|What is a close corporation?
A close or closely held corporation is a corporation whose shares of stock are held by one shareholder or a closely-knit group of shareholders. Most states impose various statutory requirements on such corporations. The applicable provisions for close corporations under Delaware General Corporation Law can be found at 8 Del. C. §§ 341-356. Generally, the statutory requirements provide for one or more of the following restrictions:
- limits on the number of shareholders;
- stock transfer restrictions;
- the stock cannot be offered to the public or listed on a national securities exchange;
- intention to form a close corporation stated in the articles of incorporation. 1A W. Fletcher Cyclopedia Corporations § 70.10; See also 8 Del. C. § 342.
In the absence of a specific statute, all states have some provision designed to meet the distinctive needs of close corporations. Id. The judicial system has also recognized the particular characteristics and needs that justify treating close corporations differently from that of publicly held corporations. Id. Depending on the situation, the strict formalities of publicly held corporations have not always been applied to close corporations. Id. Thus slight deviations or irregularities from the standards generally applied to corporations have been permitted by the courts unless the conduct would result in injury to or fraud upon creditors, minority shareholders or the public. Id. Furthermore, despite having the status of a close corporation, actions taken by its shareholders that are in direct violation of general corporation laws have been held to be invalid. Id.
Shareholders in a close corporation have a fiduciary relationship to each other. The relationship between shareholders in a close corporation is similar to the relationship between partners in a partnership. Id. A number of states, including Delaware, acknowledge this unique quality by allowing shareholders to arrange their relationships in a manner that would only be appropriate between partners. Id.; 8 Del. C. § 354. However, it is important to recognize that this notion of operating a close corporation like a partnership has not been universally accepted. 1A W. Fletcher Cyclopedia Corporations § 70.10.
Shareholders of close corporations are generally involved in actively managing the business and often serve as directors of the corporation. As such, management and ownership positions in a close corporation are frequently held by the same person or persons. Id. Unlike general corporations where management of the business operations of the corporation is reserved for the board of directors or the officers, shareholders in close corporations may enter into agreements that give them authority to run the company. Id.; 8 Del. C. §§ 350,351. With regard to shareholders participating in management of the corporation, a question of liability may arise. When shareholders act in their individual capacities rather than as officers of the corporation they may be held individually liable. 1A W. Fletcher Cyclopedia Corporations § 70.10.
Value of stock in a close corporation
As mentioned above, one of the unique characteristics of a close corporation is that its stock is not available for public sale or traded on a national securities exchange. Id. Nevertheless, shares of stock in a close corporation may be considered “securities” and therefore transactions involving such stock have been held subject to certain provisions of federal securities law. Id. Since there is no regular trading market for shares of stock in a close corporation, one must generally look to the particular facts and circumstances of each case in order to determine the value of a shareholder’s stock. Id. It has been suggested that the value to be placed on specific shares of stock would be equal to the amount that could be realized if the shares were sold on the open market.