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The Statutory Close Corporation

When choosing an organizational form, special note should be made of a particular type of corporation--the statutory close corporation. In a strict sense, this is not a separate business form. It is, instead, a corporation that is regulated by a special state law. This statute, a supplement to a state's regular corporation statutes, governs most of the operations of this type of corporation.

The close corporations statutes relax many of the formalities normally applicable to a corporation. Basically, these statutes allow the corporation to be operated in a way similar to an limited liability company (LLC). The statutory close corporation may do away with a board of directors. Generally, shareholders do not have to hold meetings. Shareholders can run the corporation, by way of a shareholder agreement, which is similar to an LLC or a partnership operating agreement. Shareholders can agree to have one vote per person, as in a partnership, as opposed to one vote per share, if they so desire.

Warning

Don't confuse a statutory close corporation with the generic terms "close corporation" or "closely held corporation." The statutory close corporation is created under a supplemental state corporation statute.

The generic term close corporation is often used to refer to any corporation formed under a state's regular corporation statutes where the stock is not traded on an exchange, such as the New York Stock Exchange. That a corporation is called a close corporation does not mean it is a statutory close corporation. Unless the corporation is created in state that allows this option, with the required special language in the articles of organization, it will not be a statutory close corporation.

By contrast, in a regular corporation, directors and shareholders must hold regular meetings. Formal requirements exist regarding notice, quorums, waiving meetings, etc. The elimination of these and other formalities by the statutory close corporation statutes has important asset protection implications.

A failure to follow the required formalities can form the basis for a court piercing the veil of limited liability, and imposing unlimited, personal liability on the shareholders of a regular corporation. With the reduction or absence of such formalities, the likelihood of this doctrine being applied is reduced significantly. The statutory close corporation shares this advantage with the LLC.

Where the special statute is silent on an issue, the regular corporation statutes apply. Thus, the statutory close corporation will be subject to restrictions on retained earnings, dividends and other aspects of its operations that will not apply to the LLC.

Moreover, even the statutory close corporation statutes do not eliminate the fact that personal creditors of the owner will be able to attach, and then vote, the shares in favor of a liquidation of the business. In many states this cannot occur in the case of an LLC.

Nevertheless, in very limited cases, a corporation may offer advantages over the LLC in terms of self-employment tax and possibly fringe benefits (see our detailed discussion comparing the LLC and corporation). Therefore, if you do intend to form a corporation, generally you should form it as a statutory close corporation. (An exception to this rule is the business owner who intends a broad-based public offering of securities or one that will exceed the 30 or 50 shareholder limits in effect in the states' statutory close corporation statutes).

The following jurisdictions recognize the statutory close corporation:

States Allowing Statutory Close Corporations
Alabama Kansas South Carolina
Arizona Maryland Texas
Delaware Missouri Vermont
District of Columbia Montana Wisconsin
Georgia Nevada Wyoming
Illinois Pennsylvania  

In addition, California, Maine, Ohio and Rhode Island have provisions within their regular corporation statutes that permit election to statutory close corporation status, but do not have special statutory close corporation statutes.

If your home state does not allow for the creation of a statutory close corporation, you can simply form the entity in one of the above states, and then register it to do business in your home state. When choosing a state, the laws of the state in which the entity is formed will govern its legal affairs. The benefits derived from forming a statutory close corporation in one of these states, and then registering the corporation in the home state, will usually outweigh any additional costs involved.

The special statutory close corporation statutes require that there be a limited number of shareholders (under 30 or, in some states, under 50), and that certain transfer restrictions appear on the stock certificates. The statutory close corporation must be formed under the special statute with particular language used in the articles of organization. A regular corporation also can be converted to a statutory close corporation in states that allow this type of corporation.

The LLC generally will provide greater asset protection and other benefits. Our section comparing the corporation and the LLC discusses how the small business owner can combine the LLC and the statutory close corporation.