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INTRODUCTION TO PENNSYLVANIA STATUTORY CLOSE CORPORATIONS
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Copyright © 1994-2004 Zegarelli Law Group. All rights reserved.
Written by Gregg R. Zegarelli, Esq.


GENERAL

1. Authority. Title 15, Chapter 23 of the Pennsylvania Business Corporation Law ("BCL") regulates statutory close corporations. The provisions of Chapter 23 do not in any way affect the law that is applicable to a business corporation that is not a statutory close corporation. However, unless otherwise expressly provided by the BCL, a statutory close corporation may be simultaneously subject to other chapters of the BCL. 15 Pa.C.S. § 2301(b) [all citations are to the 1988 BCL unless otherwise specified]. Any business corporation, other than a management corporation, may elect statutory close corporation.

2. Term Defined.
In order to reduce confusion between "closely-held corporations" and corporations elect "close corporation" status under the BCL, the term "statutory close corporation" has been introduced to identify the latter class of corporations. "Closely-held corporations" are defined as: 1) 30 or less shareholders; or 2) "statutory close corporations." § 1103. Thus, all statutory close corporations are "closely-held" regardless of their number of shareholders, but not all "closely-held corporations" are statutory close corporations.1

3. Minimum Vote.
Regardless of any limitations stated in the articles or bylaws, the shareholders of every class shall be entitled to vote on the corporate action, and the corporate action must be approved by the vote of shareholders of each class entitled to cast at least two-thirds of the votes of all shareholders of the class. The bylaws or articles adopted by the shareholders may provide that, on any corporate action subject to the minimum vote requirement, a vote greater than two-thirds or vote of all shareholders of any class may be required. Furthermore, regardless of any specific amendment provision in the bylaws or articles, any such greater vote requirement shall not be amended by a lessor vote.

CREATION

1. Mandatory Article Provisions. A statutory close corporation is formed in accordance with the rules relating to domestic business corporations except that the articles must contain: 1) A heading stating the name of the corporation and that it is a statutory close corporation; and; 2) That neither the corporation or any shareholder shall make an offering of any shares of any class that would constitute a "public offering" within the meeting of the Securities Act of 1933. § 2302.  Both of the above provisions are substantially a reenactment of the 1933 BCL.

2. Permissive Article Provisions.
The articles may set forth: 1) The maximum number of shareholders; or 2) The qualification of shareholders, either by specifying classes of persons who may be shareholders or by specifying classes of persons who may not be shareholders or both. § 2304(b).

3. Size and Structure.
This change in the law permits any size private corporation to elect statutory close corporation status. § 2304; see I.B., above. The new BCL does not require the inclusion in the articles of other provisions, such as one class of shares, that would be necessary for the corporation to qualify for the status of a close corporation for purposes of federal or state tax law. Thus, a corporation that is taxed as a close corporation need not be a statutory close corporation and conversely a statutory close corporation may not qualify for taxation as a close corporation.

4. Election. If a business chooses to become a statutory close corporation, it must amend its articles to contain the requirements stated above, in addition to a statement that it elects to become a statutory close corporation. The amendment shall not be effective unless it is adopted by the affirmative vote of all shareholders of the corporation whether or not otherwise entitled to vote thereon. § 2305. Note that following the practice under prior law, dissenter's rights are not accorded by statute upon an amendment of the articles electing statutory close corporation status. § 2305 Committee Comments.

5. Share Requirements.
A legend substantially indicating statutory close corporation status must be conspicuously set forth on each share certificate. Any person claiming an interest in shares shall be bound by the documents referred to in the notice. If the notice does not comply with the above, then the person claiming the interest in the shares shall be bound only by any documents of which they, or any person through who they claim, have knowledge or notice. § 2321(c).

TRANSFER RESTRICTIONS

1. Share Transfer Restrictions. Unless otherwise provided in the articles or a bylaw adopted the shareholders, no interest in shares may be transferred, by the operation of law or otherwise, whether voluntary or involuntary, unless the transfer is: 1) to the corporation or any other shareholders of the same class; 2) to members of the immediate family of the shareholder; 3) approved by unanimous vote of the holders of the most junior shares of the corporation having voting rights for the election of directors; 4) to a receiver in bankruptcy or similar proceeding by or against the shareholder; 5) a result of merger, consolidation or share-exchange that becomes effective pursuant to § 2336 (relating to fundamental changes) or a share-exchange of existing shares for other shares of a different class or series in the corporation; 6) a pledge of collateral that does not grant the pledgee any voting rights possessed by the pledgor; 7) made after termination of close corporation status; or 8) made through the following procedure:

a) Proposed Transferee. The proposed transferee must: i) be eligible to become qualified shareholders pursuant to any federal or state tax statute and the transferee agrees in writing not to take any action which would terminate the election; ii) the transferee is eligible to be a shareholder under any provision of the articles; and iii) the transferee agrees to purchase the shares for cash. According to the Committee Comments, excluding non-cash offers reflects the fact that most offers are made for cash and the mechanics of dealing with non-cash offers would unduly complicate the statutory framework. If the possibility of receiving non-cash offers is considered significant, appropriate language dealing with such offers should be included in the bylaws. Since the corporation cannot match in specie the non-cash portion of the offer, some mechanism, such as arbitration, must be set out to resolve any disputes over the adequacy of an offer made by the corporation made to purchase the offered shares.

b) Right of Refusal. The offering shareholder must deliver a written notice of the offer to the corporation stating the number and kind of shares, the offering price, and other terms of the offer and the name and address of the transferee. The notice is deemed to constitute an offer by the shareholder to sell the shares first to the corporation on the terms of the offer to the third party.

c) Within 20 days after receipt of the notice, the secretary must call a meeting of the shareholders, which must not be held more than 40 days after the call, for determining whether the corporation will purchase the shares. The corporation will purchase the shares upon the approval of a majority of the votes of all shareholders entitled to vote thereon, excluding the holders of offered shares.

d) With the consent of all the shareholders entitled to vote for the approval, the corporation may allocate some or all of the shares to one or more shareholders, or to other persons, but, if the corporation has more than one class of shares, the remaining holders of the class of shares being offered for sale shall have the right of first refusal to purchase the shares pro rata or in such proportion as shall be agreeable to those desiring to participate in the purchase.

e) Within 75 days after receipt of the offer, written notice of the acceptance of the offer shall be sent to the offering shareholder. Any different terms are considered a counteroffer and unless a shareholder wishing to transfer the shares accepts the counteroffer in writing, or the shareholder and the corporation or other purchaser otherwise resolve the difference in writing within 15 days of receipt by the shareholder of the initial counteroffer by the corporation, the counteroffer shall be ineffective as an acceptance.

f) If the corporation purchases the share, the shareholder shall deliver all of the certificates for the shares, duly endorsed, within 20 days of receipt of notice of acceptance. Breach of any of the terms shall entitle the non-breaching party to any remedy at law or equity including, without limitations, specific performance. If a corporation chooses not to purchase the shares, then the shareholders shall be entitled to transfer to the proposed transferee all, but not less than all, the offered shares within 120 days after delivery to the notice to the corporation and on the terms specified therein. Assuming that all corporate action is taken on the statutory deadline, the offering shareholder will have at least 30 days following in which consummate the transfer of shares to the proposed transferee.

2. Overriding the Statute. Any one of the statutory permitted transfers may be overridden by a bylaw: for example, "15 Pa.C.S. § 2322 (b)(6) does not apply." The above transfer restrictions automatically apply—a corporation must elect out of them.

3. Sale Option of an Estate.
Unless otherwise provide in a bylaw adopted by the shareholders, the personal representative of any deceased owner of shares shall have the right to require the corporation to elect either to purchase or to cause the purchase of all, but not less than all, the shares owned by the decedent or be dissolved.

4. Transfers in Breach.
If the articles state the number of persons who are entitled to be shareholders or limit the qualifications of persons who are entitled to shareholders, and if the certificate complies with the legend of § 2321(c) or it conspicuously notes the existence of the provision of the articles, then the person to whom the shares are transferred, for value or otherwise, shall be conclusively presumed to have notice of the fact. In this event the corporation may, at its option, refuse to register the name of the transferee, unless the transfer has been consented to by all shareholders or if the statutory close corporation voluntarily terminates its status. The transferee may rescind the transaction or recover under any applicable warranty expressed or implied. Any transfer of shares in violation of the transfer restriction binding on the transferee shall be ineffective. Any transfer of shares in violation of the transfer restriction not binding on the transferee, i.e. the legend on the shares was defective (see § 2321(c), II.E., above), then the corporation has the option, exercisable by notice and payment within 30 days after presentation of the shares for registration in the name of the attempted transferee, to purchase the shares from the transferee for the same price and terms as contemplated for the ineffective transfer unless such transfer was not intended to be a transfer for value. If the corporation purchases the shares, the proposed transferee may pursue breach of warranty claim or any appropriate remedy against the transferor. § 2323.

5. Invalid Restriction.
If the bylaws contain a transfer restriction adopted pursuant to § 2322(a), then even if the transfer is held not authorized by § 1529 (see VI.A.3., below), the corporation shall nevertheless have the option, for a period of 30 days after judgment setting aside the restriction becomes final, to acquire the restricted security at a price that is agreed upon by the parties or, if no agreement is reached, at the fair value is determined under Subchapter D of Chapter 15 relating to dissenters rights. § 2324.

6. Preemptive Right.
The holders of any class of voting shares shall have a preemptive right to subscribe for or purchase any voting shares unless otherwise provided in the articles or a bylaw adopted by the shareholder.

For statutory close corporations existing on January 1, 1989, if such provision is not elected, then holders of any class have preemptive rights unless otherwise provided in the articles. See 1933 BCL § 379.

MANAGEMENT

1. Directors. A written agreement among the shareholders entitled to cast at least a majority of the votes that all shareholders are entitled to cast for the election of directors is not invalid on the ground that it restricts the discretion of the Board of Directors. However, the effect of such an agreement is to relieve the directors and impose upon the shareholders who are parties to the agreement the liabilities for acts or omissions that are imposed by law on the directors to the extent and so long as the discretion of the board is controlled by the agreement. Shareholders upon whom liabilities of directors are imposed shall, to that extent, be entitled to the rights and immunities conferred upon directors of a corporation. § 2331.

2. Shareholders.
The articles or bylaws adopted by the shareholders may provide that the business of the corporation shall be managed under the direction of the shareholders rather than under the direction of the Board of Directors. So long as such provision is in effect; a) no meeting of the shareholders needs to be called to elect directors; b) unless the context clearly requires otherwise, the shareholders of the corporation shall be deemed to be directors for purpose of applying BCL provisions relating to close corporation; 3) the shareholders of the corporation shall be subject to all liabilities imposed and shall enjoy all rights and immunities conferred on directors.

Such a provision made be inserted in the articles or bylaws by amendment, if all incorporators or shareholders, regardless of any limitations stated in the articles or bylaws on the voting rights of any class, authorized the provision. An amendment to the articles or bylaws to delete the provision shall be adopted and shall become effective in accordance with the general BCL provisions relating to the amendment of the articles and bylaws, except that the shareholders of every class shall be entitled to vote on the amendment regardless of any limitations stated in the articles or bylaws on the voting of any class. If the articles or bylaws contain such a provision, then the existence shall be noted conspicuously on share certificate issued unless the certificate complies with the legend specified in § 2321(c) (see II.E., above).

3. Operating as a Partnership.
A written agreement among the shareholders or any provision of the articles or bylaws, which relates to any phase of the affairs of such corporation including, but not limited to, management of the business or payment of dividends or other division of profits or the election of directors or officers of the employment of shareholders by the corporation, shall not be invalid on the ground that it is an attempt by the parties to the agreement or by the shareholders of the corporation to treat the corporation as if it were a partnership order, arrange relation among the shareholders or between shareholders and the corporation in the manner that it would be appropriate only among partners and shall not be grounds for imposing personal liability on the shareholders for obligations for the corporation period. Section 2335 attempts to eliminate the argument that shareholders are individually liable for debts and torts of the business because they did not follow the classical model of a corporation. This section does not prevent "piercing the corporate veil" if the circumstances would justify imposing personal liability on the shareholders where the corporation not a statutory close corporation. It merely prevents court from "piercing the corporate veil" because it has utilized some or all of the organic flexibility. § 2335 Committee Comments.

4. Fundamental Changes.
Except as otherwise provided in the chapter, statutory close corporations may not effect any corporate action relating a fundamental change which requires the approval of shareholders unless the action is adopted by a Minimum Vote. § 2336.

For statutory close corporations existing on January 1, 1989, if such provision is not elected, then any voting limitation specified in the articles or bylaws control.

DEADLOCK & DISSENTION

1. Custodian. In addition to the general BCL provisions of § 1767 relating to the appointment of a custodian of a corporation in deadlock or other cause, the court, upon application of shareholder, may appoint one or more custodians and, if the corporation is insolvent, to be receivers when: a) Shareholders are unable to elect successor directors whose term has expired; b) If a closely-held corporation, the directors, officers, employees or those in control have acted fraudulently, oppressively or illegally toward a 5% or greater shareholder of any class in their official capacity; c) Corporate assets are being wasted; d) The directors are deadlocked; e) Business of the corporation are managed by or under the direction of the shareholders and they are so divided that the business of the corporation is suffering immediate and repairable injury and any remedy with respect to such deadlock provided in the bylaws or written agreement of the shareholders is failed; or f) The applicant shareholder has a right to dissolution of the corporation under a provision of the articles permitted by § 2337. § 2333. A custodian shall have the authority to liquidate the corporation and distribute assets. § 2333. Furthermore, the custodian is deemed to be an "officer." g) In lieu of appointing a custodian, the court may appoint a provisional director, whose powers and status shall be as provided below in VI.B. The appointment does not preclude a subsequent order by the court to appoint a custodian or receiver for the corporation. §§ 2333(b), 1767.

2. Director Deadlock: Provisional Director.
Notwithstanding any contrary provision of the articles, bylaws or agreement of the shareholders, a court may appoint an impartial provisional director if the directors are so divided respecting the management of the business and affairs the corporation that the votes required for action cannot be obtained and the corporation can no longer be conducted to the advantage of the shareholders. An application for relief must be filed on behalf of: a) One-half the number of directors then in office; b) The holders of one-third shares of all shareholders entitled to cast for the election of directors; or c) If there is more than one class of shares then entitled to elect one or more directors, then the shareholders entitled to cast two-thirds of the votes that all shareholders of the class are entitled to cast for the election of directors. § 2334.

A bylaw may provide a lesser proportion of the directors the shareholders or a class of shareholders may apply for relief. § 2334.

The provisional director has all of the rights of an elected director until such time as such is removed by: i. Order of Court; ii. The shareholders of that class of voting shares to file the application for appointment of a provisional director or entitled to cast for directors; or iii. The shareholders entitled to cast at least the majority of the votes that all shareholders are entitled to cast for the election of directors, in any other case. § 2334(d).

TERMINATION OF STATUS & DISSOLUTION

1. Voluntary. A statutory close corporation may voluntarily terminate its status by amending its articles to delete the heading which states the name of the corporation and that it is a statutory close corporation. The amendment must be adopted by at least the Minimum Vote and not less than that required for approval of other fundamental transactions. Following the 1933 BCL, dissenter's rights are not available. 1) Upon termination of its status as a statutory close corporation, the corporation will automatically have the status of a general business corporation; 2) Except for the transfer restrictions, after termination, any existing rights of the shareholders established by agreement, but the shareholders lose the benefit of the automatic transfer restrictions of § 2322. 3. If the shareholders wish to have transfer restrictions continue after termination of status, the restrictions must meet the requirements specified generally under § 1529 of the BCL, i.e.: a) Right of first refusal to be exercised within a reasonable time; b) Obligates the purchase of shares; c) Requires the consent of the corporation or other shareholders; d) Designates a persons or a class of persons that is not manifestly unreasonable; or e) Restrictions to maintain Subchapter S status. § 1529(c).

After the termination, all relevant documents relating to the corporation and the shareholders should be reviewed, and where necessary, revised.

2. Involuntary.
If an event occurs which causes a breach of any article provision which was required pursuant to 2304(a) the close corporation shall terminate unless: 1) Within the later of 30 days after the occurrence of the event, or 30 days after its discovery, the corporation files a certificate with the Secretary of State stating that a provision of the articles pursuant to 2304(a) has been breached. A copy of such statement must be furnished to each shareholder. 2) Concurrently with the filing the corporation must take steps necessary to correct the situation, including without limitation, the refusal to register the shares that have been wrongfully transferred as provided by Section 2308 or initiation of a proceeding cure breach. A proceeding may be instituted by either a corporation or any shareholder. The court may enjoin or set aside any transfer of shares that is contrary to any of the terms of the corporate articles and may enjoin any public offering. 3) If such steps are taken to prevent loss of status or remedy of the breach, then the corporation will continue to be subject to Chapter 23. § 2306. 4) When the threatened breach has been remedied, and if the corporation has not amended its articles in accordance with 2307 (relating to voluntary termination), the corporation shall file a certificate stating that no breach of the provision included in its articles pursuant to 2304(a) exists. Upon filing of the certificate, the status of the corporation, if terminated by reason of 2309(a), shall be restored.

3. Shareholder Dissolution.
A bylaw of a statutory close corporation adopted by the shareholders may include a provision granting to any shareholder or the holders of a specified number of percentage of shares of any class of shares the option to have the corporation dissolved at will or upon the occurrence of a contingency. The shareholder exercising the option must give written notice to other shareholders. After expiration of 30 days following sending the notice, the dissolution of the corporation shall proceed as if the required number of shareholders having voting rights and consented in writing to the dissolution of the corporation as provided relating to voluntary dissolution and winding up. If the bylaws do not contain a provision, then they may be amended if adopted by unanimous vote of all shareholders, regardless of any limitation stated in the bylaws on voting rights of any class unless the original bylaws, or bylaws adopted by such a unanimous vote, specifically authorize such an amendment to be adopted by a specified vote of shareholders, which shall not be less than a minimum vote. Any such provision in the bylaws shall be noted conspicuously on every share. Unless the certificate complies with the statutory notice.

CONCLUSION

In a nutshell, statutory close corporations allow shareholders to: 1) expand the number of shareholders without BCL limitation; 2) obtain automatic share transfer restrictions and first refusals; 3) limit the discretion of directors, if any; 4) manage the corporation themselves, with corporate indemnification; 5) to provide for conditional dissolution. 6) obtain automatic supermajority votes on issues which affect fundamental rights, and; 7) operate generally as a partnership.

1. Pursuant to 15 Pa.C.S. § 1504(c), the provisions authorized to be set forth in the bylaws may also be set forth in the articles. However, the converse is not true. Thus, one must pay close attention to the BCL's selection of the terms "articles" or "bylaws."



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