Close Corporations

In 1977, California adopted statutory provisions to govern close corporations after recognizing the unique circumstances surrounding this type of legal entity. California close corporations share certain common characteristics. For example, close corporations have minimal shareholders compared to other forms of corporations. Additionally, most shareholders in close corporation share in the management and operation of the corporation. The management structure for close corporations is often much simpler, and is similar to partnerships, rather than larger, publicly-traded corporations. Close corporations are often only privately traded rather than publicly traded.

Alongside these similar characteristics, close corporations must also meet specific requirements to accurately structure this type of legal entity. Close corporations must include certain mandatory language in their articles of incorporation. For instance, pursuant to California Corporations Code § 158(a), the articles of incorporation must limit the number of all classes of shares that the corporation can issue to thirty-five. Additionally, the articles of incorporation must specifically state that the corporation is a close corporation.

Registering as a close corporation allows the corporation to waive out of some of the requirements that apply to other forms of corporations. For example, California Corporations Code §§ 100 et seq. specifically allow close corporations to allocate management responsibilities and divide profits among the shareholders in its articles of incorporation. In California, the Corporations Code §§ 705-706 also permit close corporations to define voting agreements, voting classes, and proxy voting for the corporation.

Close corporations may dissolve voluntarily much like other corporations. However, if a close corporation is in the process of dissolving, any shareholder may petition a governing court, in the appropriate jurisdiction, to oversee the dissolution proceeding. California Corporations Code §§ 1800, et seq. governs involuntary dissolution of close corporations and other corporate forms. In a close corporation, any shareholder may initiate involuntary dissolution proceedings by filing a verified complaint seeking dissolution with the governing court of the appropriate county. In fact, California Corporations Code § 1800(b)(5) provides a specific cause of action for dissolution. The shareholders in close corporations have the unique capacity to seek involuntary dissolution where it is necessary to protect the shareholders.

A close corporation is a specialized corporate structure designed for businesses with a limited number of shareholders, offering a blend of corporate benefits and partnership-like flexibility. This structure is particularly advantageous for small, closely-held businesses, that are seeking streamlined governance.

Under California Corporations Code § 158, a close corporation is defined as a corporation whose articles of incorporation include:

• A statement that the corporation is a close corporation.
• A provision limiting the number of shareholders to no more than 35.

The following steps are required to establish a close corporation:

1. Articles of Incorporation: Must explicitly state the corporation is a close corporation and set the maximum number of shareholders (not exceeding 35).
2. Share Certificates: Each certificate must bear a conspicuous legend indicating:
   • "This corporation is a close corporation. The number of holders of record of its shares of all classes cannot exceed [specified number, not exceeding 35]. Any attempted voluntary inter vivos transfer which would violate this requirement is void."
   • This requirement is detailed in California Corporations Code § 418(c).
3. Shareholders' Agreement: A written agreement among all shareholders outlining the management structure and operational procedures, as authorized by California Corporations Code § 300(b).

Close corporations enjoy certain flexibilities not typically available to standard corporations:

• Simplified Governance: Shareholders can agree to eliminate the board of directors and manage the corporation directly, as permitted by § 300(b).
• Reduced Formalities: The failure to observe corporate formalities, such as holding regular meetings, does not, by itself, expose shareholders to personal liability, provided a valid shareholders' agreement is in place (§ 300(c)).
• Customized Profit Distribution: Shareholders can agree on profit distributions that differ from ownership percentages, offering flexibility similar to partnerships.

While offering flexibility, close corporations have certain limitations:

• Shareholder Limit: Exceeding 35 shareholders automatically terminates close corporation status, necessitating amendments to the articles of incorporation to remove close corporation provisions (§ 158(e)).
• Public Trading Restrictions: Close corporations cannot go public due to the shareholder limit and transfer restrictions.
• Fiduciary Duties: Shareholders involved in management assume fiduciary responsibilities akin to directors, making them liable for breaches of duty (§ 300(d)).
• Involuntary Dissolution: Any shareholder, regardless of ownership percentage, can petition for involuntary dissolution, which may pose risks in cases of shareholder disputes.

California close corporations offer a hybrid structure combining corporate benefits with partnership-like flexibility, making them suitable for small, closely-held businesses. However, due to their specific requirements and limitations, it's crucial to consult with legal professionals to determine if this structure aligns with your business goals.

Salar Atrizadeh, Esq. is uniquely able to help close corporations throughout formation, operation, and in voluntary or involuntary dissolutions. Mr. Atrizadeh is an experienced attorney, with extensive practice in business litigation and transactional matters. He has represented corporate clients in transactional matters, such as drafting corporate documents and business plans. Mr. Atrizadeh has also helped clients litigate matters throughout the course of their business operations.