Many people are unfamiliar with a “close corporation” or mistakenly believe that a close corporation is simply a privately held standard corporation. In fact, many attorneys and accountants in California form corporations for privately held businesses by filing the standard corporation (Form ARTS-GS) failing to realize the existence and/or advantages of filing a close corporation for their clients. A close corporation is simply a corporation that has a limited number of shareholders not to exceed thirty-five. If one forms a close corporation, it does not have to comply with the many legal requirements and formalities of doing business as a standard corporation (e.g., shareholders’ and directors’ meetings; and meeting minutes). In light of the fact that shareholders of small corporations often disregard the legal requirements and formalities for doing business in corporate form altogether, this is a significant consideration.

Neglecting to hold meetings and maintaining minutes may result in a court disregarding the limited liability of the corporation with the consequence of exposing shareholders to personal liability. “The practical consequence of this potential loss of corporate status is a tendency to fabricate the necessary documentation to preserve the image of compliance with corporate formalities.” See Cal. Corp. Code §158. In fact, it was because of this conduct that the California legislature enacted the close corporation statute.

Yes, you heard right, even the legislature recognized that shareholders will likely fabricate the formalities just to maintain the corporation’s limited liability. So save yourself the headache and consider filing as a close corp. In fact, the only reason many do not file as a close corporation is because the representative organizing the entity was not attentive to this specific concern.

For those who entertain the option of forming as a close corporation, there is one requirement. Specifically, the articles must contain a provision that all of the corporation’s issued shares of all classes shall be held of record by not more than a specified number of persons, not exceeding 35, and a statement “This corporation is a close corporation.” Fortunately, for many privately held corporations, the odds of having more than 35 shareholders may be slim to nonexistent.

An additional benefit to forming as a close corporation is that you have the option of drafting a shareholder agreement that trumps default corporation rules in a manner similar to that of a partnership operating agreement. It is in this shareholder agreement that you can do away with the many tedious formalities and allocate control without annual shareholder voting. Think about the classic family business, typically the management is set and does not require the family to cast votes annually to reconsider a board of directors.

Furthermore, under Cal. Corp. Code section 1501, a corporation must send an annual report to shareholders within 120 days of the end of its fiscal year. Here again this formality can be eliminated if the corporation has less than 100 shareholders and its shareholder agreement or bylaws waive the requirement.

Of course if there is a shareholder agreement in place, the share certificates must contain the following conspicuous legend on the face thereof:

“This corporation is a close corporation. The number of holders of record of its shares of all classes cannot exceed ________ [a number not in excess of 35]. Any attempted voluntary inter vivos transfer which would violate this requirement is void. Refer to the articles, bylaws and any shareholder agreements on file with the secretary of the corporation for further restrictions.”

Lastly, although the issuance of stock often implicates complex state and federal securities laws, at the state level, you may qualify for filing an exemption under California securities laws. Please refer to the segment on Securities Exemptions.