Question re Close Corps

Question from a student

Regarding Closely Held Corp.
Where there is a question of salary/compensation for a board member, would there be a discussion of Interested Director Transaction?

Compensation of a board member is clearly an interested director transaction.  Remember though that all that really means is – is the transaction fair to the corp?  There cannot be a safe harbor exception because the board cannot step out of the room – there will be no one in the room!

Does the fact that this is a “close corp” change the answer?  The consequence of being a close corp that we reviewed is two-fold, 1) agreements between shareholders respecting consequential decisions are enforceable and 2) shareholders of close corps owe fiduciary duties to each other and the corp.   Management including shareholders of a close corp must still focus on the corp even in a close corp jurisdiction, at least when there is no agreement.  When there is no prior agreement, shareholders/directors cannot do things for the purpose of injuring a shareholder.  Otherwise the business is run the same as non-close corps.

Another way of saying the same thing:  Assuming a close corp and there is no agreement respecting compensation of the BOD, the BOD will make that determination.  The determination is an interested director transaction and must be fair to the corp.  because it is a close corp, it also cannot be made for the purposes of injuring a shareholder.  That is generally met when there is a reasonable business reason for making the decision, even if the decision happens to injure a shareholder (usually according to the shareholder),

Hypo – BOD of close corp meets to decide its own compensation.  There is no existing agreement re compensation.  BOD decides to cut the comp by 50%.  Was that done for some corp purpose or just to injure one board member – shareholder?  If there is a reasonable business reason for doing it, the unhappy shareholder will lose a breach of fiduciary duty suit.  The 50% remaining still must be fair to the corp.

So, if it is a close corp, and there is an agreement which sets the compensation, the agreement is enforceable.  The answer then to your question is – no.  There is no interested director issue.  If there is no agreement, the BOD will make the decision, and the duty of loyalty requires that the transaction be fair to the corp.

2 thoughts on “Question re Close Corps

  1. Professor,

    Are you talking about “statutory close corporations” as an exception to the rule about “closely held corporations” – those where the owners of the stock and the day to day managers are the same persons?

    From what I understand from your summary of the law of Bus. Org., in closely held corporations that are NOT statutory close corporations, shareholders agreements must be considered very carefully to the extent the shareholders are not making “consequential decisions” otherwise they will be unenforceable.

    Respectfully,

    Vahan D.

    Sent from my iPhone

    >

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    • The problem with the idea of close corps is that there is no definition. It’s generally what ever each state says or the courts in each state. In states that have codified the concept of a close corp, the close corp is called statutory, i.e., created or defined by statute. In close corps, shareholders agreements are enforceable. Otherwise, the corp is run by the BOD. The shareholders agreement may only cover certain stuff like salaries or job descriptions. The rest of the decisions then are made by the BOD.

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