22 CH 6 Corp History (1)

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BUSINESS ORGANIZATIONS—Chapter 6 Corporate History Historical Development of the Corporation 1. Origins of the Corporate Form 2. Corporate Personhood and Constitutional Protections 3. The Modern Corporation and the Close Corporation Historical Development of the Corporation 1. O RIGINS OF THE C ORPORATE F ORM It seems beyond doubt that the vast wealth and power represented by United States business is inextricably linked to and concentrated in the corporate form. Despite the growing number of new forms of business organization, the corporation remains the dominant legal form for doing business, at least in terms of the economic impact of such ventures. Certainly it is the overwhelming choice of publicly held enterprises. American corporations always have been creatures of statute, although the nature of the statutes has changed dramatically over time. The first colonial corporations obtained corporate charters directly from the King of England. After the establishment of colonial assemblies, persons seeking a corporate charter looked to the assemblies within the colony, which purported to act on behalf of the King. After independence, the new state legislatures continued and expanded upon the work of the colonial assemblies, granting corporate charter upon the petition of persons deemed worth by the representatives. Today, every state has a general business corporation statute which governs and conditions access to the corporate form for for-profit business enterprises. These state statutes set out the basic legal rules that apply to corporations whose incorporators have elected to file appropriate organizational documentation in that particular state. While federal laws such as our securities and tax statutes and regulations have long played and will doubtless continue to play a critical role in regulating corporate conduct, the foundation of American corporate law remains in the hands of the states. It would, however, be a mistake to think of modern corporate statutes as strictly following the early English or colonial models. During America’s years as a British colony, there were no general incorporation statutes. At this time, corporations were relatively rare. In order to obtain access to the corporate form, sponsors had to petition for a special corporate charter. In essence, this entailed passage of a special, private bill, creating a corporation and outlining the terms and conditions under which it was to operate. In some cases, the special charter which was created also included special privileges such as monopoly power or eminent domain rights. 1

Because recognition of corporations was essentially a political process which occurred at the state level, it is not surprising that during the late eighteenth and early nineteenth centuries, most corporations either fulfilled particular religious purposes, met public responsibilities of the states (such as projects to form hospitals or banks) or sponsored transportation projects (like toll roads and bridges) essential to intra- and interstate commerce. Note that early corporate statutes were significantly different from modern corporate codes. In the early nineteenth century corporations likely: 1) Did NOT give their owners or managers limited liability. 2) Had specific limits on corporate purposes that had to be spelled out in the charter 3) Had substantial (for the times) minimum capital requirements 4) Often had very limited duration (for example, 20 years was the maximum duration for New York corporations) The 1784 general incorporation statute in New York allowed all religious congregations to incorporate, as did corporate statutes in other states at the time. Under these early statutes, such corporations were governed by a board of trustees, generally composed of six to nine men, but day to day governance was under the auspices of a board of vestry, deacons, or elders (depending on the denomination) chosen by the respective congregations. Trustees had the right to receive bequests and legacies, and hold property in the name of the corporation, although mortmain clauses typically limited the amount of land that a congregation could own. These rules kept the influence of these religious organizations in check, while simultaneously making sure that day to day control was vested in the local members of the congregation. The earliest legal distinction between classes of American corporations was not between business and benevolent associations, but between public (or municipal) corporations and those that were classed as being private (essentially all other corporations). The statutes that were probably originally intended to facilitate benevolent associations did become useful for entrepreneurs, who had previously been limited by the nature of sole proprietorships and partnerships. Nonetheless, the earliest business corporations tended to be corporations organized for the purpose of making improvements, financial institutions, and a few manufacturing concerns. Prior to 1800, two-thirds of American business charters were for turnpikes, and banks and insurance companies accounted for another 20% of all incorporations. Manufacturing corporations accounted for less than 4% of all incorporations at that time. It wasn’t until about 1795 that business charters began to be granted with any regularity. Systematic support for such endeavors can only be traced back to 1805. But even then it would be a mistake to think of those corporations as being the equivalent of our modern public corporations. New York’s general incorporation statute of 1811, which was in effect for a five year period, set the maximum life of a corporation at 20 years, allowed no more than nine trustees, and established a maximum capitalization of $100,000. Even though there were business and entrepreneurial aspects to these corporations, before about 1820 “most incorporated businesses 2

could be classed as public service franchises because they required a grant of one or more special powers from the state in order to perform a service closely linked to public welfare.” States gradually moved to develop statutes that more closely approximate modern models, eliminating such things as the relatively short duration of corporations and the limits on maximum capitalization. On the other hand, until 1855 corporate statutes continued to talk about director liability for failure to comply with regulations, and in New York the corporation’s maximum life-span was still fixed, albeit at a maximum of 80 years. In addition, personal shareholder liability continued to be the prevalent model, making it critical that shareholders stayed involved as owners of their business enterprises. Moreover, the general management model called for one vote per shareholder, not one vote per share or one vote per total investment, leading to much greater say for smaller investors. Remember also that at this time there were no national capital markets in which one could readily invest in such enterprises through the purchase and sale of securities. Corporate promoters had to solicit from local investors, and the number of such investors was necessarily limited. Moreover, meetings at which directors were selected actually entailed participation of a substantial number of the owners, most of whom were local anyway. And, “[i]n a world of still relatively concentrated ownerships, shareholders could control managers .... ” By 1875, the vast majority of American states had adopted general incorporation laws. This fact, combined with the waning political power of the federal government at the end of the Reconstruction Era, firmly cemented the primary power over the corporate form in the hands of the states. By the early 1900's, when federal lawmakers first sought to exert broad authority over the corporate form, the power of the states was too entrenched. For a time, most states operated under a regime where the general corporate laws co-existed uneasily with the possibility of special charters, which were generally only prohibited with amendments to the state constitutional framework. Until such constitutional amendments were made, potential corporate sponsors could choose between filing under the general law or seeking a special charter from the legislature. This is often referred to by corporate law historians as the dual incorporation or dual period, and in many cases extended for decades. Three nineteenth century developments that have most significantly impacted the development of the modern corporation were: 1) the change from incorporation only by special legislative charters to incorporation pursuant to general corporation statutes, 2) the change from restrictive to more business-focused, enabling corporate statutes, and 3) the change from unlimited liability to limited liability for shareholders, which has permitted the development of modern capitalization of the corporate form. In modern business corporations (as distinguished from non-profit organizations, which may not be run in the same way), the board of directors (composed of relatively few individuals) 3

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coordinates and oversees all business operations, although in practice (depending on the size of the organization) day to day control will necessarily be exercised by other corporate officials, who are appointed by and act under the authority of the directors. Shareholders generally do not have an active role in the management of public corporations. Despite the fact that shareholders technically “own” publicly-held corporations, it is widely acknowledged that their primary power if they do not like how “their” corporation is being managed, is to “vote with their feet,” by selling their shares and buying into another business venture. For the most part, the shareholders have very little power in controlling, overseeing, or disciplining the managers of their corporations. They certainly have no say over day to day decisions about the business. This model, which very clearly distinguishes corporate management from shareholder control, has become the generally accepted way of understanding corporate governance in modern, publicly owned business corporations in the United States. Although it was developments throughout the 19th century that lead to the proliferation of corporations as a popular form of enterprise for businesses, modern developments from around the turn of the 20th century are responsible for the distinct separation of control from ownership in corporations, including such things as “allowance of holding companies, the demise of the doctrines of ultra vires and quo warranto, the adoption of general incorporation laws and the business judgment rule, the watering down of shareholder inspection rights, and the diminishment of shareholder voting power.” Although it is possible to quibble about whether managerial power in the modern corporation is more vested in the board of directors as a whole or the corporate CEO, it is clear that under either view, power does not reside in the hands of the shareholders, in stark contrast to the model that prevailed in earlier times. In essence, in the modern, publicly-owned business corporation, directors have the legal authority to make all management decisions, including those relating to the day to day operations of the business as well as more extraordinary decisions such as whether to proceed with or allow disposition of or merger of the firm. They also have the legal power under state law to set their own compensation, and to help arrange for their own replacements. Shareholders, although theoretically the “owners” of the corporation, do not have the ability to initiate most corporate actions, and cannot substantially interfere with board discretion. The extent of directors’ power and authority is generally not subject to contractual restructuring within the confines of the corporate operational documents, although the board is theoretically restrained by statutorily and judicially imposed fiduciary obligations as tempered by the business judgement rule. Shareholder agreements or other arrangements that might seek to restrict the power of the board to act are generally limited to closely held corporations. This reality has particular significance for citizens today because modern publicly-owned, business corporations have amassed incredible wealth and power. It has been said that “[c]orporations are more powerful than any institution other than government, and in many cases, more powerful than governments.” If one treats financial wealth as the equivalent of power, it is hard to dispute this assertion. According to the IMF, in 2019 there were about 100 4

countries in the world with gross domestic product of less than $25 billion. By way of comparison, in 2009 there were121 American corporations reporting annual revenues in excess of $20 billion, and 65 of those corporations had more than $50 billion in revenues. Twenty-nine American companies had annual revenues in excess of $100 billion. Given this concentration of wealth in the hands of corporate America, it is perhaps not surprising that corporations and corporate policies have dominated the economic news in recent years. Unfortunately, the news has not been particularly positive. America started the last decade with widely publicized and spectacular corporate collapses, and financial news in the past few years has focused on the depth of the recession triggered by decisions made by this nation’s corporate financial institutions. All of these problems can be traced to questionable decisions and practices that existing corporate governance structures either permitted or facilitated, and perhaps, the “soulless” nature of the modern corporation. While few take the position that every director or manager in public corporations is corrupt or lacking in basic ethics, corporations have repeatedly adopted misleading financial reporting and corporate accounting practices, routinely approved offensively generous executive compensation packages, consistently engaged in excessive risk taking, and all too frequently have adopted policies that can most accurately be characterized as “immoral.” Such policies and decisions have resulted in growing concerns about how modern governance structures produce corporate decisions that ethical individuals would not generally countenance. Nonetheless, at the same time that concerns about corporate governance structures and resulting decision making processes in public corporations are gaining momentum, the United States Supreme Court has slowly expanded the constitutional protections afforded corporate “persons.” 2. C ORPORATE P ERSONHOOD AND C ONSTITUTIONAL P ROTECTIONS Corporations have always had certainly legal rights, most notably the right to own property and enter into binding contracts in their own names. Such legal powers were the original reason why such entities came into existence. These rights were originally quite limited, but over the past 200 years, Supreme Court jurisprudence has gradually granted corporations more and more of the constitutional rights of “persons.” Carl J. Mayer, Personalizing the Impersonal: Corporations and the Bill of Rights, 41 H ASTINGS L. J. 577, 664-667 (1990), contains an excellent summary of these developments. For example, in the early nineteenth century, Trustees of Dartmouth College v. Woodward, 17 U.S. (4 Wheat) 518 (1819), strengthened the autonomous and enduring life of corporations by recognizing their right under the Contracts Clause of Article I to unalterable terms of incorporation. A series of 19th century cases strengthened corporate access to federal courts through rulings that counted corporations as citizens of the states in which they were incorporated for jurisdictional purposes. E.g., Bank of United States v. Deveaux, 9 U.S. (5 Cranch) 61 (1809); Louisville, Cincinnati and Charleston R. Co. v. Letson, 43 U.S. (2 How) 497 (1844); Marshall v. Baltimore and Ohio R. Co., 57 U.S. (16 How) 314 (1853). 5

As the 20th century approached, in Santa Clara County v. Southern Pacific Railroad Co., 118 U.S. 394 (1886), the Supreme Court recognized corporate equal protection rights under the Fourteenth Amendment. It also recognized corporate due process rights under the Fourteenth Amendment in Minneapolis and St. L. Ry. Co. v. Beckwith, 129 U.S. 26 (1889), and similar rights under the Fifth Amendment in Noble v. Union River Logging R. Co., 147 U.S. 165 (1893). In the twentieth century, the Court recognized corporate access to a broad array of Bill of Rights protections, beginning with Hale v. Henkel, 201 U.S. 43 (1906), which granted corporations protection from unreasonable searches, and culminating with a series of cases recognizing First Amendment speech protections. See First Natl Bank of Boston v. Bellotti, 435 U.S. 765 (1978); Central Hudson Gas & Elec. Corp. v. Public Service Comm'n, 447 U.S. 57 (1980); and Pacific Gas & Elec. Co. v. Public Utilities Comm'n, 475 U.S. 1 (1986). The recent case talked about in the excerpt from one of my articles, Citizens United v. Federal Election Commission, 558 U.S. 310 (2010), further strengthens these corporate free speech rights. This jurisprudence appears to embody two separate notions or theories of corporate rights and existence. In some contexts, and especially in the early Nineteenth century, the Supreme Court treated the corporation essentially as a “fictional entity.” In the last century or so, the Court’s jurisprudence appears to have developed along the lines of treating the corporation as a “real” entity. The active scholarly attention paid to the “nexus of contracts” theory has not gone unremarked, but it has clearly not been as influential in the development of case law applicable to corporations. The fictional entity theory appears in early Nineteenth century Supreme Court decisions. It was at this juncture that Chief Justice Marshall noted "[a] corporation is an artificial being, invisible, intangible, and existing only in contemplation of law. Being the mere creature of law, it possesses only those properties which the charter of its creation confers upon it, either expressly, or as incidental to its very existence." Trustees of Dartmouth, 17 U.S. at 636. This theory was apparently most often invoked to justify limiting the rights of corporations, and on occasion continues to be called upon to support this approach. For example, then-Justice Rehnquist invoked this theory in his dissent from Bellotti, arguing that corporations have no intrinsic right to political expression. Bellotti, 435 U.S. at 822-28 (Rehnquist, dissenting). Although the fictional entity approach does support substantial limits on the constitutional rights of corporations, it did encompass certain basic rights. It is, however, quite clear that the Supreme Court has not been content to limit corporations to the property rights most appropriate to a purely fictional existence. The growing significance of the corporation as a critical factor in the national economy led the Court, in the last two decades of the Nineteenth century, to decide a trio of railroad company cases in a manner which began to treat the corporation as “real” rather than purely “fictional” 6

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entities. These cases gave corporations the first rights which had traditionally been limited to “real entities,” namely equal protection under the Fourteenth Amendment and Due Process under the Fourteenth and Fifth Amendments. See Santa Clara County, 118 U.S. 394 (1886); Beckwith, 129 U.S. 26 (1889); and Noble, 147 U.S. 165 (1893). These rights had been treated as essential constitutional protections for individuals, and the Court essentially acknowledged corporate personhood as a reality that extended beyond the limits of state charters or contracts in granting them such rights as well. In 2010, the Court overturned some of its own precedents, and struck down various federal limits on corporate participation in the American political process. That case was Citizens United v. Federal Election Commission, 558 U.S. 310 (U.S. 2010), overruling Austin v. Michigan Chamber of Commerce, 494 U.S. 652 (1992) and McConnell v. Federal Election Com’n, 540 U.S. 93 (2003). The impact of corporate participation in the political process is being felt, with more money being spent on elections than ever before, often with less attribution to the sources of the funds being expended. Most recently, and perhaps most controversially, the Supreme Court held that corporations possessed free exercise rights under the First Amendment. On June 30, 2014, a sharply divided Supreme Court held that portions of the regulations enacted to implement the Patient Protection and Affordable Care Act of 2010 (ACA) (often called "Obamacare" in the popular press) were invalid because they violated the Religious Freedom Restoration Act of 1993 (RFRA) by imposing "substantial burdens [upon] the exercise of religion" without being the "least restrictive means of serving a compelling government interest." Burwell v. Hobby Lobby, 573 U.S. 682 (2014). The Hobby Lobby opinion stemmed from a lawsuit challenging regulations promulgated by the U.S. Department of Health and Human Services (HHS), which would have required for-profit corporations to offer employees health insurance coverage including certain contraceptive methods that the plaintiffs claimed to be abortifacients objectionable on religious grounds. The challenge was brought by various individual shareholders of Conestoga Wood Specialities (a closely held Pennsylvania corporation), Hobby Lobby (a closely held Oklahoma corporation), and Mardel (also a closely held Oklahoma corporation), and was also brought in the name of the corporations, all of which were organized for profit or business purposes. The Supreme Court split 5-3 in holding that the corporations in question were indeed protected by the Free Exercise clause. Justice Alito, writing for the majority in Hobby Lobby, framed the principal issue in terms of whether the right to freely exercise religious choice disappears because of the decision to operate through the vehicle of a for-profit corporation. He pointed out that HHS had conceded that nonprofit corporations were protected by RFRA, and then noted (as did the dissent) that protecting the religious autonomy of such nonprofit corporations "often furthers individual religious freedom." It was a logical next step to conclude that in the case before the Court, the religious liberties of the shareholders of the for-profit corporations should have been similarly protected by recognizing that the corporations should be given these constitutional protections. 7

Twentieth Century jurisprudence continues to illustrate the tension between the treatment of corporations as artificial versus real “persons.” I expect this tension to continue during your professional careers. 8

3 T HE M ODERN C ORPORATION AND THE C LOSE C ORPORATION Let us put the history and constitutional law lesson aside for a moment and focus a little more specifically on the structure of modern corporate statutes and modern corporations. In most cases, a business corporation is formed when a document is filed with a designated state official. There is no political review of the filed document and in fact, in most cases there is very little review at all. The review that does take place mostly relates to compliance with unambiguous statutory requirements, and is performed by lower-level functionaries in the appropriate administrative office (which in most states is the Secretary of State). For example, articles will not be filed if they include a name which is confusingly similar to another business in the state. Articles must comply with a checklist of requirements such as being filed in duplicate, with a filing fee, with a name that clearly identifies the business as a corporation. Typically, only the English language may be used, and authorized shares of stock must be clearly described. The business must be formed for a lawful purpose. Pretty much, those requirements apply to all corporations. The same general corporate statute traditionally applied to all incorporations in a given state, regardless of the purpose of the corporation (unless it was a non-for-profit enterprise, in which case special not-for-profit statutes generally came into play, or if it was a corporation which was organized by licensed professionals for the purpose of performing professional services, in which case professional corporation or professional association statutes might have applied). In the case of business corporations, the same statute has applied and generally continues to apply to both “C” and “S” corporations (with the letter signifying the applicable chapter of the Internal Revenue Code that will determine the federal income tax rules applicable to the particular corporation, and having nothing to do with any choice under the state corporation statute). The same state business corporation statute has also applied regardless of the level or source of funding for the business; regardless of the number or nature of investors or the number or classes of shares authorized for issuance; regardless of how broadly the corporation will do business; and regardless of whether the shares are to be closely held or publicly traded. A single- shareholder corporation is often regulated, at the statutory level, by the same mandatory and same default rules as will apply to the largest, publicly owned corporation. It has been, and largely continues to be, a one-size-fits-all kind of statute. The reality is that it may make little sense to have both huge public corporations (where stock can be easily sold) and small, closely held corporations (where it is difficult to resell shares) subject to exactly the same rules concerning record keeping responsibilities, operational formalities and structures, and rights and obligations of directors and shareholders. As a result, a growing number of states have adopted special provisions applicable only to “close corporations.” A corporation which meets certain specified requirements (almost always a limited number of shareholders) may elect to be subject to the special statutory provisions, which are thought to be more appropriate for a business which is closely held. Most states simply have one or two statutory provisions in their general business corporation statute that may be elected 9

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by these close corporations. A handful of states have experimented with independent “close corporation statutes” that create a different set of operational rules for corporations electing to organize under those provisions, thus becoming “statutory close corporations.” Note the difference between a close corporation or closely held corporation (terms which mean the same thing), and a statutory close corporation (which is a much rarer and somewhat different type of organization than a traditional corporation). A corporation is said to be a “close corporation” or “closely held corporation” as a matter of common law when the following characteristics are present: (1) a relatively small number of shareholders; (2) there is no ready market for shares in the corporation (i.e., the shares are not traded publicly); and (3) some shareholders participate directly and actively in corporate management. See, e.g., Donahue v. Rodd Electrotype Co., 328 N.E.2d 505 (Mass. 1975), which is excerpted in more detail later in these materials. There are lots and lots of closely held corporations. Any corporation which is owned entirely by a single family or exclusively by a group of friends is likely to be a close corporation. In fact, any corporation with fewer than 25 owners, or maybe fewer than 50, or even more, can be a close corporation. It is really only when you begin to see a public market for the shares develop that there is no longer a possibility of treating that corporation as being closely held This does not mean that all of those corporations will be “statutory close corporations.” In order to become a statutory close corporation, there must be a special statute in the applicable jurisdiction. Most states do not have this option. Arkansas does not. Delaware does. As of early 2020, there were 16 states (plus the District of Columbia) with separate close corporation acts. That means 34 states did not have one on the books, and there was no trend suggesting that more states were considering them. The second thing is that the persons organizing the business must elect to have that special statute apply. Thus, when the business is formed, it will reference the close corporation statute, and say that the articles are being used to form a corporation under that statute rather than the general corporation statute of the state. Occasionally, an existing corporation will convert to become a statutory corporation, by filing an amendment to the articles electing such status. to such a form of business must be elected, usually by including very precise language to that effect in its articles. Invariably, in order to elect to become a statutory close corporation, the business must be closely held (most of such statutes limit the number of shareholders, often to fewer than 50, but some statutes restrict the special close corporation provisions to businesses with fewer than 35 owners.) There must also be a special election to be subject to different rules. Because there are far fewer cases dealing with statutory close corporations, there is more uncertainty associated with them. In addition, not all states have them, and there is at least some concern that the rules which may be authorized in one jurisdiction might not be recognized in another state if the business operates in multiple jurisdictions. For these and other reasons, the reality is that while there are a great many close corporations, there are very few statutory close corporations. 10

Regardless of whether a business is a publicly held corporation, a closely held corporation, or a statutory close corporation, it is still a legal person. (Former Presidential candidate Mitt Romney was right!) But let us consider what that means, because surely it does not mean that a corporation is identical to individuals. This notion merely means that a corporation has certain legal rights, and some of those are constitutionally protected. As we discusss these issues, remember that this is the introductory course in Business Organizations. Most of you will run across closely held businesses including closely held corporations throughout your practice, regardless of whether you become a litigator, a transactional attorney, a generalist, or even a criminal law specialist. Fewer of you will have prolonged responsibility for working with or against public corporations, and so the focus of this course is the closely held corporation. Recall that “close corporation,” and “closely held corporation” both mean the same thing, which is not necessarily the same as a “statutory close corporation.” These general materials refer to the general closely held business rather than corporations that are subject to special statutory provisions. As mentioned earlier, and will be discussed in more detail in a few pages, a close corporation is a business organization typified by a relatively small number of stockholders, the absence of a ready market for the corporation's stock, often by substantial participation of at least some shareholders in the management of the corporation, and typically a shareholder group located in relatively close geographical proximity. In the traditional public corporation, most shareholders are detached, passive investors who neither manage nor work for the corporation. In a close corporation, however, shareholders often expect employment and a meaningful role in the decision-making process, either in addition to or in lieu of any other return on any investment. In addition, shareholders in a close corporation are often linked by family or other personal relationships. Closely held corporations present unique problems in comparison to publicly held corporations. For example, in closely held corporations, there are more intimate relationships, a lack of marketability of shares, and greater reliance placed on the corporation by its stockholders than in publicly held corporations. Closely held, smaller businesses are also more likely to operate without the advice of sophisticated business counsel, and often without any professional managers. It is often difficult to determine how to deal with the rights of minority shareholders while respecting the essential nature of the corporation and respecting the rights of the majority shareholders. Conventional rules applicable to corporations rely upon the concept of majority rule and place all day-to-day management authority in the hands of directors. This can create very serious problems for minority shareholders in a close corporation. Traditionally, shareholders have virtually no corporate power over day-to-day decision making. In a close corporation, the board is ordinarily elected and controlled by the shareholder or shareholders holding a majority of the voting power. In many cases, the majority shareholders will elect themselves as the directors. 11

The minority may be subject to whims of the majority, and will have little recourse if they feel that they are being treated unfairly. Through their control of or positions on the board, majority shareholders often have the power to act in ways that are harmful to the minority shareholder's interests. Such actions are sometimes referred to in the cases and literature as "freeze-out" or "squeeze-out" techniques that operate to "oppress" the minority shareholders. Minority shareholders are said to be frozen out when the majority manages to prevent them from sharing in the economic gains of the corporation. A minority shareholder may find that his or her employment has been terminated, and the majority may refuse to declare dividends, instead diverting corporate income to the majority shareholders through the payment of high salaries or bonuses to majority shareholder-employees. When dividends are not paid, a minority shareholder who has been fired from employment and removed from the board of directors is effectively denied any return on his or her investment as well as any meaningful input into the management of the business. If these tactics are accompanied by efforts to force the minority shareholders to accept unreasonably low prices for their shares, it is a squeeze out. Minority shareholders who find themselves in this position are harmed regardless of whether they hold or sell their shares. In public corporations, minority shareholders can escape this type of action through the simple expedient of selling their shares on the market. By definition, however, there is no ready market for the stock in a close corporation. Thus, close corporation shareholders can be oppressed through the unscrupulous conduct of the majority. Expert commentators have suggested that more than ninety percent of American corporations are in fact closely held. (Multiple sources reported this following the Supreme Court’s decision in Burwell v. Hobby Lobby cite the 90% figure. The original source appears to be F. H ODGE O' NEAL & R OBERT B. T HOMPSON , O' NEAL ' S C LOSE C ORPORATIONS § 1.19 at 108 (3d ed. 1992). This treatise contains an excellent analysis of close corporations, but is geared more towards the practitioner rather than the student reader, and is priced accordingly.) Nonetheless, the overwhelming majority of these close corporations are organized under business corporation statutes that were fashioned with the needs and interests of a dissimilar entity, the public corporation, in mind. As a result, many of the provisions of such statutes are poorly suited for the needs of the close corporation For example, it is the rules and presumptions of these statutes which would allow oppression of the minority through freeze out and squeeze out tactics. According to the O’Neal & Thompson treatise, the following states along with the District of Columbia have enacted separate close corporation statutes: Alabama, Arizona, Delaware, Georgia, Illinois, Kansas, Maryland, Missouri, Montana, Nevada, Pennsylvania, South Carolina, Texas, Vermont, Wisconsin, and Wyoming. In 1975, Florida -- which previously had a close corporation statute -- repealed the close corporation legislation because it was not being utilized and instead was causing confusion. California, Maine, Ohio, and Rhode Island have multipurpose provisions requiring an election to close corporation status but do not have a separate corporate statute applicable to such businesses. Instead, upon making this election in the 12

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articles, a few default rules are modified, while most of the same provisions will continue to govern the “close corporation.” Other states, such as North Carolina and New York, have a few scattered provisions in their general laws, which may apply under different circumstances, but which do not require a special election to be a “close corporation.” Arkansas is one of the states which has a single, integrated corporate statute to govern all corporations, regardless of whether they are closely held or publicly owned. We do, however, have one provision in our statutes which allows, but does not require, close corporations to make special elections concerning the existence or power of a board of directors. Note that Arkansas does NOT require corporations to elect to become a “close corporation,” and the ability to change the default rules for qualifying corporations is limited. The relevant statutory provision reads as follows (emphasis added): 4-27-801 Requirement for and duties of board of directors. (a) Except as provided in subsection (c) of this section, each corporation must have a board of directors. (b) 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, subject to any limitation set forth in the articles of incorporation. (c) A corporation having fifty (50) or fewer shareholders may dispense with or limit the authority of a board of directors by describing in its articles of incorporation who will perform some or all of the duties of a board of directors. ***************************************************************************** In essence, this section allows the incorporators of a closely held corporation (i.e., one with 50 or fewer shareholders) to change the power structure of the corporation, even to the point of dispensing with the board of directors. Recent conversations with the Arkansas Secretary of State, however, reveal that this appears to be a little used provision, and in fact representatives from the Secretary of State’s office can recall no instances of an Arkansas corporation completely dispensing with a board of directors. (There are a number of reasons why this may be the case–it may be more difficult to deal with third parties such as banks and other creditors who expect to see resolutions signed by directors; various case law has developed insulated directors from mistaken but good faith judgements that has not been paralleled by similar protections for shareholders; and, put simply, no one wants to be the guinea pig to see if the provision works as intended.) There are, however, corporations that include in their articles special provisions reserving certain rights to the shareholders, particularly things like the issuance of new shares, or the election of corporate officers. Because few corporations use close corporation statutes, or elect to be governed by anything other than the rules generally applicable to all for-profit corporations, we are faced with having to turn to the common law to help us resolve the special problems of the close corporation. The 13

following case considers how courts might approach the problems caused when minority shareholders in a closely held business are being treated unfairly by those in control. NOTE–the case is included because it is one of the most often cited opinions explaining the concept of close corporations and evaluating why special laws may need to apply in order to reasonably protect minority shareholders. The opinion is not a complete or accurate statement of the current duties owed by control shareholders, but it is good law for the rule that shareholders who exercise control in a closely held corporation DO owe some duties. The parameters of those duties will be considered later in the course. ****************************************************************************** Questions about Rodd Electrotype : 1. What do we know about the corporation in this case and its stockholders? 2. Is this treated as a close corporation? Under what test? 3. Why does it matter if this is a close corporation? 4. What did Rodd’s sons do that led to this lawsuit? 5. Was what they did fair in your opinion? Why would it matter that this was a close corporation? Would the actions be any “fairer” if the corporation’s stock was publicly traded and there were hundreds or thousands of minority shareholders out there? Donahue v. Rodd Electrotype Co , 328 N.E.2d 505 (Mass. 1975) The plaintiff, Euphemia Donahue, a minority stockholder in the Rodd Electrotype Company of New England, Inc. (Rodd Electrotype), a Massachusetts corporation, brings this suit against the directors of Rodd Electrotype, Charles H. Rodd, Frederick I. Rodd and Mr. Harold E. Magnuson, against Harry C. Rodd, a former director, officer, and controlling stockholder of Rodd Electrotype and against Rodd Electrotype (hereinafter called defendants). The plaintiff seeks to rescind Rodd Electrotype's purchase of Harry Rodd's shares in Rodd Electrotype …. The plaintiff alleges that the defendants caused the corporation to purchase the shares in violation of their fiduciary duty to her, a minority stockholder of Rodd Electrotype. The trial judge, after hearing oral testimony, dismissed the plaintiff's bill on the merits. He found that the purchase was without prejudice to the plaintiff and implicitly found that the transaction had been carried out in good faith and with inherent fairness. The Appeals Court affirmed with costs .... The case is before us on the plaintiff's application for further appellate review .... The evidence may be summarized as follows: In 1935, the defendant, Harry C. Rodd, began his employment with Rodd Electrotype, then styled the Royal Electrotype Company of New England, Inc. (Royal of New England). … Mr. Rodd's advancement within the company was rapid. The following year he was elected a director, and, in 1946, he succeeded to the position of general manager and treasurer. In 1936, the plaintiff's husband, Joseph Donahue (now deceased), was hired …. His duties were confined to operational matters within the plant. Although he ultimately achieved the positions of 14

plant superintendent (1946) and corporate vice president (1955), Donahue never participated in the 'management' aspect of the business. …. [Harry Rodd came to own 200 shares of the company, while Joseph Donahue owned the remaining 50 shares.] Subsequent events reflected Harry Rodd's dominant influence. …. In 1962, Charles H. Rodd, Harry Rodd's son (a defendant here), who had long been a company employee working in the plant, became corporate vice president. In 1963, he joined his father on the board of directors. In 1964, another son, Frederick I. Rodd (also a defendant), replaced Joseph Donahue as plant superintendent. By 1965, Harry Rodd had evidently decided to reduce his participation in corporate management. That year Charles Rodd succeeded him as president and general manager of Rodd Electrotype. From 1959 to 1967, Harry Rodd pursued what may fairly be termed a gift program by which he distributed the majority of his shares equally among his two sons and his daughter, Phyllis E. Mason. Each child received thirty-nine shares. Two shares were returned to the corporate treasury in 1966. We come now to the events of 1970 which form the grounds for the plaintiff's complaint. In May of 1970, Harry Rodd was seventy-seven years old. The record indicates that for some time he had not enjoyed the best of health and that he had undergone a number of operations. His sons wished him to retire. Mr. Rodd was not averse to this suggestion. However, he insisted that some financial arrangements be made with respect to his remaining eighty-one shares of stock. A number of conferences ensued. Harry Rodd and Charles Rodd (representing the company) negotiated terms of purchase for forty-five shares which, Charles Rodd testified, would reflect the book value and liquidating value of the shares. A special board meeting convened on July 13, 1970. As the first order of business, Harry Rodd resigned his directorship of Rodd Electrotype. The remaining incumbent directors, Charles Rodd and Mr. Harold E. Magnuson (clerk of the company and a defendant and defense attorney in the instant suit), elected Frederick Rodd to replace his father. The three directors then authorized Rodd Electrotype's president (Charles Rodd) to execute an agreement between Harry Rodd and the company in which the company would purchase forty- five shares for $800 a share ($36,000). The stock purchase agreement was formalized between the parties on July 13, 1970. Two days later, a sale pursuant to the July 13 agreement was consummated. At approximately the same time, Harry Rodd resigned his last corporate office, that of treasurer. Harry Rodd completed divestiture of his Rodd Electrotype stock in the following year. As was true of his previous gifts, his later divestments gave equal representation to his children. Two shares were sold to each child on July 15, 1970, for $800 a share. Each was given ten shares in 15

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March, 1971. Thus, in March, 1971, the shareholdings in Rodd Electrotype were apportioned as follows: Charles Rodd, Frederick Rodd and Phyllis Mason each held fifty-one shares; the Donahues held fifty shares. A special meeting of the stockholders of the company was held on March 30, 1971. At the meeting, Charles Rodd, company president and general manager, reported the tenative results of an audit conducted by the company auditors and reported generally on the company events of the year. For the first time, the Donahues learned that the corporation had purchased Harry Rodd's shares. According to the minutes of the meeting, following Charles Rodd's report, the Donahues raised questions about the purchase. They then voted against a resolution, ultimately adopted by the remaining stockholders, to approve Charles Rodd's report. Although the minutes of the meeting show that the stockholders unanimously voted to accept a second resolution ratifying all acts of the company president (he executed the stock purchase agreement) in the preceding year, the trial judge found, and there was evidence to support his finding, 1 that the Donahues did not ratify the purchase of Harry Rodd's shares. A few weeks after the meeting, the Donahues, acting through their attorney, offered their shares to the corporation on the same terms given to Harry Rodd. Mr. Harold E. Magnuson replied by letter that the corporation would not purchase the shares and was not in a financial position to do so. This suit followed. In her argument before this court, the plaintiff has characterized the corporate purchase of Harry Rodd's shares as an unlawful distribution of corporate assets to controlling stockholders. She urges that the distribution constitutes a breach of the fiduciary duty owed by the Rodds, as controlling stockholders, to her, a minority stockholder in the enterprise, because the Rodds failed to accord her an equal opportunity to sell her shares to the corporation. The defendants reply that the stock purchase was within the powers of the corporation and met the requirements of good faith and inherent fairness imposed on a fiduciary in his dealings with the corporation. They assert that there is no right to equal opportunity in corporate stock purchases for the corporate treasury. For the reasons hereinafter noted, we agree with the plaintiff and reverse the decree of the Superior Court. However, we limit the applicability of our holding to 'close corporations,' as hereinafter defined. Whether the holding should apply to other corporations is left for decision in another case, on a proper record. A. Close Corporations. In previous opinions, we have alluded to the distinctive nature of the close corporation... but have never defined precisely what is meant by a close corporation. There is no single, generally accepted definition. Some commentators emphasize an 'integration of ownership and management'... in which the stockholders occupy most management positions .... Others focus on the number of stockholders and the nature of the market for the stock. In this view, close 1 [fn renumbered] Dr. Robert Donahue's testimony at trial contradicted the minutes of the meeting. He testified that no vote to ratify the acts of the company president had taken place at the meeting. 16

corporations have few stockholders; there is little market for corporate stock. ... We deem a close corporation to the typified by: (1) a small number of stockholders; (2) no ready market for the corporate stock; and (3) substantial majority stockholder participation in the management, direction and operations of the corporation. As thus defined, the close corporation bears striking resemblance to a partnership. Commentators and courts have noted that the close corporation is often little more than an 'incorporated' or 'chartered' partnership. Ripin v. United States Woven Label Co., 98 N.E. 855, 856 (NY 1912) ('little more (though not quite the same as) than chartered partnerships') .... The stockholders 'clothe' their partnership 'with the benefits peculiar to a corporation, limited liability, perpetuity and the like.' In the Matter of Surchin v. Approved Bus. Mach. Co., Inc., 286 N.Y.S.2d 580, 581 (Sup.Ct.1967). In essence, though, the enterprise remains one in which ownership is limited to the original parties or transferees of their stock to whom the other stockholders have agreed, in which ownership and management are in the same hands, and in which the owners are quite dependent on one another for the success of the enterprise. Many close corporations are 'really partnerships, between two or three people who contribute their capital, skills, experience and labor.' .... Just as in a partnership, the relationship among the stockholders must be one of trust, confidence and absolute loyalty if the enterprise is to succeed. Close corporations with substantial assets and with more numerous stockholders are no different from smaller close corporations in this regard. All participants rely on the fidelity and abilities of those stockholders who hold office. Disloyalty and self-seeking conduct on the part of any stockholder will engender bickering, corporate stalemates, and, perhaps, efforts to achieve dissolution. In Helms v. Duckworth, 249 F.2d 482 (DC App 1957), the United States Court of Appeals for the District of Columbia Circuit had before it a stockholders' agreement providing for the purchase of the shares of a deceased stockholder by the surviving stockholder in a small 'two- man' close corporation. The court held the surviving stockholder to a duty 'to deal fairly, honestly, and openly with . . . (his) fellow stockholders.' Id. at 487. Judge Burger, now Chief Justice Burger, writing for the court, emphasized the resemblance of the two-man close corporation to a partnership: 'In an intimate business venture such as this, stockholders of a close corporation occupy a position similar to that of joint adventurers and partners. While courts have sometimes declared stockholders 'do not bear toward each other that same relation of trust and confidence which prevails in partnerships,' this view ignores the practical realities of the organization and functioning of a small 'two-man' corporation organized to carry on a small business enterprise in which the stockholders, directors, and managers are the same persons' (footnotes omitted). Id. at 486. Although the corporate form provides the above-mentioned advantages for the stockholders (limited liability, perpetuity, and so forth), it also supplies an opportunity for the majority 17

stockholders to oppress or disadvantage minority stockholders. The minority is vulnerable to a variety of oppressive devices, termed 'freezeouts,' which the majority may employ .... An authoritative study of such 'freeze-outs' enumerates some of the possibilities: 'The squeezers (those who employ the freeze-out techniques) may refuse to declare dividends; they may drain off the corporation's earnings in the form of exorbitant salaries and bonuses to the majority shareholder-officers and perhaps to their relatives, or in the form of high rent by the corporation for property leased from majority shareholders . . .; they may deprive minority shareholders of corporate offices and of employment by the company; they may cause the corporation to sell its assets at an inadequate price to the majority shareholders . . ..' F. H. O'Neal and J. Derwin, Expulsion or Oppression of Business Associates, 42 (1961). In particular, the power of the board of directors, controlled by the majority, to declare or withhold dividends and to deny the minority employment is easily converted to a device to disadvantage minority stockholders .... The minority can, of course, initiate suit against the majority and their directors. Self-serving conduct by directors is proscribed by the director's fiduciary obligation to the corporation .... However, in practice, the plaintiff will find difficulty in challenging dividend or employment policies. Such policies are considered to be within the judgment of the directors. This court has said: 'The courts prefer not to interfere . . . with the sound financial management of the corporation by its directors, but declare as general rule that the declaration of dividends rests within the sound discretion of the directors, refusing to interfere with their determination unless a plain abuse of discretion is made to appear ..... Judicial reluctance to interfere combines with the difficulty of proof when the standard is 'plain abuse of discretion' or bad faith, see Perry v. Perry, supra, to limit the possibilities for relief. Although contractual provisions in an 'agreement of association and articles of organization' ...or in by-laws ...have justified decrees in this jurisdiction ordering dividend declarations, generally, plaintiffs who seek judicial assistance against corporate dividend or employment policies do not prevail .... Thus, when these types of 'freeze-outs' are attempted by the majority stockholders, the minority stockholders, cut off from all corporation- related revenues, must either suffer their losses or seek a buyer for their shares. Many minority stockholders will be unwilling or unable to wait for an alteration in majority policy. Typically, the minority stockholder in a close corporation has a substantial percentage of his personal assets invested in the corporation. The stockholder may have anticipated that his salary from his position with the corporation would be his livelihood. Thus, he cannot afford to wait passively. He must liquidate his investment in the close corporation in order to reinvest the funds in income-producing enterprises. At this point, the true plight of the minority stockholder in a close corporation becomes manifest. He cannot easily reclaim his capital. In a large public corporation, the oppressed or dissident minority stockholder could sell his stock in order to extricate some of his invested capital. By definition, this market is not available for shares in the close corporation. In a partnership, a partner who feels abused by his fellow partners may cause dissolution by his 'express will . . . at any time' (G.L. c. 108A, § 31(1)(b) and (2)) and recover his share of partnership assets and 18

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accumulated profits. If dissolution results in a breach of the partnership articles, the culpable partner will be liable in damages. G.L. c. 108A, § 38(2)(a) II. By contrast, the stockholder in the close corporation or 'incorporated partnership' may achieve dissolution and recovery of his share of the enterprise assets only by compliance with the rigorous terms of the applicable chapter of the General Laws. Rizzuto v. Onset Café, Inc., 116 N.E.2d 249 (Mass. 1953). 'The dissolution of a corporation which is a creature of the Legislature is primarily a legislative function, and the only authority courts have to deal with this subject is the power conferred upon them by the Legislature.' Leventhal v. Atlantic Fin. Corp., 55 N.E.2d 20, 26 (Mass 1944). To secure dissolution of the ordinary close corporation subject to G.L. c. 156B, the stockholder, in the absence of corporate deadlock, must own at least fifty per cent of the shares or have the advantage of a favorable provision in the articles of organization. The minority stockholder, by definition lacking fifty per cent of the corporate shares, can never 'authorize' the corporation to file a petition for dissolution ... by his own vote. He will seldom have at his disposal the requisite favorable provision in the articles of organization. Thus, in a close corporation, the minority stockholders may be trapped in a disadvantageous situation. No outsider would knowingly assume the position of the disadvantaged minority. The outsider would have the same difficulties. To cut losses, the minority stockholder may be compelled to deal with the majority. This is the capstone of the majority plan. Majority 'freeze- out' schemes which withhold dividends are designed to compel the minority to relinquish stock at inadequate prices .... When the minority stockholder agrees to sell out at less than fair value, the majority has won. Because of the fundamental resemblance of the close corporation to the partnership, the trust and confidence which are essential to this scale and manner of enterprise, and the inherent danger to minority interests in the close corporation, we hold that stockholders 2 in the close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another. In our previous decisions, we have defined the standard of duty owed by partners to one another as the 'utmost good faith and loyalty.'... Stockholders in close corporations must discharge their management and stockholder responsibilities in conformity with this strict good faith standard. They may not act out of avarice, expediency or self-interest in derogation of their duty of loyalty to the other stockholders and to the corporation. We contrast this strict good faith standard with the somewhat less stringent standard of fiduciary duty to which directors and stockholders of all corporations must adhere in the discharge of their corporate responsibilities. Corporate directors are held to a good faith and inherent fairness standard of conduct and are not 'permitted to serve two masters whose interests are antagonistic.' 'Their paramount duty is to the corporation, and their personal pecuniary interests are subordinate to that duty.' 2 [fn renumbered] We do not limit our holding to majority stockholders. In the close corporation, the minority may do equal damage through unscrupulous and improper 'sharp dealings' with an unsuspecting majority. See Helms v. Duckworth, 249 F.2d 482 (DC App 1957). 19

The more rigorous duty of partners and participants in a joint adventure, here extended to stockholders in a close corporation, was described by then Chief Judge Cardozo of the New York Court of Appeals in Meinhard v. Salmon, 164 N.E. 545 (NY 1928): 'Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arm's length, are forbidden to those bound by fiduciary ties…. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.' Id. at 546. Application of this strict standard of duty to stockholders in close corporations is a natural outgrowth of the prior case law. In a number of cases involving close corporations, we have held stockholders participating in management to a standard of fiduciary duty more exacting than the traditional good faith and inherent fairness standard because of the trust and confidence reposed in them by the other stockholders .... B. Equal Opportunity in a Close Corporation. Under settled Massachusetts law, a domestic corporation, unless forbidden by statute, has the power to purchase its own shares .... An agreement to reacquire stock '(is) enforceable, subject, at least, to the limitations that the purchase must be made in good faith and without prejudice to creditors and stockholders.'. When the corporation reacquiring its own stock is a close corporation, the purchase is subject to the additional requirement, in the light of our holding in this opinion, that the stockholders, who, as directors or controlling stockholders, caused the corporation to enter into the stock purchase agreement, must have acted with the utmost good faith and loyalty to the other stockholders. …. C. Application of the Law to this Case. We turn now to the application of the learning set forth above to the facts of the instant case. The strict standard of duty is plainly applicable to the stockholders in Rodd Electrotype. Rodd Electrotype is a close corporation. Members of the Rodd and Donahue families are the sole owners of the corporation's stock. In actual numbers, the corporation, immediately prior to the corporate purchase of Harry Rodd's shares, had six stockholders. The shares have not been traded, and no market for them seems to exist. Harry Rodd, Charles Rodd, Frederick Rodd, William G. Mason (Phyllis Mason's husband), and the plaintiff's husband all worked for the corporation. The Rodds have retained the paramount management positions. Through their control of these management positions and of the majority of the Rodd Electrotype stock, the Rodds effectively controlled the corporation. In testing the stock purchase from Harry Rodd against the applicable strict fiduciary standard, we treat the Rodd family as a single controlling group. We reject the defendants' contention that the Rodd family cannot be treated as a unit for this purpose. From the evidence, it is clear that the Rodd family was a close-knit one with strong community of interest. Harry Rodd had hired his sons to work in the family business, Rodd Electrotype. As he aged, he transferred portions of his stock holdings to his children. 20

Charles Rodd and Frederick Rodd were given positions of responsibility in the business as he withdrew from active management. In these circumstances, it is realistic to assume that appreciation, gratitude, and filial devotion would prevent the younger Rodds from opposing a plan which would provide funds for their father's retirement. Moreover, a strong motive of interest requires that the Rodds be considered a controlling group. When Charles Rodd and Frederick Rodd were called on to represent the corporation in its dealings with their father, they must have known that further advancement within the corporation and benefits would follow their father's retirement and the purchase of his stock. The corporate purchase would take only forty-five of Harry Rodd's eighty-one shares. The remaining thirty-six shares were to be divided among Harry Rodd's children in equal amounts by gift and sale. Receipt of their portion of the thirty-six shares and purchase by the corporation of forty-five shares would effectively transfer full control of the corporation to Federick Rodd and Charles Rodd, if they chose to act in concert with each other or if one of them chose to ally with his sister. Moreover, Frederick Rodd was the obvious successor to his father as director and corporate treasurer when those posts became vacant after his father's retirement. Failure to complete the corporate purchase (in other words, impeding their father's retirement plan) would have delayed, and perhaps have suspended indefinitely, the transfer of these benefits to the younger Rodds. They could not be expected to oppose their father's wishes in this matter. Although the defendants are correct when they assert that no express agreement involving a quid pro quo--subsequent stock gifts for votes from the directors-- was proved, no express agreement is necessary to demonstrate the identity of interest which disciplines a controlling group acting in unison. On its face, then, the purchase of Harry Rodd's shares by the corporation is a breach of the duty which the controlling stockholders, the Rodds, owed to the minority stockholders, the plaintiff and her son. The purchase distributed a portion of the corporate assets to Harry Rodd, a member of the controlling group, in exchange for his shares. The plaintiff and her son were not offered an equal opportunity to sell their shares to the corporation. In fact, their efforts to obtain an equal opportunity were rebuffed by the corporate representative. As the trial judge found, they did not, in any manner, ratify the transaction with Harry Rodd. Because of the foregoing, we hold that the plaintiff is entitled to relief. …. ****************************************************************************** It is worth emphasizing that Donahue applies to closely held corporations. A “statutory close corporation” is different from this–it is a corporation which has been organized in compliance with specific statutory provisions applicable only to close corporations which elect to be subject to special rules. Less than a third of the states have free-standing close corporation statutes, and not all close corporations in such jurisdictions will elect to register or file under those special provisions. (In fact, very few do.) A traditional corporation, organized under traditional corporate statutes, can still be closely held, even without complying with any available close corporation statute. 21

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What is the advantage of complying with or registering under a special “close corporation” statute? In general, although the specific advantages may vary from jurisdiction to jurisdiction, the advantages are two-fold: (1) a statutory close corporation is usually presumed to operate with less formalities (i.e., statutory rules applicable to meetings and records are usually far less complicated); and (2) the shareholders have the right (although not necessarily the obligation) to assume direct responsibility for the management of their corporation. In addition, not all close corporations can register as statutory close corporations. First, only a few states have such statutes. Second, there are usually relatively stringent requirements so that a corporation could still be considered to be “closely held” but not eligible to register under the statue. For example, in some states only corporations with no more than 30 or 50 shareholders can elect to become statutory close corporations. In other states, the rules are much looser. Although there is considerable variation in these rules, there are some common themes. First, the statutes are elective–a corporation need not opt into the special provisions if it does not want the special provisions to apply. Second, if the corporation does wish to be subject to the special rules, it must (under the terms of the statutes at least) include a provision to that effect in its articles. Third, only corporations with a limited number of shareholders are eligible. And finally, all of the provisions are designed in some way to reserve certain power or authority to the shareholders, reducing the power of the directors as a distinct group responsible for making decisions on behalf of the business. In these materials, a “statutory close corporation” is any corporation which complies with or has been deemed to comply with a special statutory authorization available only to electing closely held corporations. (Almost invariably this means that the corporation will have included an election to be a “close corporation” in its articles of incorporation.) If I am speaking more generally, about rule applicable to any corporation with a limited number of shareholders, no ready market for shares, and typically some shareholder participation as managers, I will use the terms “close corporation” or “closely held corporation.” For a variety of reasons, this course does not focus on publicly owned or held corporations (phrases which are synonymous), despite their importance to the national, state and local economies. Although issues that are of primary importance to public corporations will not be covered in this class, it should be emphasized that the reason for this limitation has nothing to do with the importance of such topics. Topics that are specifically applicable to public companies are covered in other courses (including Public Corporations, Securities Regulation, Mergers and Acquisitions, and some corporate counsel externships). These may be of significant interest if you anticipate a career in which you will be representing public corporations or working for one as in-house counsel or otherwise. 22

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22 CH 6 Corp History (1)

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