversight responsibilities, directors have legal and customary rights of access to the information and resources they need to do their job. Among the most important of directors’ legal rights are the rights to:
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* inspect books and records and be provided with copies of such other data as a director may reasonably request
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* inspect facilities as reasonably appropriate for the performance of duties
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* receive notice of all meetings in which a director is entitled to participate
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* receive copies of all board meeting minutes.
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In addition to these legal rights, and subject to coordination with senior management and reasonable-time-and-manner constraints, directors customarily are given access to key executives and other employees of the corporation and to the corporation’s legal counsel and other advisors. Directors should also receive oral or written reports of the activities of any board committees on which they do not serve.
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A director’s access to information is accompanied by the duty not to disclose confidential corporate information to unauthorized persons or to misuse such information for personal benefit or for the benefit of others.
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The Model Act provides the baseline standard that every director must discharge his or her director duties, including duties as a member of a committee, (a) “in good faith” and (b) “in a manner the director reasonably believes to be in the best interests of the corporation.” This baseline standard is central to the mandate often referred to as the “duty of loyalty.” The Model Act also provides that directors must discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances. This mandate, which builds upon the baseline standard, is often referred to as the “duty of care.”
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Parsing the language of these Model Act standards is helpful in analyzing the components of a director’s duties:
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* in good faith–acting honestly
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* reasonably believes–although the director’s honest belief is subjective, the qualification that it must be “reasonable”–that is, based upon a rational analysis of the situation understandable to others–makes the standard of conduct also objective, not just subjective
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* best interest of the corporation–emphasizing the corporate director’s primary allegiance to the business as an entity
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* care–expresses the need to pay attention, to ask questions and to act diligently and reasonably to become and remain generally informed, including doing the “homework” of reading materials and other preparation in advance of meetings in order to participate effectively in board deliberations
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* person in a like position–avoids implying special qualification and incorporates the basic attributes of common sense, practical wisdom and informed judgment generally associated with the position of corporate director
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* under similar circumstances–recognizing that the nature and extent of the preparation for decision-making and level of oversight will vary, depending upon the corporation concerned and the factual situation presented.
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A director’s duty of care relates to the director’s responsibility to exercise appropriate diligence in making decisions and taking other action, as well as in overseeing management of the corporation. In meeting their duty of care, directors should take into account the following considerations:
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Directors are expected to attend and participate, either in person or by conference telephone (to the extent authorized by law), in board meetings and meetings of committees on which they serve. In most states, directors may not vote or participate by proxy
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b. The Need to Be Informed
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Management should supply directors with sufficient and accurate information to keep them properly informed about the business and affairs of the corporation. Those directors who also are management and have regular access to this information should take special steps to ensure that nonmanagement directors also receive the necessary information. When specific actions are contemplated, directors should receive appropriate information sufficiently in advance of the board or committee meeting to allow study of, and reflection upon, the issues raised. Important time-sensitive materials that become available between meetings should be promptly distributed to board members.
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On their part, directors are expected to review the materials supplied. If information is believed to be insufficient or inaccurate or is not made available in a timely manner, a director should request that action be delayed until the desired information is made available and can be studied.
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c. The Right to Rely on Others
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In discharging board or committee duties, a director is generally entitled to rely on board committees or management performing their delegated responsibilities. A director is also entitled to rely (absent knowledge that would make the reliance unwarranted) on reports, opinions, information and statements, including financial statements and other financial data, presented by (i) the corporation’s officers or employees whom the director reasonably believes to be reliable and competent in the matters presented, (ii) legal counsel, accountants or other persons as to matters that the director reasonably believes to be within their professional or expert competence or with respect to which the person otherwise merits confidence and (iii) committees of the board on which the director does not serve. A director who relies on others, however, has a responsibility to keep informed of the efforts of those to whom work has been delegated. The extent of this review function will vary depending upon the nature and importance of the matter in question.
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Directors should make inquiry into potential problems or issues when alerted by circumstances or events that indicate that board attention is appropriate: for example, when information provided on an important matter appears materially inaccurate or inadequate, or there is reason to question the veracity of management. When directors see “red flags” indicating that the corporation may be experiencing significant problems in a particular area of business, or may be engaging in unlawful conduct, they should make further inquiry until they are reasonably satisfied that management is dealing with the situation appropriately Directors should also periodically satisfy themselves that corporate compliance programs are reasonably effective to help attain compliance with laws and corporate policies and procedures.
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The duty of loyalty requires a director to exercise powers in good faith, in the best interests of the corporation and not in the director’s own interest or in the interest of another person (such as a family member) or another organization with which the director is associated. Simply put, a director should not use the director’s corporate position to make a personal profit or gain or for other personal advantage. This can be a particularly delicate area for a closely held corporation that has adopted an informal corporate governance model and practices. Although once void or voidable under common law, transactions that present conflicts of interest are not necessarily viewed as inherently improper today. It is the manner in which an interested director and the board deal with a conflict that determines the propriety of the transaction and of the director’s conduct. The duty of loyalty has a number of specific applications.
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Each director should be alert and sensitive to any interest he or she may have that might be considered to conflict with the best interests of the corporation. When a director, directly or indirectly, has a financial or personal interest in a contract or transaction to which the corporation is to be a party, or is contemplating entering into a transaction that involves use of corporate assets or competition against the corporation, the director is considered to be “interested” in the matter. Such an interested director should seek approval from disinterested directors for the transaction or conduct in which he or she is interested and should, subject to any confidentiality obligations owed to others outside the corporation, first disclose that interest to the board members who are to act on the matter. The interested director should then describe all known material facts concerning the matter. After such disclosure, the interested director should abstain from voting on the matter and, in most situations, after disclosing the interest, describing the relevant facts and responding to any questions, leave the meeting while the disinterested directors complete their discussion and vote.
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State statutes usually provide procedures that may be used to authorize or ratify the corporation’s transactions with interested directors.
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The duty of loyalty requires that a director make a business opportunity available to the corporation–if the opportunity is related to the business of the corporation–before the director may pursue the opportunity for the director’s own or another’s account. Whether such an opportunity must first be offered to the corporation will often depend upon one or more of the following:
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* the correlation of the opportunity to the corporation’s existing or contemplated business
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* the circumstances in which the director became aware of the opportunity
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* the possible significance of the opportunity to the corporation and the degree of interest of the corporation in the opportunity
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* the reasonableness of the basis for the corporation to expect that the director should make the opportunity available to the corporation.
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If a director believes that a contemplated transaction might be found to be a corporate opportunity, the director should bring it to the attention of the board. When any doubt exists, the rule should be to disclose. If the board, acting through its disinterested directors, disclaims interest in the opportunity on the part of the corporation, then the director is free to pursue it. A director should bear in mind that the obligation to put the corporation’s interests first also applies to opportunities for subsidiaries or affiliates of the corporation.
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If applicable state law permits the corporation and its shareholders to enter into a control agreement to alter the scope of a director’s duties, it may be possible for the corporation to renounce any expectation of engaging in specific types or classes of business opportunities. Delaware has a statute which enables a corporation, in its certificate of incorporation or by action of its board of directors, to renounce in advance any claim it may otherwise have on specified business opportunities that might become available to its directors or officers. This statute, however, does not absolve the board of the need to consider the interests of the corporate enterprise as it makes such decisions.
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c. Fairness to the Corporation
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Disinterested directors reviewing the fairness of a transaction having conflict-of-interest or self-dealing elements are essentially seeking to determine (i) whether the proposed transaction is on at least as favorable terms to the corporation as might be available from other persons or entities, (ii) whether the proposed transaction is reasonably likely to further the corporation’s business activities and (iii) whether the process by which the decision is approved or ratified is fair. If minority shareholders could be adversely affected, the directors should be especially concerned that the minority interests in the transaction receive fair treatment. This concern is heightened when a director or dominant shareholder or shareholder group has a divergent or conflicting interest (see Section 4 for a discussion of the duty of fairness owed by a controlling shareholder or group of related shareholders to the corporation and the noncontrolling shareholders).
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d. Documentation of Conflicts
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As a general rule, disclosures of conflicts of interest and the results of the disinterested directors’ consideration of the matter should be documented in the minutes or reports of the meeting.
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Publicly held corporations are required to adopt written policies on conflicts of interest (often in conjunction with other major policies) and have established procedures to monitor compliance with these policies. Many closely held corporations also adopt such policies.
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Independent advice, which may be confirmed by oral or written fairness opinions, appraisals or valuations from investment bankers or others, is often helpful when a transaction is significant and conflicts of interest are involved.
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7. The Duty of Disclosure or Candor
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Some courts have, in recent years, spoken of another aspect of a director’s duty–a fiduciary duty of disclosure or candor, which is said to flow from both the duties of care and loyalty. This emerging concept encompasses the idea that directors of a corporation should furnish shareholders with all material relevant information known to the directors when the directors present the shareholders with a voting or investment decision. This duty may also extend to the related concept that directors should not mislead or misinform shareholders about the affairs of the corporation.
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B. THE BUSINESS JUDGMENT RULE
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If directors’ decisions are challenged in court by a claimant asserting deficient conduct, judicial review of the matter will normally be governed by the business judgment rule. This rule, well-established in caselaw, protects a disinterested director from personal liability to the corporation and its shareholders, even though a corporate decision the director has approved turns out to be unwise or unsuccessful. The business judgment rule presumes that, in making a business decision, directors acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the corporation.
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Unlike the standards of conduct encompassed in the duties of care and loyalty, the business judgment rule is not a description of a duty or standard used to determine whether a breach of duty has occurred
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A director should keep confidential all matters involving the corporation that have not been disclosed to the general public. An individual director is usually not authorized to be a spokesperson for the corporation and, particularly when confidential information is involved, should avoid responding to inquiries from outside of the boardroom. Directors should refer requests for corporate information to the CEO or other individual designated by the corporation to deal with such inquiries.
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If, after a thorough discussion, a director disagrees with any significant action proposed to be taken by the board, the director may vote against the proposal and request that the dissent be recorded in the meeting’s minutes. Except in unusual circumstances, taking such a position should not cause a director to resign. If a director believes that information being disclosed by the corporation is inadequate, incomplete or incorrect, or that management is not dealing with the directors, the shareholders or others in good faith, the director should first encourage corrective action. If that request is not satisfied or the problem continues, the director should encourage the board to replace management and, if such a change does not occur, the director should resign.
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E. RESPONSIBILITIES IN SPECIAL SITUATIONS
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In a number of special situations the directors may have additional responsibilities. Among these situations are (1) considering the sale of the business
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F. REPRESENTATIVE DIRECTORS
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The director who is the nominee of a shareholder, class of shareholders, creditor or other interested party is in a special position. Not only does the director owe the corporation a duty of loyalty, but the director has been placed on the corporation’s board to look out for and represent the interests of his or her sponsor. Although certainly the sponsor may act or vote in its own interest, the director may not if such vote or action might otherwise conflict with the duties owed to the corporation. This result is often contrary to the intentions of the participants, especially in closely held corporations where every director may be deemed to be a representative director. One way to address this dichotomy is to give shareholders veto rights and other controls over corporate actions (see Section 5 for a discussion of the ways shareholders can modify the role and authority of directors). When the matter is one that directly involves the sponsor, a representative director should fully disclose to the board the interests of the sponsor and, if feasible, abstain from board deliberations and voting.
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As a general proposition, corporate officers owe the corporation the same overall fiduciary duties of care and loyalty as do directors. Moreover, because in the closely held corporation the same person may be both an officer and a director, courts often may not distinguish between these capacities when analyzing duties. The Model Act articulates a general standard of conduct for officers that is very similar to the standard for directors. In this context, the term “officer” refers to those in whom executive or senior administrative functions are entrusted and does not apply to those without judgment or discretion as to corporate matters. An officer’s duty of loyalty is of general applicability but most frequently affects officers in the areas of corporate opportunity, competition with the corporation and the use of corporate trade secrets. Officers must refrain from doing anything of a self-dealing nature that would cause loss to the corporation. Relatively few cases involve claims against a corporate officer for a breach of his or her duty of care, and the business judgment rule should protect officers as well as directors against such claims. Officers should be aware that their fiduciary duty of care includes the obligation to inform the board or a superior officer of any activity that comes to the officer’s attention that appears to affect the corporation’s best interest.
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SECTION 4: SHAREHOLDER DUTIES AND REMEDIES
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A. DUTIES OF THE CONTROLLING SHAREHOLDER
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A common feature of closely held corporations is the presence of a shareholder or shareholder group that controls the corporation. Ownership of a majority of voting securities can give absolute control. Working control of a corporation may, however, exist even with ownership of less than a majority of voting securities or through contractual rights and obligations and other relationships.
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Courts have generally imposed a duty of fairness on controlling shareholders in their dealings with the controlled corporation and its noncontrolling shareholders. Some courts have referred to this duty as one of “entire” or “intrinsic” fairness, encompassing both a duty of substantive fairness (i.e., fair price) and procedural fairness (i.e., fair dealing and full disclosure).
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If a controlling shareholder:
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* enters into an important contract with the controlled corporation,
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* proposes to eliminate the noncontrolling shareholders by means of a “freeze-out” merger,
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* proposes to have the corporation buy back securities from the controlling shareholder and not the noncontrolling shareholders or
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* pursues an opportunity that may be deemed to be a corporate opportunity,
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a noncontrolling shareholder may challenge such transaction as inconsistent with the duty of fairness. In such a challenge, the controlling shareholder and the directors approving such a transaction must prove that the transaction met the standards of substantive and procedural fairness, or the transaction may be enjoined or damages awarded equal to the difference in value between the challenged transaction and a fair transaction. If the corporation or controlling shareholder, however, is able to demonstrate that the challenged transaction has been approved by disinterested directors, or by the noncontrolling shareholders after full disclosure, courts have held that the burden shifts to the challenging party to prove the transaction was not fair or that it failed to meet some other standard used by the court.
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For these reasons, boards should generally seek disinterested director approval of significant transactions with a controlling shareholder, freeze-out transactions (where minority shareholders are forced out of the corporation), controlling shareholder use of corporate assets and controlling shareholder pursuit of opportunities that could be deemed corporate opportunities. The board should seek the advice of counsel in structuring disinterested approval of controlling shareholder transactions.
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B. RIGHTS AND REMEDIES OF MINORITY SHAREHOLDERS
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Minority shareholders in a closely held corporation have special vulnerability. They have no ability to control the policies and direction of the corporation. If they disagree, they have little opportunity to extract the value of their investment in the corporation by selling their shares. As a result, corporation statutes afford minority shareholders in closely held corporations certain special protections and remedies in addition to the duty of fairness imposed by courts on controlling shareholders and the fiduciary duties of care and loyalty imposed on officers and directors.
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The Model Act and all state corporation statutes give shareholders the right, in connection with certain designated corporate events affecting shareholders, to dissent, seek appraisal of the fair value of their shares by a court and be cashed out at such value by the corporation in lieu of participating in the triggering corporate event. The events triggering such appraisal rights vary from statute to statute, but include freeze-out and other mergers in all states and major sales of corporate assets, statutory share exchanges and certain articles amendments affecting shareholder rights in most states. Appraisal rights afford minority shareholders some degree of liquidity and protection but only if management and controlling shareholders take the affirmative step of engaging in one of the triggering transactions, and no statutory exception applies. A shareholder who simply has a falling out with the controlling shareholder, loses his or her job or position in management and wishes to extract the value of his or her shares and move on is not provided an appraisal right.
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The Model Act and all state corporation statutes require the board to give shareholders notice of their appraisal rights when submitting a triggering event to them for approval.
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2. Dissolution and Judicial Intervention Statutes
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The Model Act and most state corporation statutes provide for judicial dissolution of the corporation, upon petition of a shareholder, if the shareholder succeeds in proving that management or shareholders are deadlocked and unable to act, that corporate assets are being misapplied or wasted by management or that management has acted in a manner that is illegal, oppressive or fraudulent. Minority shareholders of closely held corporations may pursue judicial dissolution as a means of gaining liquidity and an exit from the corporation when they have a falling out with management or their plans otherwise change.
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In light of the special vulnerability of minority shareholders of closely held corporations, some courts have tended to interpret misapplication and waste of assets and illegal, oppressive or fraudulent behavior rather broadly under judicial dissolution statutes in order to come to the aid of such shareholders. Some courts have also interpreted judicial dissolution statutes as implicitly authorizing courts to order a minority shareholder buyout in lieu of a full-scale dissolution and liquidation of the corporation upon proof of grounds for dissolution.
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Some state legislatures have broadened the judicial dissolution provisions in their corporation statutes to provide explicitly for more liberal grounds for remedy in the case of minority shareholders of closely held corporations and for a broader range of remedies that a court may order. The Model Act explicitly permits the board to elect to buy out the shares of a minority shareholder of a closely held corporation who brings a judicial dissolution action as a defensive response and a means of avoiding the risk of dissolution. The Model Act provides that, if the board and the minority shareholder cannot agree on a price for such buyout, the court shall determine the price. Some other state statutes vest the authority to determine an appropriate remedy entirely in the court, giving extremely broad discretion for ordering buyouts and other forms of judicial intervention in closely held corporations not only upon showings of traditional grounds but also upon showings of other events adversely affecting minority shareholders, such as frustration of the reasonable expectations of a shareholder.
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SECTION 5: MODIFYING TRADITIONAL ROLES AND STRUCTURE
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Section 2 describes the default rules of corporate governance set forth in the Model Act and most state corporation statutes. Many of these statutes also afford great flexibility to participants in closely held corporations to modify and tailor the rules of corporate governance and the roles of the participants to fit expectations and practical needs. The role and authority of shareholders, directors and officers can be modified by contract and by provisions contained in the articles of incorporation or bylaws, subject only to broad public policy limitations.
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Under the Model Act, shareholders in a closely held corporation may enter into a control agreement that allocates decision-making authority in practically any way the shareholders desire. For example, the control agreement can authorize weighted voting by directors or shareholders, eliminate the board of directors or assign the duties of the board to a specific director, certain shareholders or an officer. Unanimous shareholder approval of a control agreement is required under the Model Act, along with a notice of the agreement placed on the stock certificates.
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Short of the radical modification of corporate governance possible through a control agreement, two or more shareholders may enter into a voting agreement in which they agree to vote their shares in particular ways to effect agreed-upon changes in corporate governance. For example, three entrepreneurs may decide to incorporate and agree that each should be an equal shareholder. One of the most common expectations in such a situation would be that each of the three would serve on the board of directors so long as he or she remains an owner and involved in the business. In this regard, the traditional corporate structure would fail them without modification. In the event that the three had a falling out, two could join forces to remove the third director and keep him or her off the board by majority voting power. Using a voting agreement, the expectations of the shareholders could be captured by having the three shareholders agree that, so long as each remains a shareholder, they will vote their shares in such a manner as is necessary to keep all three on the board.
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More formal voting arrangements can be established by using a voting trust. In a voting trust, each shareholder deposits his or her share certificates with a trustee who is empowered to vote the shares in accordance with instructions previously provided to the trustee.
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D. MULTIPLE CLASSES OF SHARES
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A corporation may also use multiple classes of shares, with each class possessing unique powers and privileges, to meet the expectations of the participants. In many closely held corporations, the articles of incorporation designate that the holders of preferred shares have the right, voting as a separate group, to elect one or more directors with the balance of the directors elected by the holders of common shares or by the common shareholders and the preferred shareholders voting together. One drawback to using multiple classes of shares (if more than voting rights vary between classes) is that it will prevent the corporation from being eligible for tax treatment as an S corporation (see Section 1).
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A significant shareholder or a class of shareholders in a closely held corporation often will desire a veto right over certain corporate actions. This “negative” control over corporate actions is achieved by requiring a class vote or the prior approval of a named shareholder before a corporate action can be taken. Venture capitalists and other private equity investors generally will require a significant degree of negative control as a condition to making an investment in a corporation. Corporate actions over which a shareholder or class of shareholders may seek a veto right include: any amendment to the articles of incorporation that would adversely affect the rights of the shareholder or class
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F. OTHER PROTECTIVE PROVISIONS
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Although veto rights protect against a corporation taking action without a shareholder’s consent, veto rights do not give a shareholder any particular power to compel a corporate action. Even the right to appoint a director to the board will not guarantee a shareholder the ability to exert influence or control over the board’s decisions. Absent the ability to control the board, a shareholder can achieve a measure of affirmative control by agreeing with other shareholders in advance on certain corporate policies (e.g., dividend or capital expenditure policies). These types of agreements are frequently contained in a shareholder agreement.
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SECTION 6: BUY-SELL AGREEMENTS
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Buy-sell agreements are an essential part of planning in closely held corporations. They are used to give individual shareholders liquidity in certain events and to give shareholders as a group the ability to restrict the resale of shares, thereby controlling who becomes an owner of the corporation. As with voting agreements and shareholder agreements, a buy-sell agreement is binding only on the parties that sign it. This Section describes the terms commonly found in buy-sell agreements.
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A. RESTRICTION ON TRANSFER
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Most buy-sell agreements restrict shareholders from transferring their shares to persons or entities other than a shareholder’s immediate family members or entities controlled by a shareholder or a shareholder’s immediate family members unless certain procedures are followed. In the case of a transfer of shares to a permitted transferee, the transferee is required to agree to the terms of the buy-sell agreement. Often, the agreement will authorize the corporation not to register a transfer made in violation of the agreement.
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B. RIGHT OF FIRST REFUSAL
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In the most common form of restriction, shareholders are prohibited from selling shares to a third party without first offering the shares to the corporation and its shareholders. The corporation usually has the first option to purchase the shares on the same terms as would be offered to the third party or sometimes at a fixed price. If the corporation elects not to purchase all or any of the shares, or is unable under applicable law to make the purchase, the option is extended to the nonselling shareholders or their assignees, who may purchase the shares on a pro rata basis. The corporation and the nonselling shareholders have a specified number of days within which to exercise their right of first refusal. Thereafter, if the right of first refusal is not exercised, the selling shareholder may sell the shares to the third party Few third-party purchasers will accept the delay and uncertainty associated with buying shares that are subject to a right of first refusal. As a result, a right of first refusal is a powerful tool to control share ownership in a closely held corporation.
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C. REPURCHASE RIGHTS IN THE EVENT OF SHAREHOLDER DEATH OR DISABILITY
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Another common feature of a buy-sell agreement is the right or obligation of the corporation to repurchase a shareholder’s shares when the shareholder dies or becomes permanently disabled.
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D. REPURCHASE OPTION IF SHAREHOLDER TERMINATES EMPLOYMENT
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A common issue for closely held corporations is what to do when an employee owning shares in the corporation leaves the corporation. Many closely held corporations view former employee shareholders as potentially disruptive. The buy-sell agreement can provide a solution to this problem by giving the corporation an option to repurchase the departing employee’s shares. This option is especially useful when a shareholder employee leaves the corporation involuntarily or as a result of a dispute.
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In order for a buy-sell agreement to reduce or avoid disputes, it must provide a mechanism for determining the price to be paid for shares purchased under the agreement when the price is not established by reference to a third-party offer. A variety of approaches is available for setting the purchase price, including employment of an independent valuation or arbitration, a periodic agreement as to share value, a formula that references earnings, book value or other financial measure, or a good faith determination by the board of directors made annually or at the time a sale is imminent.
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The agreement should also provide for how the purchase price of the shares is to be paid. The agreement may provide for deferred payout in the event that the corporation is purchasing the shares and is unable to pay the purchase price in a lump sum or needs time to generate the cash to pay the obligation. The agreement may permit the corporation to issue the selling shareholder a promissory note, and the shares may then be cancelled or held as collateral for the debt obligation. Some corporations purchase insurance products to fund the repurchase obligation in the event of the death of a shareholder.
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Some buy-sell agreements include the right of all shareholders to participate in the sale of shares by one shareholder to a third party. This is particularly useful to prevent a founder of the corporation or other key shareholder from selling out his or her interest and leaving the company If the key shareholder decides to sell his or her shares, the other shareholders will have the right to participate in the sale and sell their shares on a pro rata basis on the same terms. Sometimes the co-sale right will replace a right of first refusal
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H. PUT AND DRAG-ALONG RIGHTS
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Professional investors, such as venture capital and private equity funds, may demand the right to sell their shares back to the corporation (a “put” right) or the right to have the corporation redeem their shares at some future date. They may also seek the right to force others to sell shares (“drag-along” rights) at the time the investor sells in order for the investor to capture a higher price, or “control premium,” for the share sale.
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I. RESTRICTIVE LEGEND ON SHARE CERTIFICATES
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As with a control agreement, the existence of a buy-sell agreement should be noted in a legend on the share certificates. The failure to note the buy-sell agreement may result in the agreement being unenforceable against parties without knowledge of the restrictions contained in the agreement.
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SECTION 7: RAISING MONEY, ISSUING SHARES AND DISTRIBUTING ASSETS
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A. FINANCING THE CORPORATION
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One of the most important roles of the board of directors is to authorize financing of the corporation to meet its business needs. The corporation may raise equity capital by selling its stock or obtain debt financing by borrowing from a bank, the shareholders or others. Determining the best capital structure (mix of equity and debt) for the corporation and approving and overseeing the raising of capital is the board’s responsibility. Selling stock and debt securities involves important strategic and practical considerations as well as legal compliance concerns, both under corporate law and under federal and state securities laws.
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1. Strategic and Practical Concerns
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The tremendous diversity in closely held corporations means that there is an equally tremendous diversity in financing needs and strategic and practical concerns in financing the corporation. For many closely held corporations, the business is funded from operating income or some combination of operating income and bank or other debt financing. Equity financing beyond the initial issuance of stock to founders and other close participants is generally not part of the business plan. For others, especially those operating development-stage businesses, equity financing is a clearly foreseeable necessity.
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Among the most important strategic and practical considerations is determining who will own the company’s equity. A company may want to restrict share ownership to a relatively small group (e.g., family members or active participants in the business) or open investment to financial or outside investors. The decision on share ownership is often inextricably tied to the corporation’s long-term strategy. Financial or outside investors may have little interest in investing in a minority interest in the nonliquid equity of a closely held corporation if its strategy does not include some means by which investors may eventually realize the value of their investment. To attract such investors, the corporation may be pressed to present evidence of a viable exit strategy within a reasonable time frame, such as an initial public offering or a sale of the company.
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Selling shares may also provide a strategic advantage to the corporation by broadening the experience, expertise and contacts of its shareholders. Care should be taken, however, in evaluating the merits and limitations of selling shares to a particular shareholder. Selling shares solely because the prospective investor has available cash can be ill-advised. Selling shares to unsophisticated or nonprofessional investors, even if they are family, friends or employees of the business, can also lead to unhappy consequences. For instance, such persons may not fully appreciate their limited role as shareholders, resulting in a diversion of corporate resources and management’s attention. Moreover, in some instances, the decision to sell shares to unsophisticated investors may preclude the later participation of venture capital or other sophisticated investors. Many venture capital funds and other professional investors will not invest in a company that has already obtained a round of financing from nonprofessionals. Finally, selling shares to investors who fail to qualify as “accredited investors” under the SEC’s rules can create legal problems for the corporation under federal and state securities laws and may also greatly reduce the company’s range of financing opportunities in the future.
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Professional investors, such as venture capital funds, may bring substantial value to the corporation in addition to their initial cash investment. Venture funds typically set aside substantial reserves to allow them to invest in subsequent rounds of financing should the corporation require additional funds. Managers of venture funds may also bring great expertise to the corporation and valuable business connections. On the other hand, professional investors may insist on much tougher terms than family and friends (e.g., lower corporate valuation that results in the investor acquiring a larger percentage of the corporation’s equity, board representation or extensive veto powers).
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2. Corporation Law Concerns
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The board of directors must authorize and approve the corporation’s issuance of securities (either equity or debt) as well as the grant of rights to purchase stock and other securities (e.g., options and warrants). The maximum number of shares a corporation may have issued and outstanding at any one time is limited to the number of authorized shares provided for in the corporation’s articles of incorporation. A corporation may increase or decrease the number of authorized shares by amending its articles of incorporation. Amending the articles of incorporation generally requires both board and shareholder approval.
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The corporation may prescribe, in its articles of incorporation, the type of equity it is authorized to issue. If the corporation fails to create different classes of shares, all of the corporation’s shares will be regarded as common stock. The corporation may authorize more than one class of common stock (e.g., class A, class B) and authorize other classes of stock such as preferred stock. In doing so, the corporation generally assigns to each type or class of stock it creates specific rights or limitations with respect to such matters as voting, rights to receive dividends and rights to receive assets upon liquidation. The articles of incorporation may also empower the board to tailor such rights and limitations to the needs of the corporation at the time the board authorizes the actual issuance of such shares. In such cases, the shares are frequently referred to as “blank check” shares because the rights and limitations must await the passage by the board of a resolution setting forth their particular rights and limitations.
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When issuing shares, the board must determine what consideration or payment the corporation is to receive for such shares. The Model Act permits issuance of stock in consideration of “any tangible or intangible property or benefit to the corporation, including cash, promissory notes, services performed, contracts for services to be performed, or other securities of the corporation.” Some state corporation statutes are, however, more restrictive and limit share issuances for certain categories of consideration, especially promissory notes and the promise to perform services in the future. If the corporation is to receive real or personal property as consideration for the issuance of its shares, the directors must approve of the value assigned to such property.
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The issuance of shares must also take into account the rights of existing shareholders. For instance, existing shareholders may have preemptive rights, which are the statutory rights of existing shareholders to avoid dilution of their equity interest by purchasing a pro rata portion of any new shares being offered. All corporation statutes provide for preemptive rights, but, under most statutes, shareholders have such rights only if the articles of incorporation affirmatively opt in. Under other statutes, shareholders have preemptive rights unless the articles of incorporation opt out. Generally, statutory preemptive rights are difficult to deal with and can restrict and encumber the board in pursuing its financing strategies. Directors should confer with counsel to make sure that the corporation is not burdened with statutory preemptive rights.
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Shareholder agreements and other agreements to which the corporation is a party (e.g., loan agreements or joint venture agreements) and some special government regulations (e.g., those governing public utilities) may contain limitations and restrictions on, or consequences to be incurred by, the corporation as a result of issuing additional shares. Directors should confer with legal counsel to the corporation to confirm that all relevant agreements, statutes and regulations have been reviewed and that shares may be validly issued.
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3. Securities Law Concerns
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Federal and state securities laws prohibit the offer and sale of any security without first registering the securities with the SEC and the appropriate state securities regulators and delivering a prospectus containing required information, unless an exemption from registration is available under these respective securities laws. Federal and state securities laws also impose antifraud liability for misstatements or omissions of material fact in connection with the purchase or sale of any security
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Failure to comply with the registration requirements under federal and state securities laws can result in the investor having an absolute right to rescind the transaction (i.e., return the security to the corporation in exchange for return of the purchase price plus interest at a statutory rate) or collect damages from the corporation and possibly its directors and officers. Such failure to comply can also result in the corporation and its officers and directors being subject to civil enforcement actions and even criminal prosecution. Antifraud violations can also lead to private claims for money damages as well as civil enforcement actions and criminal prosecution against the corporation, its officers and directors.
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It is important to seek expert legal advice any time that the board is contemplating the offer or sale of stock or other corporate securities and before the offers and sales are made. All offers and sales are subject to federal and state securities laws, including initial issuances to founders as well as offers and sales to employees and to outsiders. Counsel can help the board structure a proposed financing or other transaction to come within an available exemption from the federal and applicable state securities law registration requirements and can help the board ensure that disclosures made to investors are adequate to avoid antifraud liability.
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Once offers and sales are made, it may be impossible to use an exemption that would have otherwise been available with advance planning. Mistakes may be extremely costly to the corporation and may not only have an impact on the immediate transaction but also severely limit the corporation’s flexibility in obtaining financing in the future.
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B. DIVIDENDS AND STOCK REPURCHASES
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The board of directors has the authority to authorize the corporation to pay dividends or otherwise distribute corporate assets to shareholders. State corporation statutes specify the circumstances under which a corporation may pay a dividend or distribute its assets. The corporation’s articles or incorporation or bylaws or other contractual arrangements may also contain restrictions or limitations on dividend or other distributions. These restrictions are designed to protect creditors of the corporation who are ultimately entitled to payment prior to return of capital to shareholders. They are also designed to protect shareholders from having corporate assets depleted beyond the point necessary for continuation of corporate business. Directors who permit the payment of dividends or the distribution of assets in contravention of relevant restrictions and limitations may expose themselves to personal liability.
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1. Strategic and Practical Concerns
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So long as the corporation is not restricted by the statutory requirements discussed above, deciding when to pay a dividend, how much the dividend should be and what form the dividend should take (i.e., cash, stock or other property) is left to the discretion of the board of directors. Because dividends represent a transfer of wealth from the corporation to its shareholders, directors should consider how that transfer may affect the corporation’s ability to realize its short-term and long-term strategic goals.
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All shareholders in a corporation rarely have the same economic standing and level of financial security. Consequently, some shareholders may view and come to rely upon dividends as a source of short-term cash flow while others may be more interested in the corporation reinvesting earnings as a means of increasing the long-term value of their shares. Frequently, the dividend policy adopted by the board will seek to address both concerns by distributing some but not all of the corporation’s earnings.
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If the corporation has elected S corporation tax status, the board should consider adopting a dividend policy that, at the very least, will distribute to the shareholders enough money to meet their periodic tax obligations incurred as a result of their stock ownership. Corporations typically adopt a formula to determine the highest possible tax rate incurred by any particular shareholder so that no shareholder will receive less than the taxes he or she incurs.
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Equally important as the amount of the dividend is the timing of the dividend payments. Boards should take into consideration the timing of the tax payments required of shareholders, as well as the corporation’s own contractual obligations and cash flow needs, in establishing the schedule upon which dividends will be paid. Many corporations pay dividends on an annual basis after fiscal year results have been tabulated and reserves established for the following fiscal year. Others declare and pay dividends on a quarterly or semi-annual basis.
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Restrictions on distributions to shareholders vary significantly from corporation statute to corporation statute. Most state statutes restrict the payment of dividends or the distribution of assets if such payment or distribution would render the corporation insolvent. The Model Act’s approach is consistent with these states in that it prohibits a corporation from paying dividends or distributing assets if, after giving effect to such action “(1) the corporation would not be able to pay its debts as they become due in the usual course of business
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If the primary purpose of the payment of dividends or the distribution of corporate assets to its shareholders is to frustrate the collection efforts of legitimate creditors of the corporation, such distributions may also be nullified as fraudulent conveyances. If the corporation has engaged in a fraudulent conveyance, the assets must be returned to the corporation.
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The payment of dividends in a closely held corporation is often confused with the payment of compensation for services performed. This confusion frequently arises when some or all of the shareholders are employees of the corporation. The board should set a dividend policy in which all shareholders are treated alike and separately consider and set the compensation for those shareholders who are also employees. Failing to distinguish between what is a dividend and what is compensation can have significant legal as well as tax implications.
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C. GIVING EMPLOYEES AN OWNERSHIP INTEREST
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Giving employees an ownership interest in the corporation has become extremely common. From the point of view of the corporation, stock-based compensation may permit a business to attract and retain key employees while conserving precious cash. Making employees owners may also give them greater incentive to work for long-term enhancement of the corporation’s value by giving them a share of the future upside.
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There are, however, important practical and legal issues raised by offering stock to employees (in addition to the corporate and securities law issues discussed above with respect to any stock issuance). First, closely held corporations have no public market for their shares, and stock-based compensation is illiquid. Second, if shares are not subject to substantial risk of forfeiture, the employee may be taxed at the time he or she receives the stock without having cash to pay the tax. Third, those employees acquiring stock gain legal rights (e.g., rights to inspect certain corporate records and to receive notice of and attend shareholder meetings) and standing to challenge or question board decisions by legal action and otherwise. As a result, the corporation may have to adopt more formal procedures than what existed when all of the shares were held by a more intimate group, and corporate action may become more complex, contentious and time-consuming.
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If the corporation decides to issue shares to its employees, it should require them to enter into appropriate buy-sell agreements providing for repurchase of the shares by the company in the event of death or termination of employment or in the event the employee desires to sell the shares to a third party.
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Publicly held companies often use stock options to provide employees with equity incentive compensation, but option holders may become shareholders. Consequently, the same considerations that apply to issuance of stock to employees apply to stock option grants. In addition, the tax, securities and accounting rules associated with the granting and exercise of stock options are complex. Determination of fair market value, essential for granting certain tax-advantaged options, poses difficulties due to the absence of a trading market. Employees and the closely held corporation can be adversely affected by tax, accounting and other rules relating to options if careful planning is not undertaken when establishing a plan and granting options.
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An alternative to issuance of shares or the grant of options to buy shares is for the corporation to issue quasi-equity inducements, such as phantom stock, that reward employees financially for increases in the value of the corporation without actually giving them an ownership interest. Phantom stock and similar compensatory rewards are deferred bonus arrangements that entitle an employee to receive cash in an amount equal to the increase in value of stock between the grant date and a later trigger date (e.g., termination of employment, sale of the company or commencement of an initial public offering). Phantom stock and similar bonus units may be made subject to vesting requirements. They may also provide for the payment of the appreciated value over a period of time to avoid draining the corporation of cash.
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SECTION 8: LIABILITY CONCERNS
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A. DIRECTOR AND OFFICER LIABILITY
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Directors and officers may incur personal liability for breaches of either their duty of care or their duty of loyalty or for failure to meet the requirements of certain other applicable laws. If a director or officer breaches a duty or violates the law but still meets the prescribed statutory standards for indemnification discussed below, the corporation is empowered to indemnify the director or officer against liability and expenses incurred.
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Directors and officers may be liable for money damages for breach of their fiduciary duty of care or loyalty in actions brought by or on behalf of the corporation or in direct actions by shareholders. State corporate statutes also contain special provisions making directors liable for payment of illegal dividends or other distributions.
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2. Liability under Other Laws
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Directors and officers can be personally liable under the federal and state securities laws, in some cases even where they act in good faith (see Section 7). Directors and officers also may be subject to personal liability under such other state and federal statutes as environmental laws. Timely legal advice and careful monitoring of management programs directed toward corporate legal compliance should provide substantial safeguards against personal liability.
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B. SHAREHOLDER LIABILITY–PIERCING THE CORPORATE VEIL
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Although a shareholder of a corporation is generally not liable for the obligations of the corporation, under certain circumstances courts will disregard the existence of the corporation and impose personal liability on shareholders for obligations of the corporation arising either in tort or contract. Courts call this “piercing the corporate veil.” The willingness of courts to disregard the corporation varies from state to state. The rationale often employed by the courts for piercing the corporate veil is that the corporation has been managed in ways that ignore, or are inconsistent with, the concept of the corporation as a separate entity Historically, the doctrine of piercing the corporate veil has only been used successfully against shareholders of closely held corporations. Consequently, directors of closely held corporations should be aware of the possible consequences to shareholders of lax management practices and should seek to avoid conditions that might expose shareholders to personal liability. A number of important factors have been cited as justification for piercing the corporate veil in those cases that have resulted in shareholder liability:
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* Inadequate capitalization from inception. One of the reasons frequently cited by courts for piercing the corporate veil is that the corporation had never received adequate capital to operate the business and provide for the foreseeable obligations and risks inherent in the business. In a tort case, for example, where the plaintiff is injured in an accident involving a corporate vehicle and the corporation does not have adequate insurance coverage, under-capitalization from inception might be sufficient in itself to justify piercing.
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* Fraud or mispresentation. In a contract case, where the plaintiff has voluntarily chosen to enter into the contract with the corporation, courts typically require that some element of deception or inequity be involved to justify piercing the veil. Misrepresenting the finances of the corporation or otherwise misleading the plaintiff could supply the necessary element.
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* Commingling corporate and shareholder assets
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* Inattention to corporate formalities. Failure to observe corporate formalities is one of the most frequently cited factors justifying disregard of the corporate entity. Failure to adopt bylaws, hold annual meetings and keep minutes and records are factors that militate in favor of piercing.
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C. LIMITATIONS ON LIABILITY FOR MONEY DAMAGES
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The Model Act and most state corporation statutes permit the corporation to eliminate or limit the liability of directors to the corporation or its shareholders for money damages for breaches of certain duties, most frequently the duty of care. For instance, the Model Act permits inclusion of a provision in the articles of incorporation eliminating or limiting directors’ personal liability for money damages, except liability for the receipt of a financial benefit to which the director is not entitled, the intentional infliction of harm on the corporation, an unlawful distribution or an intentional violation of criminal law.
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Shareholders in a closely held corporation may also enter into a control agreement pursuant to which the duties of all or certain directors are delegated to others. To be effective, all shareholders must sign such an agreement. The Model Act provides that an agreement authorized by shareholders that restricts the discretion or powers of a director relieves that director from liability otherwise imposed by law.
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Corporation statutes specify the circumstances in which the corporation is permitted or is required to indemnify its directors and officers against liability and related reasonable expenses incurred in connection with their service to the corporation.
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Under the Model Act, a director or officer may be indemnified for liabilities and expenses only if the director or officer took the actions giving rise to them were taken in good faith and with a reasonable belief that his or her conduct was in the best interests of the corporation. In the case of criminal proceedings, the person must also have had no reasonable cause to believe that his or her conduct was unlawful. The Model Act provisions, which have been adopted in substance by many states, give corporations the power to indemnify directors and officers in actions by third parties, including class actions, for expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement of the actions. In derivative actions brought in the name of the corporation itself, indemnification is allowed for expenses (including attorneys’ fees), but when a person has been found liable, indemnification is allowed only with court approval. Further, the Model Act provides that amounts paid in settlement of a derivative action may be indemnified only if approved by a court.
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The Model Act provides that indemnification for reasonable expenses (including court costs and legal fees) is mandatory if the director or officer has been “wholly successful” in the defense of any action, on the merits or otherwise.
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Many corporations have articles or bylaw provisions mandating indemnification to the fullest extent permitted by law. Such broad, mandatory indemnification may be undesirable from the corporation’s perspective–especially to the extent that it binds the corporation to indemnify not only directors and officers but also other employees and agents of the corporation. Mandatory indemnification provisions in the articles or bylaws should be reviewed carefully with legal counsel for the corporation. Some corporations have separate indemnification contracts with directors and officers to provide mandatory indemnification to the extent that the applicable statute permits. From the perspective of the director or officer, the main advantages of indemnification contracts are that they cannot be rescinded without his or her consent (whereas an articles or bylaw provision may be subject to amendment) and that they can provide more advantageous terms for advancing expenses and indemnification procedures and timing.
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Directors and officers should be aware that a corporation’s ability to honor its indemnification obligations is only as strong as the corporation’s financial condition. If the corporation is in financial distress, relying upon the corporation’s pledge of indemnification could leave the director or officer with personal liability, unless insurance or other indemnity is available.
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The right of a director or officer to indemnification is usually triggered by the conclusion of the litigation or proceeding after his or her conduct has been fully adjudicated. However, prior to that point, the director, in defending his or her conduct, will incur legal costs and other expenses. The Model Act and state corporation statutes specify the circumstances in which corporations may advance funds to pay or reimburse reasonable expenses incurred in defense of a matter before final disposition of the proceeding and final determination of the right to indemnification for those expenses.
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Nearly every state permits corporations to purchase directors and officers liability insurance (commonly referred to as D&O insurance). D&O insurance may be used by the corporation to fill gaps in its indemnification coverage. These gaps include situations in which the corporation is not permitted to provide statutory indemnification or exculpation or where the corporation’s indemnification does reach but the corporation is unable to meet the financial obligation of indemnification.
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Every person considering service as a director or officer of a corporation, no matter how large or small the entity, should give careful consideration to the corporation’s indemnification provisions as well as the corporation’s financial ability to honor its indemnification obligations. A regular review by the directors of the corporation’s indemnification provisions and insurance coverage is advisable.
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SECTION 9: CORPORATE BOOKS, RECORDS AND REPORTING
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The ongoing maintenance by a corporation of its books and records is required by the Model Act and all state corporation statutes. For closely held corporations, well-organized and complete records may be especially helpful in demonstrating the separateness of the corporate entity and its shareholders, thereby helping to maintain the liability shield of the corporation (see the discussion of shareholder liability in Section 8). Also, in many commercial or financial transactions the other party will insist upon evidence of board or shareholder authorization of the transaction. If the corporation anticipates entering into certain significant corporate transactions, such as debt or equity financings or the sale of the business, the other party will most likely ask to review all the historical records of the corporation. Thus, the timely maintenance of corporate records cannot be overemphasized.
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A. MINUTES, WRITTEN CONSENTS, ARTICLES AND BYLAWS
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The Model Act and many state corporation statutes require that a corporation keep written minutes of the meetings of its shareholders and board of directors, copies of actions of the shareholders or the board taken by written consent, an up-to-date copy of the articles and bylaws, and any written communication to shareholders in the last three years, including the financial statements that are required to be sent to shareholders. The statutes do not specify the amount of detail to be included in board or shareholder minutes, and it is generally advisable to keep the minutes concise.
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B. FINANCIAL RECORDS AND STATEMENTS
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A corporation is required to maintain current accounting records that are sufficiently complete to permit the preparation of annual financial statements. The Model Act requires a corporation to distribute to its shareholders annual financial statements, including a balance sheet and an income statement, within 120 days after the close of the corporation’s fiscal year.
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In addition to a record of corporate actions and financial information, a corporation must maintain basic information concerning its shareholders and its directors and officers. A corporation must be able to produce a list of its shareholders showing their addresses and the class and number of shares owned by each shareholder. The shareholder list is usually derived from the share register maintained by the corporation, which records all issuances, transfers and cancellations of shares, the date each such event occurred and the certificate number of any share certificates issued.
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A corporation may maintain all or part of its books and records in electronic form. The Model Act permits a corporation great flexibility in using technology to its advantage, provided that the method of storage (i.e., computer memory or computer disk) is capable of being produced in written form within a reasonable time.
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D. RIGHT TO INSPECT BOOKS AND RECORDS
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The Model Act gives shareholders a limited right, after giving advance notice to the corporation, to inspect and copy the articles of incorporation and bylaws of the corporation, the minutes of shareholder meetings and any written communication to shareholders made during the previous three years, including the financial statements sent to shareholders, any board minutes that relate to the creation of shares that are currently outstanding and the names and business addresses of the directors and officers. Prior to a meeting of shareholders, a shareholder or his or her agents may also inspect the list of shareholders entitled to vote at the meeting. This list must be available for inspection from at least two days after notice of the meeting is given through the date of the meeting.
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Shareholders may inspect additional books and records of the corporation, but their right to do so is neither absolute nor immediate. If a shareholder can demonstrate a purpose that is relevant to his or her interest as a shareholder and not simply a disagreement with management, then the shareholder can inspect excerpts of board and committee meetings, accounting records and shareholder records that are relevant to the shareholder’s purpose. A corporation may limit or deny a shareholder’s access to its books and records if the corporation believes that the shareholder is acting in bad faith or will misappropriate or otherwise use the information in a manner that harms or is intended to harm the corporation. With proper grounds, a court may order a corporation to open its books and records for inspection.
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Financial investors in closely held corporations frequently negotiate the right to receive more extensive information, including monthly or quarterly financial statements and annual budgets and periodic comparisons to budget. In addition, these investors may negotiate the right to send observers to board meetings (see Section 2).
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Under the Model Act and many state corporation statutes, a corporation incorporated or otherwise doing business in the state is required to file an annual or biannual report with the secretary of state. A corporation may be administratively dissolved or its articles of incorporation revoked if it fails to file the report.
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The content and form of the reports vary widely from state to state. Under the Model Act, the corporation is required to file only limited information: the location of the principal office, the names and addresses of the corporation’s directors and principal officers, a general description of the business and the corporation’s capital structure. Often, the corporation must pay a fee along with the filing.
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By the Committee on Corporate Laws, ABA Section of Business Law *
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* The members of the Corporate Laws Committee (2002-2003) are as follows: Harold S. Barron, Chicago, Illinois
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(1.) Approximately fifteen states have special statutory provisions supplementing their general business corporation statute for closely held corporations. Closely held corporations meeting designated criteria may elect in their articles of incorporation to be governed by such special supplemental provisions. This election should not be made without advice of legal counsel.
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(2.) The Model Act was originally promulgated by the Committee on Corporate laws of the Section of Business Law of the ABA in 1950 and has since been updated on a regular basis. See Richard A. Booth, A Chronology of the Evolution of the MBCA, 56 BUS. LAW. 63 (2000). The Model Act serves as the primary basis for the corporation statutes in approximately half the states, and many of its provisions have been adopted in almost all of the other states.
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(3.) Most people use the term “close corporation” interchangeably with the term “closely held corporation” to refer to any corporation that has a relatively small number of holders of equity securities and no active trading market for those securities. Some people use the term “close corporation” to refer to closely held corporations that have made a special statutory election in their articles of incorporation (permitted in about fifteen states) for special close corporation status. By making this election, these corporations become governed by special statutory provisions supplemental to the state corporation statute. This Guidebook uses the term “closely held corporation” in the broader sense.
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The Model Act and other corporation statutes (as well as other bodies of law) may define “closely held corporation” more precisely (and more or less broadly) than common usage for purposes of particular legal provisions. Such specialized legal provisions are generally beyond the scope of this Guidebook.
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(4.) Although there are significant differences between the organization and operation of a closely held corporation and a publicly held corporation, the director’s duties, responsibilities and rights do not differ. Because the law is the same, this chapter is, in large part, derived from previous publications on the subject by the Committee on Corporate Laws of the American Bar Association’s Section of Business Law.
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For those interested in learning more about closely held corporations, a list of books and materials relating to some of the major topics covered in this Guidebook follows.
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AMERICAN BAR ASSOCIATION, THE AMERICAN BAR ASSOCIATION LEGAL GUIDE FOR SMALL BUSINESS (2000).
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AMERICAN LAW INSTITUTE, PRINCIPLES OF CORPORATE GOVERNANCE: ANALYSIS AND RECOMMENDATIONS (1994).
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CONSTANCE E. BAGLEY & CRAIG E. DAUCHY, THE ENTREPRENEUR’S GUIDE TO BUSINESS LAW (2d ed. 2003).
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JOSEPH W. BISHOP, JR., THE LAW OF CORPORATE OFFICERS & DIRECTORS: INDEMNIFICATION AND INSURANCE (1981 & Supp. 2002).
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DENNIS J. BLOCK, NANCY E. BARTON & STEPHEN A. RADIN, THE BUSINESS JUDGMENT RULE: FIDUCIARY DUTIES OF CORPORATE DIRECTORS (5th ed. 1998 & Supp. 2001).
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COMMITTEE ON CORPORATE LAWS, CORPORATE DIRECTOR’S GUIDEBOOK (3d ed. 2001).
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Committee on Corporate Laws, Guidelines for the Unaffiliated Director of the Controlled Corporation, 45 BUS. LAW. 429 (Nov. 1989).
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COMMITTEE ON CORPORATE LAWS, MODEL BUSINESS CORPORATION ACT ANNOTATED (3d ed. 2001 & Supp. 2000/01/02).
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JAMES A. DOUGLAS, CLIFFORD R. ENNICO, DAVID E. FELD & MARY SPRAGUE LANGSTON, CLOSELY HELD CORPORATIONS FORMS AND CHECKLISTS (2001-2002).
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ROBERT J. HAFT, VENTURE CAPITAL AND SMALL BUSINESS FINANCINGS (2002).
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EDWIN T. HOOD, JOHN J. MYLAN & TIMOTHY P. O’SULLIVAN, CLOSELY HELD BUSINESSES IN ESTATE PLANNING (2d ed. 1998 & Supp. 2000).
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DAVID H. KELLEY, DAVID A. LUDTKE & BURNELL E. STEINMEYER JR., ESTATE AND ENTITY PLANNING: FAMILY BUSINESS ORGANIZATIONS (2d ed. 2000).
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JOHN F. OLSON, JOSIAH O. HATCH III, & TY R. SAGALOW, DIRECTOR AND OFFICER LIABILITY: INDEMNIFICATION AND INSURANCE (2001).
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F. HODGE O’NEAL & ROBERT B. THOMPSON, O’NEAL’S CLOSE CORPORATIONS (3d ed. 1986 & Supp. 2002).
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F. HODGE O’NEAL & ROBERT B. THOMPSON, O’NEAL’S OPPRESSION OF MINORITY SHAREHOLDERS (2d ed. 2001 & Supp. 2002).
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WILLIAM H. PAINTER, PAINTER ON CLOSE CORPORATIONS: CORPORATE, SECURITIES, AND TAX ASPECTS (3d ed. 1991 & Supp. 1999).
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LEE R. PETTILON & ROBERT JOE HULL, REPRESENTING START-UP COMPANIES (2002).
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LEWIS D. SOLOMON & LEWIS J. SARET, VALUATIONS OF CLOSELY HELD BUSINESSES: LEGAL AND TAX ASPECTS (1998).
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Robert B. Thompson, The Shareholder’s Cause of Action for Oppression, 48 BUS. LAW. 699 (Feb. 1993).
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