Forming a Statutory Close Corporation

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Surprisingly, many entrepreneurs neglect to take the time to strategize the appropriate entity to operate their business. Indeed, businesses should consider the various tax and legal advantages and disadvantages of the various entities.

I find that many businesses would like to operate as a corporation and take advantage of certain tax benefits. But, many decline to do so because they are intimidated about having to follow the corporate formalities such as corporate meetings, annual election of officers and directors, and preparation of written corporate minutes and resolutions, etc. As you may be aware, the failure to follow these formalities will be grounds for a claimant suing the corporation to “pierce the corporate veil” and subject a business owner to personal liability.

One overlooked entity that many businesses fail to take advantage of is the “statutory close corporation” which is established under California Corporations Code section 158. It was designed to give small businesses the benefits of a corporation, but allow them the freedom to disregard corporate formalities and manage the corporate business with the flexibility of a LLC or partnership. You can take advantage of this “loophole” as long as your business has no more than 35 shareholders. Even if you plan to have more than the statutory limit of 35 shareholders in the future, you can still incorporate as a statutory close corporation for the time being, and then amend the articles of incorporation to become a regular corporation when you exceed that 35 shareholder limit.

California Corporations Code Section 300 provides that, “The failure of a close corporation to observe corporate formalities relating to meetings of directors and shareholders in connection with the management of its affairs, pursuant to an agreement authorized by subdivision (b), shall not be considered a factor tending to establish that the shareholders have personal liability for corporate obligations.” Thus, a close corporation may be managed in an informal manner, using procedures established in the shareholders’ agreement, without the necessity of compliance with certain provisions of the Corporations Code that otherwise might require formal action by the board of directors or the shareholders.

In addition to waiving the corporate formalities, the shareholders’ agreement should also provide for other matters, such as restrictions as to whom a shareholder can sell or otherwise transfer his/her stock, or requiring a shareholder to sell his/her shares upon certain triggering events (i.e. breach of fiduciary duties or embezzlement).

A statutory close corporation therefore offers greater protection in that you are bulletproof from allegations that you failed to follow the corporate formalities. In addition, it also saves a business owner from the time and expense of having to follow these corporate formalities, which can be better spent building up the business.

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