Forming a Close Corporation in Ohio

Close Corporations are the entity of choice for successful family businesses.  Roughly 90% of all companies in the United States are closely held, according to a 2000 study by the Copenhagen Business School.  Close Corporations are formed the same way as with LLCs or general Corporations, but with some caveats.  Close Corporations must satisfy certain requirements imposed by Ohio law.  These requirements are imposed in order to protect minority shareholders, for the reasons discussed below.

What is a Close Corporation?

The Internal Revenue Service (IRS) defines a closely held corporation as one that has more than 50% of the value of its outstanding shares directly or indirectly owned by 5 or fewer individuals.  Family run businesses that span generations are usually organized as close corporations.  This is done in order to keep ownership of the company in the family, and provide for ownership and succession down through the generations.  However, because of the nature of close corporations, and also the nature of family conflicts that often occur in the running of close corporations, Ohio law has mandated certain protections for minority shareholders.  

Close Corporation Agreement

A close corporation can be organized as a LLC or a Corporation, however, it is more commonly organized as a Corporation.  A close corporation has a few additional formalities that it must go through in order to become a validated legal entity under the laws of Ohio.  Ohio Revised Code section 1701.591 requires close corporations to have a close corporation agreement.  This agreement must be approved by every single shareholder of the company.  Furthermore, close corporations cannot be listed on any national stock exchange and there are strict limits on the sale and exchange of shares in the company.  

Enhanced Obligations of Close Corporation Majority Shareholders

Closely held corporations are the entity of choice for family owned businesses because the law imposes such great restrictions on the sale and exchange of shares.  This basically ensures that the business stays in the family.  However, because of the nature of the restrictions on the sale and exchange of shares, the law imposes special obligations on majority shareholders.  

Usually with closely held corporations, members of a family both own and work at the company.  However, problems often arise when one member of the family wants to get out of the business or certain members of the family want one person out of the business in particular.  Because there is no real way to sell or exchange one's ownership shares in the company, there is sometimes the problem of someone having ownership of the company but having no way to cash it in, rendering the shares essentially useless to them.  Because of this, the law imposes certain requirements for the company to buy back shares from the shareholders.

With close corporations there has also been a history of oppression by majority shareholders.  The law in Ohio has special protections for minority shareholders for these reasons.  Often, an owner of the closely held company will both own shares and work at the company.  However, if the company does not ever issue dividends, then that owner's only source of income is from payroll.  There have been problems with majority shareholders firing minority shareholders from their positions and refusing to issue dividends.  This essentially 'freezes out' the minority shareholders to where they have no say in the business (because they are minority shareholders and always get outvoted) and no income.  That makes it so minority shareholders have no leverage to get the company to pay dividends, and as has happened in the past, the company will make the minority shareholders wait things out until they have no money and then the company will offer to buy back the shares at a minimal price.  

Exception to Employment At-Will Doctrine for Close Corporations

Due to the problems of attempts to "freeze out" minority shareholders by firing them from their positions and offering no dividends, Ohio carves out an exception to the employment at-will doctrine for close corporations.  Majority shareholders cannot terminate the employment of minority shareholders without a "legitimate business purpose."  Crosby v. Beam, 47 Ohio St.3d 105 (Ohio 1989).  Ohio law imposes on majority shareholders a greatly elevated fiduciary duty to the minority shareholders.  Majority shareholder must act with the "utmost good faith and loyalty" towards minority shareholders.  The majority shareholders breach this duty when they "utilize control of the close corporation to prevent the minority from having an equal opportunity in the corporation..."  Id.  This essentially means that control of the stock of the close corporation cannot be used to give the majority benefits that the minority do not also share.  

The Attorneys at Harris & Engler Work With Close Corporations in Order to Reach Effective Solutions

If you are a shareholder in a close corporation and are involved with a dispute with the other shareholders the attorneys at Harris & Engler can help.  Whether you want to set up a close corporation with built in protections, need to change the corporate structure of your company, or are having a dispute with shareholders, contact an attorney at Harris & Engler by calling (614) 610-9988.


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