Chap 5 - Closely held corps

Question 1

What is a close hold corp? Give an example

Answer 1

A corporation whose shares are held privately amongst a small group of shareholders, and these shares are not sold through public markets. Ex. Chic-Fil-A

Question 2

In Deleware how many shareholders can a closed corp have?

Answer 2

30

Question 3

What is the general rule for other shareholder maximums?

Answer 3

About 50

Question 4

What are the 3 ways a closed corp controls its shareholders?

Answer 4

1. Shareholder agreements
2. Transfer restrictions
3. Voting controls - voting trusts, cumulative voting , supermajority requirements and so on

Question 5

What is a shareholder agreement?

Answer 5

Any contractual binding that defines the limits of shareholder voting power. They are usually made to protect the interests of minority shreholders

Question 6

Are MBCA guidelines around shareholder agreements binding?

Answer 6

Not really. Such agreements are allowed to: (1) eliminates the board of directors or restricts the discretion or powers of theboard of directors;* (2) governs the authorization or making of distributions whether or not inproportion to ownership of shares, subject to the limitations in section 6.40;* (3) establishes who shall be directors or officers of the corporation, or theirterms of office or manner of selection or removal;* (4) governs, in general or in regard to specific matters, the exercise or division ofvoting power by or between the shareholders and directors or by or among anyof them, including use of weighted voting rights or director proxies
(5) establishes the terms and conditions of any agreement for the transfer oruse of property or the provision of services between the corporation and anyshareholder, director, officer or employee of the corporation or among any ofthem;* (6) transfers to one or more shareholders or other persons all or part of theauthority to exercise the corporate powers or to manage the business andaffairs of the corporation, including the resolution of any issue about whichthere exists a deadlock among directors or shareholders;* (7) requires dissolution of the corporation at the request of one or more ofthe shareholders or upon the occurrence of a specified event or contingency;or* (8) otherwise governs the exercise of the corporate powers or themanagement of the business and affairs of the corporation or the relationshipamong the shareholders, the directors and the corporation, or among any ofthem, and is not contrary to public policy.

Question 7

How long do shareholder agreements last?

Answer 7

Generally 10 years, but this term can be modified

Question 8

According to the MBCA what needs to be done in order to adopt a shareholder agreement?

Answer 8

They must be approved by ALL shareholders and set down in either:

1. the article of incorperation
2. the bylaws, or
3. a separatedocument that all shareholders sign

notice is such an agreement is required to be given to incoming shareholders

Question 9

What is a vote pooling agreement?

Answer 9

An agreement between at least 2 shareholders to vote together as one unit

Question 10

Are vote polling agreements allowed in the MBCA?

Answer 10

Yes so long as they are in writing, signed, and:
(a) Two or more shareholders may provide for the manner in which theywill vote their shares by signing an agreement for that purpose(b) A voting agreement created under this section is specificallyenforceable. MBCA 7.31

Question 11

Are vote pooling agreements allowed in Delaware?

Answer 11

Yes. the requirements are the exact same as in the MBCA

Question 12

Isaac, Adam, and Omar, three minority shareholders of a closelyheld corporation, enter into a vote pooling agreement wherebythey agree to vote their shares to elect Naomi to the Board ofDirectors during the annual meeting next week. However, beforethe meeting, Omar has a change of heart and decides not to votehis shares for Naomi. He tells Isaac & Adam about this change.What can Isaac & Adam do in this situation?

Answer 12

They can seek to have the vote pooling agreement specificallyenforced, which is allowed under both the MBCA & DGCL.

Question 13

Isaac, Adam, and Omar, three shareholders of a closely heldcorporation that together hold a majority of the shares, enter into avote pooling agreement whereby they agree to appoint Naomi as theChairwoman of the Board of Directors immediately. Since they havethe majority, the don’t want to wait until the annual meeting since theresult of any election won’t be in doubt. May these three do this by using a vote pooling agreement?

Answer 13

No. Corporate statutes require elections despite the futility of theexpected result. MBCA 8.03(c) & DGCL 211(b)

Question 14

How many votes per share?

Answer 14

one to one

Question 15

What are share classes?

Answer 15

Different groups of shares which can be given different voting rights. Ex. A shares get voting rights and dividends, but B shares only get dividends, or can vote only on specific issues

Question 16

What was the holding of Salamone v. Gorman?

Answer 16

The (vote pooling) agreement may be read to restrict the normal/default rule (that a majority of shares can elect a director) only if trial court finds by clear and convincing evidence that the contract was intended to restrict the default rule - IE the default rule is that there is one vote per share and that to elect a director there must be a majority of shares voting that vote for that person. BUT this can be changed to a majority of SHAREHOLDERS if the court finds clear and convincing evidence of an intent to do that within the vote pooling agreement

Question 17

What does the MBCA say about removing directors?

Answer 17

MBCA § 8.08(a): a director may be removed with or withoutcause unless the articles of incorporation state that removal mustbe for cause* MBCA § 7.32(a)(3): permits shareholder agreements to determinethe manner of removing a director* MBCA § 8.10(a): unless the charter requires otherwise, boardvacancies may be filled by a shareholder vote or by a vote of themajority of the remaining directors.

Question 18

What is a share transfer restriction?

Answer 18

A provision that blocks a shareholder from exercising their right to transfer (or other share rights) unless certain conditions are met

Question 19

What is the default rule for share transfers?

Answer 19

All shares are trnasferable

Question 20

How can a transfer restriction be found?

Answer 20

In the charter, bylaws, or a operate agreement between shareholders or between a shareholder and the coropration

Question 21

Does a transfer restriction affect shoes before the restriction was implemented?

Answer 21

No. UNLESS

1. The holders of the shares were parties to the transfer restriction agreement, or
2. The holders of the issued shares voted in favour of the restriction

Question 22

When are shares issued?

Answer 22

When the shares BECOME OWNED by someone

Question 23

What are the 4 types of transfer restrictions?

Answer 23

MBCA 6.27. Types of transfer restrictions (same under DGCL)* Option: a shareholder must offer the corporation or othershareholders the option to purchase their shares* Buy-sell agreement: the corporation or other shareholders areobligated to purchase shares from a shareholder at a specified price* fixed price, book value, appraisal, formula* Prior approval: the corporation or other shareholders must approveany transfer of shares (but approval may not be unreasonablywithheld)* Prohibition: a shareholder is prohibited from transferring to certainpersons

Question 24

How do courts generally view each type of restriction?

Answer 24

• Options and buy-sell agreements are common and are usuallyenforced by courts.* Prior approvals are usually enforceable, but approval may notbe unreasonably withheld.* Flat prohibitions on transfer are viewed very skeptically bycourts and usually would be struck down as unreasonable.

Question 25

Billy wants to buy in to Bob’s Bakery shop. He is told that he can purchase shares at $5 a share, but under no circumstance can he give those shares to Bob’s nemesis Hank. Billy asks if h can sell shares on to his brother. Bob says, “I dunno. I’ve never met your brother”. What are the issues if this comes to court?

Answer 25

Court would view the prohibition upon selling to Hank as un reasonable, and the reluctance to sell to the brother would probably go through

Question 26

In Deleware, does there need to be notice of a transfer restriction?

Answer 26

Yes. Failure to notify will render the restriction ineffective unless the stockholder has ACTUAL KNOWLAGE of the restriction

Question 27

What is per se reasonableness in Delaware?

Answer 27

That transfer restrictions are presumed to be for some reasonable purpose such as
(1) Maintaining any local, state, federal or foreign tax advantageto the corporation or its stockholders …* (2) Maintaining any statutory or regulatory advantage orcomplying with any statutory or regulatory requirements underapplicable local, state, federal or foreign law.

Question 28

What was the rule from Henry v Phixios Holdings?

Answer 28

For a stockholder to be bound by stock transfer restrictionsthat are not conspicuously noted on the stock certificate(s), theymust:(a) have actual knowledge of the restrictions before buying the stock, or(b) affirmatively vote to approve or agree to the restrictions after theacquisition of the stock

In this case, the stock had no notice on it, the stockholder had neither actual knowledge of it and they hadn’t voted to agree to the restriction after they bought the stock, so they remain a stockholder

Question 29

Walking out of Bob’s Bakery with 5 $5 shares, Billy decides to examine his new stock certificates under a microscope and notices some VERY fine print saying that he has no right to vote on the Bakery’s auditing process. Is this restriction valid?

Answer 29

Probably not. Putting the notice in print that can only be seen under a microscope probably wouldn’t be reasonable and in either case, he had no actual knowledge before buying the stock, and hasn’t voted to affirm the restriction. If it came down to it, Billy could probably exercise a right to vote on Backery audits

Question 30

What are voting trusts? What is the main legal consequence of them?

Answer 30

allow shareholders to transfer theirvoting rights to a trustee, effectively giving temporary control ofthe corporation to the trustee.* Fairly common in closely held organizations as a ways to prevent orfacilitate takeovers, to ensure continuity of management, etc.

Once a trustee is agreed to, the legal title of the shares is transferred to the trustee - the original shareholders get the financial benefits, but the trustee has all the voting power

Question 31

Are voting trusts allowed today?

Answer 31

Yes, but they must be created for a proper purpose

Question 32

What are some proper purposes of a voting trust?

Answer 32

Legitimate Purposes for Voting Trusts(1) to aid in reorganization plans and adjustments with creditors inbankruptcy or financial difficulty;(2) to assist financing, to procure loans, and to protect bondholders andpreferred shareholders;(3) to accomplish some definite plan or policy for the benefit of thecompany and to assure stability and continuity of management for thispurpose;(4) to prevent rival concerns or competitors from gaining control;(5) to apportion representation and protect minority interests by putting theselection of directors in impartial hands; and(6) as a device in connection with mergers, consolidations, or purchases ofa business to assure that predecessors or constituents, though in theminority, may have representation.

Question 33

Bob’s Bakery is under threat of being bought out by Hank. The shareholder’s all enter into a voting trust agreement, designating Bob as the trustee. Is this proper?

Answer 33

Yes because it was to fend off a takeover

Question 34

What are some improper uses for a voting trust?

Answer 34

To maintain minority control of the company for long periods of time. And, to secure employment or other individual benefits form the company

Question 35

What is the big difference between a voting trust and a voting agreement (vote pooling agreement)?

Answer 35

A trust transfers ownership to a trustee while a pooling agreement allows shareholders to maintain full title of their shares

Question 36

What is cumulative voting?

Answer 36

It allows shareholders to cast all of their votes for a single nominee to the board of directors when there are multiple openings on the board

Question 37

In cumulative voting, how many votes does a shareholder get?

Answer 37

The number of shares they have, times the amount of openings on the board. Example: If I had 100 shares to vote and there were 3 directors to bevoted on, I could vote up to 300 shares (100x3) for one candidate.

Question 38

Does Delaware allow for cumulative voting?

Answer 38

Yes, but ONLY if it is within the articles of incoroperation

Question 39

Does the MBCA allow for cumulative voting?

Answer 39

Yes, but only if it is in the articles of incorporation

Question 40

What is a supermajority voting requirement?

Answer 40

A standard to approve major changes, such as amending the charter. Usually sits between 67-90%

Question 41

In Delaware can supermajoirtit requirements be adopted?

Answer 41

Yes, though simple majority. And amending supermajority requirements laid out in the articles require a supermajority

Question 42

Can supermajority requirements be adopted in the MBCA?

Answer 42

Yes, through a simple majority, or if amending a voting requirement in the charter a supermajority is required

Question 43

Can a bylaw override a supermajority requirement?

Answer 43

Yes, if it is expressly stated by the bylaw

Question 44

Can a bylaw outlining only a simple majority requirement ovveridea charter requirement for a supermajority?

Answer 44

No. The articles/charter, can only be amended by a supermajority

Question 45

What is a preemptive right?

Answer 45

A preemptive right is a right of existing shareholders to purchasenewly issued stock before it is offered to others.* They help maintain the shareholder’s relative voting power as against othershareholders* The right is meant to protect current shareholders from dilution in value orcontrol.* They are helpful to protect early investors.

Question 46

How are pre-emptive rights created?

Answer 46

Usually through a provision or prohibition in the Charter. Usually the amount of share available early will be equal to what that shareholder already owns in the company, but this can vary depending on the charter formula

Question 47

What did Kimberlin v Ciena Corporation hold?

Answer 47

Pre-emptive voting rights can be waived

Question 48

What was the rule from Shawe v Elting?

Answer 48

Courts have discretion to appoint a custodian to sell the company

Question 49

What is the problem of oppression of minority shareholders in closed corps?

Answer 49

Because minority shareholders can’t easily sell their stock in a close hold company, they are stuck if they are in the minority

Question 50

What are remedies in Delaware and elsewhere for minority oppression?

Answer 50

Deleware relieso n market forces and blame the minority shareholder for not engaging in a better deal

In Massachusetts courts have imposed a duty of good faith and loyalty upon majority shareholders

Question 51

What are the remedies for infringing upon a minority shareholder rights?

Answer 51

What are the remedies for violating a minority shareholder’srights?1. Dissolution of the company (and liquidation of assets)2. Court-Ordered Buyouts3. Monetary Damages4. Injunctive Relief to stop the oppression

Question 52

What was the holding of Leslie v. Boston Software Collaborative? This was a Massachusetts case

Answer 52

The majority shareholders did not uphold their duties of loyalty and good faith the the minority shareholder because they did not have a legitimate business purpose for their actions - this burden was on the defendants and they did not prove this. instead the majority shareholders could have maintained tier duty by modifying the minority shareholders functions, involving the minority shareholder in more decisions, but unilaterally removing them as an employee/director is too far

Question 53

What are the 2 things the MBCA looks at when determining iid there is minority oppression?

Answer 53

(1) The majority of MBCA states asks whether the majorityshareholders have acted reasonably from the minorityshareholders’ point of view and whether the minority’sreasonable expectations have been met, AND* (2) The minority of MBCA states considers reasonablenessfrom the point of view of the majority.