Today we will be talking California corporations and, specifically, closely held corporations and important documents like a voting agreement, shareholder agreement, and buy-sell agreement. These documents are critical to shareholders and their involvement with closely held corporations, sometimes referred to as S Corps. This blog entry will not discuss a corporation’s by-laws. You should contact an attorney for more information on by-laws.
VOTING AGREEMENTS
The shareholders of a corporation may want to allocate control of the corporation in a way that is disproportionate to the ownership of shares of the corporation. Toward that end, they may want to ensure that their shares will be voted in a certain way. For example, they may want to vote their shares for specified persons as directors, vote as a majority of shareholders in the group may decide, or vote to effect a particular corporate policy. Common devices to accomplish these purposes are (1) voting agreements (or pooling agreements), in which the shareholders agree to vote their shares as provided in a voting agreement, and (2) voting trusts, in which legal title to the shares is transferred to a trustee, to be voted as provided in a trust agreement.
Voting agreements may be used in a close corporation to permit the shareholders to control the management of the corporation. Several management alternatives to voting agreements and voting trusts exist. These include a close corporation shareholder agreement; or a provision in the corporation’s articles of incorporation for super-majority votes by the corporation’s directors or shareholders on various matters. In addition, a corporation’s capital structure can be designed to give some shareholders control that is disproportionate to their dollar investment, either by providing for voting and nonvoting shares or shares with special voting rights. This result can also be obtained by issuing debt securities for a portion of the corporation’s initial financing, instead of issuing voting shares for that financing. A group of majority shareholders in a close corporation can also use a holding company, instead of a shareholder’s voting agreement or voting trust, to consolidate their voting power. Further, shareholders may sometimes find it useful to create a partnership to hold their shares, or, on rare occasions, to cause the corporation to issue stock to several persons to be held jointly.
A voting agreement differs from a shareholder agreement in three significant respects. First, the use of a voting agreement is not limited to shareholders of a close corporation, as is a shareholder agreement. Second, a voting agreement may be among less than all of the shareholders. Third, a voting agreement covers only the exercise of shareholder voting rights and does not change the role of the shareholders with respect to the directors. Thus, if the shareholders of a close corporation want to enter into an agreement that extends beyond how their shares will be voted, and controls functions that are traditionally within the realm of the directors (for example, appointing officers and setting corporate policies), a shareholder agreement, not a voting agreement, should be used.
SHAREHOLDER AGREEMENTS
A shareholder agreement is a written agreement among all of the shareholders of a statutory close corporation [see Corp. Code § 158 (“close corporation” requires provision in articles limiting shareholders to 35 and specifically identifying corporation as a close corporation)] relating to the affairs and management of the corporation. If the close corporation has only one shareholder, the shareholder agreement is between the shareholder and the corporation.
The General Corporation Law [Corp. Code § 300(b)] provides that no shareholder agreement that relates to any phase of the corporation’s affairs will be invalid as between the parties to it on any of the following grounds:
• It relates to the conduct of the affairs of the corporation so as to interfere with the discretion of the directors;
• It is an attempt to treat the corporation as if it were a partnership; or
• It is an attempt to arrange relationships among the shareholders in a manner that would be appropriate only between partners.
Thus, in practice, a shareholder agreement permits shareholders to do the following:
• Manage the close corporation informally, according to the provisions of the agreement, without observing corporate formalities related to director and shareholder meetings; and
• Make decisions in areas usually reserved for the board of directors, such as dividend policy, distribution of assets on liquidation, selection of officers, and determination of their compensation and tenure
Unless otherwise provided in the shareholder agreement, the agreement may not be modified, extended, or revoked by less than unanimous agreement of the parties. A shareholder agreement terminates when the corporation ceases to be a close corporation, or on the original issuance of shares by the Corporation to a new shareholder who does not become a party to the agreement, unless the agreement provides that it will continue to the extent it is enforceable apart from Corp. Code § 300(b).
Shareholders in close corporations frequently want to manage the corporation in a partnership-like manner, determining among themselves who will manage the corporation’s business and how that management will be exercised, while retaining the limitation on personal liability and the other benefits of the corporation form. An important objective in many shareholder agreements is to protect a minority shareholder from the majority’s power by giving the minority shareholder a voice in the corporation’s management, either as a member of the board of directors or otherwise. Other shareholder agreements protect shareholder-employees by ensuring continued employment, and protect shareholder-investors by assuring a specified return of capital through dividends. A shareholder agreement may provide a mechanism requiring the corporation to buy back a shareholder’s shares on the occurrence of certain events such as the shareholder’s death, disability or termination of employment. The price for the buy back can be determined by a formula set forth in the shareholder agreement.
BUY-SELL AGREEMENTS
A buy-sell agreement (also known as a buyout agreement) is a contract, particularly important in the case of a close or closely held corporation, under which the shareholders or owners of a business agree to purchase the interests of a withdrawing or deceased shareholder [Black’s Law Dictionary (5th ed. 1979). At 181]. The agreement describes the conditions (usually death, disability, or termination of employment) and the terms under which shareholders may or must transfer their shares [Black’s Law Dictionary (5th ed. 1979, at 181].
A buy-sell agreement is merely an executory contract to buy and sell personal property (that is, an employee’s shares) if and when a particular event such as termination of employment occurs. A shareholder under such an executory contract is entitled to the benefits of ownership until delivery is made or tendered to the buyer, unless the buy-sell agreement specifies or implies a different intention.
Generally, a buy-sell agreement provides the corporation and the shareholders with the certainty of a legally binding transfer plan well in advance of the actual events, facilitating agreement on the terms and manner of transfer. It ensures the uninterrupted continuation of the business entity in the event of the death or withdrawal of a participant, prevents “outsiders” from becoming transferees of corporate shares upon a shareholder’s death, disability, or retirement from the corporation, and enables the shareholders to sell their shares for a fair price despite the lack of a public market. Further, if the agreement is properly shareholder’s interest in the corporation, and ensures that his or her estate will receive the liquid assets it may need for taxes, creditor’s claims, or probate expenses. An agreement may also give the remaining shareholders an option to dissolve the corporation upon the death of a major shareholder.
I hope this was a good summary of important shareholder documents for California corporations. That’s all for today.
For more information on the matter, please contact the Law Offices of Omar S. Anorga at 213 489-1271. Thank you.
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