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Close Corporations

General Definition:  A corporation whose shares are not freely traded and are held by a limited number of people.  

In a Close Corporation shareholder's are actively involved in managing and operating the corporate business.  Shareholders ordinarily will agree through a written Shareholder's Agreement how management decisions are made and what restrictions may apply to the sale of stock.

 

Limiting Personal Liability:  An S Corporation, like a C Corporation, protects owners, directors and employee from exposure to the liabilities, debts and obligations incurred by their business.  In many states, one person may own all the stock in an S Corporation and act as the corporation's only employee while still maintaining protection from personal liability.

Exceptions to limited liability protection:

1. A corporation takes out a loan, and someone within the corporation personally guarantees the loan.  Since most Close Corporations are fairly small, and function with minimal capital, banks often require personal guarantees from directors of Close Corporations.
2. State and federal governments can hold the corporate employee who is responsible for reporting and paying corporate taxes personally liable for unpaid taxes or penalties that come as a result of not paying taxes.  Normally, the party burdened with personal liability is the corporate Treasurer.
3. Members of a Close Corporation can be found personally liable for breach of duty that they owe to the corporation.  Directors and officers have a "duty of care" to act responsibly when performing corporate duties.  Generally, if directors and officers attend meetings and carry out their responsibilities designated to them in the corporate bylaws, they will not be found in breach of their duty of care.

Piercing the Corporate Veil: In certain limited instances, creditors or litigants can attempt to impose personal liability on principals in a Close Corporation by claiming that the corporation is a sham, a device created merely to defraud creditors, or is being run as a sole proprietorship (e.g., there has been a commingling of corporate and individual property, the entity was not properly formed, formalities have not been followed, or the entity was not properly capitalized).  The process of imposing individual and personal liability is referred to as "piercing the corporate veil" or "disregarding the corporate entity."  Ordinarily, a party seeking to pierce the corporate veil will have a heavy burden in attempting to persuade the courts to disregard the corporate entity.

 

Directors:  In a Close Corporation, the board of directors are usually subset of shareholders acting as representatives of the all shareholders.  They make policy decisions for the business and elect officers.  Most states require Close Corporations to have the lesser of 1) three directors, or 2) directors equaling the number of shareholders in the corporation. 

Officers:  In most cases, officers in a Close Corporation are also shareholders.  Officers manage the day to day operations of the corporation.  Generally, the first three officers of a corporation are the President, Treasurer and Secretary.  In many states, a for-profit Close Corporation with one director may have one officer fill all three roles.

Meetings:  Since shareholders are active in the day to day management of a Close Corporation, state laws generally do not require Close Corporations to hold annual meetings.  

Shareholder Reports:  Similarly, most states do not require shareholder reports.

State Reports:  Close Corporations must file annual (in some states biannual) reports with the state, updating the status of directors, officers, shareholders, and/or the corporation in general.

Most states require one of the following words, or an abbreviation thereof, to be included in the name of a Close Corporation:

names	abbreviations
Corporation	Corp.
Incorporated	Inc.
Limited	Ltd.

Close Corporations can do business under additional fictitious names if they file for a "DBA" in their state or county.  (If you are interested in filing a DBA, please inquire when placing your order.)

When forming a Close Corporation, the founders must determine how many shares the corporation will be authorized to issue.  For example, the founders may authorize the corporation to issue 1,000 share, but only actually issue 10 shares to the first owner.  This leaves the corporation with the flexibility to issue 990 more shares to future owners.  

Stock ownership is limited to a close knit group of no more than 30 to 50 shareholders (depending on the state).  Generally corporate Bylaws and/or the Shareholder Agreement restrict the transfer of shares to parties not involved in the operation of the business.  

*Common stock in an Close Corporation represents a percentage of ownership.  Common stock owners are generally entitled to their pro-rata share of corporate profits.

 

capitalization

Many states require a minimum amount of capital to be contributed to a Close Corporation for the issuance of shares at incorporation.  For example, in Texas, the corporation must receive at least $1,000.  

tax implications

A Close Corporation may elect to be taxed as either an S Corporation or a C Corporation.

 

business expenses

Day to day business expenses can be deducted under an Close Corporation they same way they would be deducted under a C Corporation or S Corporation.  Business expenses must conform with IRS guidelines and be kept separate from personal expenses.  

 

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