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Class Agenda
Introduction, including definition of close corporation and the true plight of close corporation minority shareholders Shareholder Voting Arrangements Agreements Relating to Board Discretionary Matters Fiduciary Duty of Shareholders Restrictions on Transfer Dissolution
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What are some of the problems when they are all the same people?
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Close Corporations
What is the true plight of the minority stockholder in a close corporation? If he is dissatisfiedin a more legal sense, this means that he is oppressed by the majority owners or he is a dissident minority shareholderhe cannot readily sell his interest and he cannot readily cause a dissolution as he could were the business organized as a partnership.
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FACTS
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Fiduciary Duty
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Close Corporations
Shareholders of close corporations owe a more rigorous duty to one another that is akin to the fiduciary duty of partners of a partnership. It is a duty of good faith and a duty of the finest loyalty. See Meinhard v. Salmon.
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Close Corporations
It has been said that a close corporation is nothing more than an incorporated partnership because of the relationships among the corporation constituencies.
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Close Corporations
Close corporations are subject to substantially the same statutory regime that applies to other corporations, except for special provisions and practical opportunities for highly flexible shareholder agreements and voting agreements as well as the law of fiduciary duties applicable to them.
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Close Corporations
Common law and statutory law have contractualized close corporations. Given the recognition of contracts governing relationships in close corporations, advance planning is extremely important in the representation of small businesses and their constituencies.
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Voting Agreements
Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling (Del. Ch. 1947) recognized that shareholders may enter agreements to vote their stock jointly, but the court did not specifically enforce the terms of the agreement in this case.
As a result of this and other similar cases, most states have enacted statutes for the specific enforceability of shareholder voting agreements.
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Voting Agreements
Ala. Code 10-2B-7.31
Voting agreements. (a) Two or more shareholders may provide for the manner in which they will vote their shares by signing an agreement for that purpose. A voting agreement created under this section is not subject to the provisions of Section 10-2B-7.30. (b) A voting agreement created under this section is specifically enforceable
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Voting Trusts
Likewise, the RMBCA authorizes voting trusts whereby shareholders transfer their shares into a trust and a trustee votes such shares in accordance with the terms of the trust. Alabama Code section 10-2A-7.30 is identical to the RMBCA provision, which was derived from Delaware and California provisions.
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Voting Agreements
Stockholders may invoke arrangements that enhance the voting requirements to obtain certain voting results and make it more difficult to carry action without broad support from the stockholder base. For example, remember that the general requirement is that a quorum for a stockholder or director meeting is a majority of the votes or members entitled to vote on the action. But the requirement for a stockholder or director quorum may be increased in the articles or bylaws.
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Voting Agreements
Therefore, a superquorum or supervotvote might be used to increase the percentage required above a mere majority. For example, the articles or bylaws might require the presence of 80% of the outstanding shares entitled to vote on the action to constitute a quorum for a stockholders meeting.
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To what extent may shareholders of a close corporation contractually agree to curtail the discretion of the board of directors?
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Voting Agreements
An agreement entered into by corporation directors, or between a director and a stockholder, committing the director to vote a certain way at a directors meeting is not, however, valid. It is because of a theory that a corporation is entitled to the unfettered discretion of directors to vote in what they believe to be the best interests of the corporation. However, agreements that narrowly dictate a director vote are generally valid.
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Voting Agreements
For example, a director agreement regarding the declaration of dividends or the election of officers is generally valid.
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Proxies
The agency relationship created by the delivery of a proxy gives rise to the problem of the irrevocability of the proxy since a principal can terminate the authority of an agent at will, even if the termination constitutes a breach of contract.
The exception is where the agent holds a power coupled with an interest.
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Proxies
Alabama Code section 10-2B-7.22 expressly authorizes voting of shares by proxy. It also states that an appointment of a proxy is revocable by the shareholder unless the appointment form conspicuously states that it is irrevocable and the appointment is coupled with an interest.
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Proxies
Under the statute, appointments coupled with an interest include the appointment of: (1) a pledgee; (2) a person who purchased or agreed to purchase the shares; (3) a creditor of the corporation who extended it credit under terms requiring the appointment; (4) an employee of the corporation whose employment contract requires the appointment; or (5) a party to a voting agreement created under Alabama Code section 10-2B-7.31.
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This statute provides the vehicle for advance planning for foreseeable events.
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Fiduciary Obligations
An important subject concerning close corporations pertains to the fiduciary duty, if any, of one shareholder-owner to another and, in particular, the duty of majority shareholders, when acting in the capacity of shareholders, to minority shareholders. Naturally, this is the primary area for litigation concerning close corporations.
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True Example
A, B, and C organize a corporation 20 years ago for the purpose of owning and operating a health care facility A, B, and C are the only members of the board A, B, and C each own 1/3 of the outstanding stock and they enter a shareholder agreement with customary provisions A serves as president, B serves as VP and treasurer, and C serves as VP and secretary
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True Example
The business does reasonably well and A, B, and C enjoy harmonious relations for 20 years A dies As surviving spouse (Spouse) inherits his 1/3 interest in the corporation and B and C (reluctantly) elect Spouse to the board to fill the vacancy created by the death of A B and C do not have harmonious relations with Spouse
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True Example
Within 3 years of As death, the business begins to suffer financially, it lacks management attention, it neglects marketing efforts, all of which appear suspicious to Spouse and her lawyer B and C never vote in favor of proposals by Spouse, fail to provide requisite notice of meetings, and upon independent observation appear to treat Spouse disrespectfully, chauvinistically, and cavalierly Spouse now wants to sell the business
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True Example
This is a common fact pattern.
What fiduciary duty is owed by B and C to Spouse? In the event of a shareholder vote on whether to sell the business, which Spouse can veto if she disapproves of the terms, what fiduciary duty is owed by Spouse to B and C?
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Fiduciary Duty
If B, C, and Spouse were in business as a partnership, the duty among them would be one of utmost good faith and loyalty. They would each have a duty to act in the interest of their partners with the same zeal with which they each would act in pursuing their own personal interest. Courts have demonstrated difficulty in balancing the interests of controlling shareholders and protecting against the oppression of minority shareholders.
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Fiduciary Obligations
Most jurisdictions, including Alabama, have traditionally followed the view that directors and shareholders of close corporations are subject to a duty of "good faith and inherent fairness" that is applicable to large, publicly held corporations. See, e.g., Smith v. Burton, 283 Ala. 391, 217 So.2d 540 (1968).
Massachusetts is a notable exception to the majority approach and has applied a duty more akin to the higher standard for partnerships.
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Fiduciary Obligations
Some relatively recent decisions by the Alabama Supreme Court suggest that there may be a movement toward the Massachusetts partnership standard, at least in cases involving freeze-outs of minority holders by the majority, including board and officer removals, non-payment of dividends or remuneration, and other oppressive conduct.
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Dissolution
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Dissolution
Ala. Code 10-2B-14.30 through -14.34: Note the special dissolution and shareholder-initiated purchase election procedures applicable to close corporations that are set forth in -14.34.
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