Archive for October, 2012

A “Close Corporation” or “Closely Held Corporation”? Or Does it Matter?

Think of a “corporation,” and you probably think of a large company with hundreds or thousands of shareholders with a separate board of directors. But a second kind of corporation exists alongside the large, public corporation. Known as the closely held corporation, close corporation, or even family corporation, this business structure differs in many ways.

The closely held corporation shares many of the characteristics of a public corporation in that it is formed by the filing of articles of incorporation, has shareholders, has bylaws (sometimes), and has a board of directors (sometimes).  An important difference exists in how the organization is managed. The entity has few shareholders and some or all of those shareholders also serve as the directors and officers of the corporation.

Business entities are primarily created by statute, but courts have long recognized the existence of the closely held corporation at common law. That is, courts have been willing to recognize that a corporation is “closely held” if it had certain characteristics.  For example, Missouri courts sometimes consider a corporation to be “closely held” if it has a small number of shareholders, does not have a public market for its stock, and its shareholders substantially participate in the business operations.

The purely common law existence of closely held corporations is now (mostly) an artifact of the past. Both Kansas and Missouri have enacted statutes creating the “close corporation.” In both states, a corporation must elect in its articles of incorporation to be a close corporation, and there is a limit to the number of shareholders of the corporation. Election to close corporation status means that the company falls under a different subset of statutory rules than the traditional corporation.

Nevertheless, the enactment of the statutory “close corporation” has not driven the common law “closely held corporation” extinct. Courts in both Kansas and Missouri continue to recognize its existence when the entity has not made the statutory election in its articles of incorporation but displays the characteristics of a closely held corporation.

Why does it matter? Because the duties owed to shareholders in a close (or closely held) corporation often are higher than in the typical public corporation. Meaning that directors (and sometimes shareholders) may owe a higher duty to the shareholder of a corporation displaying the qualities of a close corporation, even if it has not expressly elected such a status. Therefore, a shareholder in the “close corporation” or “closely held” corporation may be entitled to a higher duty of care than in a large, public company.