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Drafting Shareholders’ Agreements with Stock Transfer Restrictions and Buy-Out Provisions

The following rules be followed when preparing a shareholders’ agreement con­taining stock transfer restrictions, buy-out provisions, and related matters:

(1)    The parties to the agreement should be explicitly identified and should include the corporation.  To render the agreement enforceable against the corporation, it is important to include it as a party, even if it has no options to exercise or explicit duties to perform.  The successors in interest of the participants and the corporation should also be included as parties.

(2)    The business purpose of the agreement should be explicitly set forth.

(3)    The consideration for the agreement should be explicitly described.  This rule should be followed even if, as is often the case, the consideration consists of the mutual obligations and promises of the parties.

(4)    Both the restrictions imposed and the types of transfer of the stock to which the restrictions apply should be clearly and unambiguously described.  In defining the types of transfers to which the restrictions apply, it is important to state whether the restrictions apply to pledges or other secu­rity-type transfers, transfers by operations of law, gifts, and transfers by reason of death or incom­petency.

(5)    The valuation figure or formula should be given or described in detail.

(6)    Any buy-out or option provisions should be thoroughly described, and the duties of all parties with respect to such provisions should be clearly delineated.

(7)    Any funding provisions included in the arrangement should be set forth, together with the duties and obligations of all parties with respect to these provisions.  A list of all life insurance policies provided under the agreement should be included.

(8)    Provisions should be made for the amendment and termination of the agreement.

(9)    If the agreement is to provide disability buy-outs for disabled participants, a definition of disability and the amount and source of any disability insurance should be set forth.

(10)    The state whose laws are to govern the agreement should be stated.

(11)    Especially in community property states, the written consent of the participants’ spouses to the agreement should be obtained.  This is particularly necessary in agreements containing buy-out provisions in the event of the death or disability of a participant.

(12)    The stock certificates of all stock subject to the agreement should contain an appropriate notice of the transfer restrictions.

(13)    The participants should be required to take the steps necessary to reconcile their personal estate documents (wills, trusts, etc.) with the provisions of the agreement.

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How to Keep Corporate Minutes

It is important that all business participants know how to keep corporate minutes.  In most small business corporations the shareholders, directors, and officers are the same persons, and more often than not there is no day-to-day differentiation between what they do in their different capacities.  In many such corporations formal meetings are not held, bylaw requirements are ignored (if, indeed, they even exist), and only fragmentary records are kept.  While such practices may have no adverse affect on the corporation or its participants early in the life of the corporation, in the long run they can lead only to problems, even for a one-person corporation.

Disregarding the distinctions between shareholders and directors or officers may result in the participants being personally liable for corporate debts.  Without adequate records, it may be difficult for the corporation to obtain financing in its own name, and an Internal Revenue Service audit could result in disaster.  Should disputes later arise, either between the individual corporate participants or between the corporation and others, the lack of formal records and a failure to follow the required corporate rituals may again result in needless confusion and expense.  If the business participants wish to form a corporation, it is important that they observe, on paper at least, the traditional corporate distinctions between shareholders, directors, and officers, and that they maintain records sufficient to sustain the corporation’s account on matters of importance.

In most states a corporation is required by law to keep as permanent records minutes of all shareholder and board of director meetings, including committee meetings, a record of all shareholder and board of director action taken without a meeting, a record of its shareholders, and appropriate accounting records.  In addition, in many states a corporation is required to keep at its principal office copies of its articles of incorporation (including all amendments), bylaws (including all amendments), all board of director resolutions creating classes or series of stock, all written communications to shareholders made within the last three years, a list of the names and addresses of its directors and officers, and the most recent annual report filed with the state filing official.  The corporate records are required to be kept in a written form or in a form capable of conversion into written form within a reasonable time.  In addition, a corporation that files a federal tax or informational return is required by the tax laws to maintain permanent books and records establishing the income, deductions, credits, and other matters reported in a federal tax return.  See Treasury Reg. 1.6001-1(a). 

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Piercing the LLC Veil

Piercing the LLC Veil.

It is now well established in most states that the veil piercing doctrine applies to limited liability companies.  See, e.g., Westmeyer v. Flynn, 889 N.E.2d 671, 676-77 (Ill. App. 1st Dist. 2008) (holding Delaware law applies doctrine of corporate veil piercing to limited liability companies).  In order to pierce the llc veil (under the corporate veil piercing doctrine), it must be shown that: (1)  There is such a unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist, but the corporation is, instead, the alter ego of one or a few individuals; and (2)  If observed, the corporate form would sanction a fraud, promote injustice, or result in an inequity.

Significant factors in determining whether this test has been met include: (1) undercapitalization of a close corporation; (2) failure to observe corporate formalities; (3) siphoning of corporate funds by the dominant shareholder; (4) nonfunctioning of other officers or directors; and (5) the use of the corporation as a facade for operations of the dominant shareholder.  See, e.g., Ditty v. CheckRite, Ltd., Inc., 973 F. Supp. 1320, 1335-36 (D. Utah 1997).websm-Small-Business-Package

Some state statutes explicitly apply corporate veil piercing to limited liability companies.  See, e.g., C.R.S. § 7-80-107; Minn. Stat. Ann. § 322B.303.  Other statutes imply the doctrine may apply by stating that members do not lose limited liability merely by failing to comply with appropriate formalities.  ULLCA § 303(b).  However, most courts that have considered the issue apply the corporate veil piercing doctrine to LLCs, even in the absence of a statute.  Westmeyer v. Flynn, 889 N.E.2d 671, 676-77 (Ill. App. 1st Dist. 2008) (holding Delaware law applies doctrine of corporate veil piercing to limited liability companies). For more information on piercing the limited liability company veil, see Argyle’s Small Business Handbook.