- “Close Corporation”: Probably Not The Right Choice
- March 15, 2016 | Author: James H. Gulseth
- Law Firm: JGPC Business & Corporate Law - Pleasanton Office
One type of entity people sometimes ask us about is the California statutory “close corporation.” In general legalese a “close corporation” means a closely held corporation, a corporation that has only a few shareholders, usually people who work for the corporation.
But there is a California statutory creation for small closely held (small number of shareholders) corporations created by the California legislature in the early 1990’s for people who wanted their corporation that functioned like a general partnership. A California corporation is created as a statutory “close corporation” when sentences similar to the following are included in the Articles of Incorporation; “This corporation is a close corporation”, and “The corporation’s issued shares shall be held by not more than 35 shareholders”.
The creation of the limited liability company option by the California legislature in the mid 1990’s eliminated the much of the motivation to use the California statutory “close corporation” option.
In the 1990s many people were interested in the “close corporation” because they were told that the “close corporation” was simpler to operate than a regular corporation. For example, the “close corporation” statutes did not require shareholders and directors to do things like hold annual meetings or keep annual shareholder and director minutes or actions.
But the reality was and is that the California statutory “close corporation” is usually not the best choice of entity because it can be a very dangerous entity to use for a number of reasons
Why you probably shouldn’t use a “close corporation”
The statutory framework for the California statutory “close corporation” is not organized well and the laws that apply to “close corporations” are difficult to find. These provisions that apply to the “close corporation” are scattered throughout various corporate code sections. This can make it rather tricky to know when the normal corporate provisions don’t apply and are superseded by a special law that only applies to a statutory “close corporation”.
A major part of the problem with using the “close corporation” entity is that the attorneys who formed them did not form them properly. Of the hundreds of statutory “close corporations” I have run across in my years of practice, probably only one or two were properly formed. Attorneys who formed these entities usually used formation documents that were designed for regular corporations and which had provisions contrary to the statutory “close corporation” laws.
And when these “close corporations” are properly formed, the special “close corporation” statutory provisions are quicksand traps that can create huge hidden problems in operating a statutory “close corporation”.
You and your attorney may never be aware that these problems exist until you run into them and some legal problem develops that you never anticipated.
Why an LLC is probably a better choice for you
People still use statutory “close corporations” because they are still marketed by certain lawyers and law firms as the best new thing in the law.
But the reality is that a limited liability company is usually a better choice and a much safer entity to use than a statutory “close corporation”.
The LLC is a very flexible form of business entity. It can be structured to operate however you wish. If you want an LLC to function like a general partnership, you just need to set up your operating agreement properly to provide for that.
But remember, each fact situation is different, and a business structure that might work for others may be a disaster for you.