Control in Closely Held Corporations

a. Ringling Bros. v. Ringling: A group of shareholders may lawfully contract to vote in any manner they determine. Vote pooling agreements, then, are validbut you must be careful about your language. i. Generally, a shareholder may exercise wide liberality of judgment in the matter of voting, and it is not objectionable that his motives may be for personal profit, as long as she violates no duty owed to fellow shareholders. ii. Edith has 2205 votes (315 x 7), Aubrey has 2205, and North has 2590 (370 x 7). If Edith and Aubrey work together, they can elect five of the officers and North would elect two. So Edith and Aubrey make an agreement on how to vote, but Aubrey doesnt vote per the agreement. iii. The agreement was held as valid, but the enforcement mechanism was a problem. Note on Shareholder Agreements, Voting Trusts, Statutory Close Corporations and Involuntary Dissolution: Other Ways to Control the Voting Process: i. Vote Pooling: Provide referee, but give the referee irrevocable proxy (more than in Ringling). This gives us an enforcement mechanism. You keep your right in the stock, but you agree to vote a certain way. Since you can shut out other voters, courts dont like them as much and will only enforce them on their terms. ii. Create Classes of Stock: Must amend articles of incorporation. Understand that if the Board creates new classes of stock, your vote will be diluted. Only works as long as a class member is there to vote. Preferred stock has no voting rights, but might have preferred liquidation rights over common stock. i. E.g., Father = Class A with voting rights. Kids = Class B with no voting rights. Father controls. If he is the only one and he becomes disabled or dies there is a problem. We would need a conservator. ii. S-Corps cannot have different classes of stock; therefore, some go to LLC because there are no limits on classes of stock. iii. Have Specific Board Members Elected by Certain Classes of Stock: Remember, directors are independent, so you cannot control them once they are on the Board; you can only vote them off. Sometimes this is referred to as classified board. i. E.g., You have six directors on a board and two classes of stock, one with four seats on the board and one with two. That way, if youve got a group that wants to maintain control over the company, they can control four seats, and the other class can control two seats. iv. Voting Trust: A voting trust is an agreement establishing a trust, whereby shareholders transfer their legal title to their shares to a trustee who is then authorized to exercise their voting powers. Trustee has fiduciary duty to do what is best on behalf of the beneficial owners, who retain the equity in the stock and continue to receive the dividends from the stock. 10-year limit, usually. Must file something to alert incoming shareholders that there is a voting block in place. Unenforceable if you dont comply with statutory requirements. If you put your stock in a voting trust, then who is the one with the right to inspect the books? Is it the beneficial owner or the trustee? This can be a problem. v. Irrevocable Proxy: Proxy must be coupled with an interest; someone must retain an interest in the stock. Courts are very reluctant to enforce against a stockholder because any vote could change at the last minute. Therefore a proxy vote by default should be revocable. Only transfer your right to vote in a given vote. Close Corp. vs. Closely-Held Corp. i. A closely-held corp. means simply that there are not very many shareholders (35 or less, or only a couple of families. A close corp. is one in which the stock is held in a few hands, or in a few families, and wherein it is not at all, or only rarely, dealt in by buying or selling. ii. A statutory close corp. means that you have agreed that you want to be treated as a close corp. under state statute. iii. The statute allows you to bypass corporate structure and shareholders can run the corporation. iv. States allow them because all that structure is a paperwork formality and this allows the corporation to run as it actually happens. v. If you dont elect this status, you will have to do corporate formalities (which can be a problem with piercing) vi. Unless Huss specifies statutorily close corporation, assume they are closely-held. If statutory close corporation and regular corporation did the same bad thing, the regulated corp. will be in bigger trouble. Galler v. Galler: Shareholders in a closely-held corporation are free to contract regarding the management of the corporation absent the presence of an objecting minority, and threat of public injury. In Galler, there was an agreement to elect each other to the board, which was okay because it was signed by all of the shareholders and no one was objecting to that system. i. A shareholder does not have the right to be an employee. You can contract for rights, but they arent just assumed. Statutory corporate codes are drafted for people to contract away any rights they have; the courts arent going to protect stupid parties.

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If the vote is unanimous or no one is objecting, for closely-held corporations, then the shareholder agreement will be upheld for the appointment of individuals as officers or directors, or dividends, as long as they can make the argument that it is in the best interests of the corporation. iii. You can get rid of your shareholder right to vote (voting trust, irrevocable proxy) iv. The problem is the independent duties as a director with the obligations of duty of care. As long as a director with a duty isnt being told what to do, you can agree who to vote onto the board. Ramos v. Estrada: Voting agreements binding individual shareholders to vote in concurrence with the majority constitute valid contracts. The state wants to protect the contract and the intent of the parties. i. The court held Estrada to the shareholder voting agreement (not a proxy situation). Even though the price was low, it was still a valid agreement. Mrs. Estrada switched sides because she was told that she would be secretary. As her attorney, tell her she is out of luck and to honor the agreement. ii. To have voting agreements in larger corporations is unrealistic, but still possible, if a majority of the shareholders sign the agreement. You cannot agree how you will vote when you are a director, but if the group who voted you on doesnt like your decision, they will vote you out of office. But in pooling agreement, make sure it sates that you are only controlling the vote, as opposed to the directors decision. Why do courts allow this control over closely-held companies? i. How do you get money out of a closely-held company, usually? Be an employee (get a salary), get dividends, and selling stock. ii. There is not a wide market for closely-held company stock. iii. Part of the reason for protecting minority shareholders is that there is no wide market for these shares. In public companies, if a minority is unhappy with his shares, he can sell it because theres a market for it. iv. In an S-Corp, its a closely-held company where you get the profits after the business pays the taxes. S-Corps have pass through taxation. The profits go into your individual name, and you pay taxes on them as an individual. v. In a C-Corp, you have people getting salaries, which is deductible to the corporation, but the money is doubletaxed (once at the corporate level and again at the individual salary level).

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