3 Ways Shareholder Agreements Can Protect the Rights of Owners of Close Corporations
This post explains some of the most common shareholder agreements that can be agreed to by owners of corporations with regard to governance and ownership.
In closely held corporations there is typically a concentration of ownership in just a few people, and a small number of people participating in the management of the company. Action by one of the owners can have drastic impact on the company itself, as well as on the other owners. It is therefore important to set reasonable expectations at the outset via shareholder agreements. Shareholder agreements frequently address the issues of governance, management, ownership, and restrictions on the transfer of stock.
What is a shareholder agreement? A shareholder agreement is simply an agreement (a contract) between owners about a how a company should be operated, or about the shareholders’ respective rights and obligations. They are often used to ensure that all shareholders are treated fairly and that their interests in the corporation are protected.
Here are few of the most common issues addressed in shareholder agreements:
Restricting transfer of shares in the corporation that could disqualify the corporation from securities laws exemptions or income tax statutes.
For example, the shareholders may have formed an S corporation to avoid the problem of double taxation (i.e., taxation at both the corporate and individual level). If another corporation were to acquire the shares in this corporation, however, you could lose the right to be an S corporation. For that reason, shareholders may want to prevent other shareholders from transferring stock to another corporation.
Restricting transfer of shares in the corporation to unwanted outsiders.
In a close corporation the owners owe each other a heightened fiduciary duty. The owners likely made a strategic decision to go into business with the other shareholders and do not want third parties brought into the corporation without all the shareholders’ agreement. A shareholder agreement thus may restrict the transfer of shares to such third parties.
Guaranteeing a minority shareholder a voice in the management of the corporation.
A minority shareholder owns less than half the stock and therefore cannot make decisions that will affect the management of the corporation without agreement from the majority shareholders. Nevertheless, the majority shareholders may want to bring in a minority shareholder as an investor or business advisor due to his or her value to the corporation. A shareholder agreement may thus provide that the corporation cannot make important decisions without agreement from the minority partner.
These are just a few examples of shareholder agreements that owners of a close corporation can enter into in order to affect or protect their rights. The types of agreements that shareholders can make are essentially limitless, though. For example, shareholders might also decide how shares in the company can (or cannot) be sold to provide a market for the shares. Shareholder agreements may also relate to the election of directors by minority shareholders, ensuring that those minority shareholders have a voice in the operation of the company. Or, a shareholder agreement may even restrict the transfer of stock to a shareholder’s spouse if the shareholder dies.
North Carolina law provides that shareholder agreements are generally enforceable under the North Carolina Business Corporation Act, N.C.G.S. § 55-7-31. This departs from earlier law that disfavored shareholder agreements. The business and legal community has come to recognize that shareholders should have the right to manage their businesses in innovative ways that are contractually enforceable.
Dye Culik PC represents owners of corporations, LLCs, and other business entities in both corporate matters and disputes. If you are an entrepreneur, investor, business owner, or executive, contact us to see how we can help you achieve your business and legal goals in ways that are efficient, creative, and effective.