Transcript Slide 1

Close Corporations - Planning
Stock – transfer limitations
 Goals: Maintain control over ownership, both identity and size
Third Party
Shares are
freely
transferable
Shareholder
Shareholder
Shareholder
Corporation
Third Party
Shareholder
Shareholder
Transfer
Shares are
restrictions
freely
may limit
transferable
freedom
Shareholder
Corporation
Transfer Restrictions
 May appear in charter, bylaw, or separate agreement.
MBCA § 6.27(a); DGCL § 202(b)
 Requirements:
 Must be noted conspicuously on stock certificates
 Must be “reasonable”
 Types (MBCA § 6.27(d); DGCL § 202(c))
 Options (right of first refusal, right of first offer)
 Buy-sell
 Prior approval or consent
 Prohibitions on transfer
The SRA Transfer Restriction
“No Stockholder shall sell, assign, transfer (whether by
merger, operation of law or otherwise), dispose of or
encumber any of the Stockholder’s Shares or any interest
therein except as specifically provided in this Agreement.
Any purported or attempted sale, assignment, transfer,
disposition or encumbrance of Shares or any interest
therein not in strict compliance with this Agreement
shall be void and shall have no force or effect.”
Is this
restriction
“reasonable”?
The Delaware Court interpreting
such a restriction
 “The Delaware courts have been reluctant to invalidate
stock restrictions because they are unreasonable.”
 “The policy of restricting the number of record
shareholders to avoid public company reporting and
filing requirements is clearly a valid purpose….”
 “Likewise, the Delaware Supreme Court expressly found
that the alignment of the employees’ interests with those
of the company is a legitimate policy.”
 “It is reasonable to conclude that CGC’s purposes would
not be achieved if the stock was transferable.”
Shareholder Agreements in a Close
Corporation
 Goals: Maintain control directly, not through ability to elect and
vote out directors
Enforcing SH Agreements
Why is this an issue?
 SHs in a close corp sign a SH agreement obligating them to vote in favor of a specified
slate of directors
Directors favor expanding into the widget market

 Some SHs renege on the agreement; vote for directors who refuse to expand into
widgets
As a result, Acme does not expand into widgets

 Other SHs sue for breach of the agreement
 What are the damages? How easy is it to prove them?
 How can you make the agreement easier to enforce?
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Enforcing SH Agreements
1. Voting Trust

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Title of shares transferred to a trust
Agreement forming the trust gives
trustee power to vote the shares
Disadvantages?
Statutory restrictions
 Some statutes limit the duration of voting trusts [MBCA §7.30: 10 year limit, but renewable]
 Some states require the voting trust to be made public [DGCL §218]
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Enforcing SH Agreements
2. Contractual Enforcement
a)

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Specific performance
MBCA §7.31(b) states that voting agreements are specifically enforceable
DGCL §218(c) allows voting agreements –
implicitly allows for specific performance
Court may refuse to enforce in cases
of oppression or violation of other
SHs’ rights
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Enforcing SH Agreements
2. Contractual Enforcement
b)

Irrevocable Proxies
Proxies are usually revocable, but can be made irrevocable if attached to an interest
[MBCA §7.22(d)]


Being a party to a voting agreement is considered an interest [MBCA §7.22(d)(5)]
So, the proxy tends to be an
enforcement mechanism that is
ancillary to a voting agreement
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Enforcing SH Agreements
2. Contractual Enforcement
c)

Is the SH agreement valid?
Constraining discretion that isn’t subject to FDs
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E.g., appointing directors
Voting agreements generally permissible [DGCL §218(c); MBCA §7.31]
Constraining discretion that is subject to FDs

Actions that are typically in the domain of directors/officers
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E.g., appointing officers
Does it impermissibly constrain BoD’s discretion? [McQuade/Clark]
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Enforcing SH Agreements
McQuade v. Stoneham [N.Y., 1934]
 Stoneham owned a majority of the stock of the NY Giants
 McGraw (the Giants’ manager) & McQuade (a city
magistrate) bought a small amount of stock from Stoneham
 The three signed a SH agreement in which they agreed to do
their best to elect each other as directors & appoint each
other officers at specified salaries
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Enforcing SH Agreements
McQuade v. Stoneham
 McQuade lost Stoneham’s favor & was fired
 McQuade sues for specific performance
 Court:
 BoD must exercise independent business judgment on behalf of all SHs
 If directors agree in advance to constrain BoD’s judgment, SH will not receive the benefits of their
independence
 Therefore, agreement is void as against public policy
 Protection in the SH agreement didn’t save McQuade
 How can he protect himself from being fired?
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Enforcing SH Agreements
McQuade v. Stoneham
 McQuade seems to offer a bright line rule
Valid
Constrain
Shareholder
Judgment
Void
Constrain
Director/Officer
Judgment
 But the rule is not so bright
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Enforcing SH Agreements
Clark v. Dodge [N.Y., 1936]
 Clark knows a valuable secret formula.
Dodge contributes money. They form two
drug companies.
 C and D sign an agreement:
C agrees to disclose his secret formula
D agrees to invest the required money
C receives 25% of profits (salary & dividends)
D would vote, both as SH & director, to
assure that C would be a director &
General Manager as long as his performance was faithful, efficient and competent.

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 Why does C need the agreement? Why does D?
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Enforcing SH Agreements
Clark v. Dodge
 C discloses secret formula. D eventually fires C.
Clark’s lesson…
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Enforcing SH Agreements
Clark v. Dodge
≠
 Clark sues. Dodge claims SH agreement is void.
 Apply the reasoning in McQuade to this case.
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Enforcing SH Agreements
Clark v. Dodge
 Clark court: Minority SH are not harmed by a commitment to keep someone as an
officer “as long as he is faithful, efficient and competent”
I.e., SH agreements are valid if SH merely agree to do as directors what they could do validly
anyway
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 This does not explain the holding in McQuade
 Also, SHs may be harmed by an obligation not to fire without cause (e.g., downsizing;
better/cheaper candidate)
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Enforcing SH Agreements
Clark v. Dodge
 Clark court: McQuade was designed to protect minority SH who were not parties to
the agreement
In Clark, all SHs are parties to the SH agreement

 Clark creates an exception to McQuade when all SHs are parties to the SH agreement
 How can Dodge avoid the SH agreement (reach a McQuade outcome)?
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Enforcing SH Agreements
“Homemade McQuade”
The homemade
McQuade
Turning Clark…
… into McQuade
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Enforcing SH Agreements
“Homemade McQuade”
 Preempting the “Homemade McQuade”
 The company can prevent a “Homemade McQuade” by creating constructive knowledge of the
agreement – incorporating it in the AoI, or printing a reference to the agreement on all stock
certificates.
 Another obstacle for Homemade McQuades – Galler v. Galler
 In Galler, the court held that a SH agreement is valid even if not all SHs are parties to it, if:
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The corporation is closely-held
The terms are reasonable (i.e., minority SH should not object)
The minority SH does not object
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Enforcing SH Agreements
Case Law Summary
 McQuade: SH can commit to how they vote as SH, but cannot constrain their
judgment (or others on their behalf) as directors
 Clark: SHs can constrain their judgment as directors, if all SH are parties to the SH
agreement
 Galler: SHs can constrain their judgment as directors even when some SHs aren’t
parties to SH agreement, if terms of agreement are reasonable and fair to those SHs
(& those SHs don’t complain)
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