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Editorial 9 MIN READ

The close corporation, a decade in: still narrow, still useful

Ten years of LLC dominance, one 2019 round of Delaware housekeeping, and an estate-planning niche that will not die

The Editors
Staff, Incorporator.org
9 min read Updated
Contents 7 sections
  1. What the 2019 round of Delaware amendments did, and did not, do
  2. The form's status on paper, a decade after its effective eclipse
  3. The decline, by what we can honestly observe
  4. Where the form still earns its keep, three years shorter than it used
  5. Failure modes, a decade of the same ones
  6. The question we still get
  7. Sources

elaware logged 226,589 new entity formations in 2019, of which 165,910 were LLCs and 45,405 were corporations of any stripe. The number of new close corporations in that mix was, as it has been for several years running, a rounding error. The close corporation is a form whose statutory bones have not moved in a decade and whose market share keeps drifting toward zero.

We wrote about the form in October 2016 and again in June 2018 after TCJA. Twenty months later, the story is the same one, slightly further along.

What the 2019 round of Delaware amendments did, and did not, do

Delaware enacted its 2019 General Corporation Law amendments through Senate Bill 88, which Governor Carney signed on June 19, 2019, with an effective date of August 1, 2019. The bill is the ordinary annual tune the DGCL does every June: the Council of the Corporation Law Section of the Delaware State Bar Association drafts, the General Assembly passes, the Governor signs.

Close-corp practitioners scanning the 2019 bill for anything touching Subchapter XIV found nothing direct. Sections 341 through 356 came out of the session exactly as they entered it. What did change, and what reaches close corporations the way any other DGCL corporation is reached, sits in three places.

The most consequential is a new § 116, which creates a safe harbor for electronic signatures and delivery of documents under the DGCL or the governing documents of a corporation. A close corporation run by a shareholders' agreement under § 350 or § 351 now has a clean statutory anchor for signing consents, waivers, and corporate acts by electronic means. Many were doing this already under the Delaware Uniform Electronic Transactions Act; § 116 is belt and suspenders.

Section 232 was amended to let corporations default to email notice to stockholders, subject to any individual stockholder's written or electronic objection. For a close corporation with five stockholders who all work in the same building, this is immaterial. For a close corporation whose thirty holders are scattered by inheritance across three generations, it is a modest quality-of-life improvement on the old first-class-mail presumption.

Section 136 was amended to let a registered agent of a void corporation resign, and to impose additional certificate-of-resignation requirements. A close corporation that has gone void by failure to pay franchise tax can now lose its agent on the state's schedule rather than drift in the agent's accounts-receivable file. For close-corp shareholders who inherited their shares and forgot the Delaware tax hits every March 1, this is mostly a source of surprise letters.

Those are the 2019 touches: real, present, and not specific to Subchapter XIV. The close corporation sections themselves remain whatever they were in 1967, as variously amended through the 1990s, with the November 2017 reshuffle of § 391 filing fees (not part of the 2019 bill) still the last material fiscal adjustment to anything a close-corp forms-and-fees table cares about.

The form's status on paper, a decade after its effective eclipse

All three of the state frameworks we described in 2018 are still in place. Delaware's Subchapter XIV (8 Del. C. §§ 341 through 356) still requires the certificate of incorporation to state that the corporation is a close corporation, cap the number of record holders at a number not exceeding thirty under § 342(a)(1), subject all issued stock to one or more of the transfer restrictions permitted by § 202, and prohibit any public offering under the Securities Act of 1933. Sections 350 and 351 still validate shareholder agreements that run the company without a board. Section 354 still authorizes operating the corporation "as if it were a partnership" for governance purposes. Section 355 still lets the certificate grant a dissolution option.

California Corporations Code § 158 still defines a close corporation as one whose articles so state and whose issued shares of all classes are held by not more than a specified number of persons, not exceeding thirty-five. Spouses, single trusts, and single business entities still count as one shareholder. Exceeding the cap still flips the corporation out of close-corp status automatically.

Texas Business Organizations Code, Chapter 21, Subchapter O (§§ 21.701 through 21.732) still defines a close corporation as a for-profit corporation formed under or governed by that subchapter, still imposes no shareholder cap, and still lets the shareholders' agreement under § 21.714 cover the fifteen categories of governance matter the statute enumerates.

The statutes are stable. What is not stable is the count of entities choosing them.

The decline, by what we can honestly observe

The Delaware Division of Corporations does not publish new formations broken out by "close corporation" as a distinct line on Subchapter XIV. Its 2019 Annual Report gives the topline split we cited up top: 165,910 LLCs, 45,405 corporations, 13,513 LPs and LLPs, 1,761 statutory trusts, 226,589 total. Close corporations sit inside the 45,405, and every practitioner who watches this lane knows they are a small fraction of that fraction. The Division's own published count of close corporations has hovered around five thousand total entities on the rolls for most of the decade, against more than one million active LLCs as of 2019. The ratio is roughly one close corporation for every two hundred LLCs, and the gap widens every year.

Cook County, California, and Texas filings tell the same story qualitatively. California Secretary of State filings that carry the "close corporation" statement under § 158 are a tiny share of corporate formations. Texas close-corp elections under Subchapter O are likewise uncommon. No state has reversed that trend; a handful of states (Illinois, Georgia, South Carolina) have let their close-corp statutes fall into disuse without formally repealing them.

The arithmetic behind the decline is the one we described in 2016 and 2018. An LLC under any modern statute can reach the close-corp governance destination with an operating agreement, stays a single-layer pass-through by default under § 301.7701-3, and avoids the shareholder-cap failure mode that silently strips Subchapter XIV status when a second-generation heir pushes Delaware past thirty or California past thirty-five. For an operating business, the LLC is cheaper, simpler, and more forgiving. It also is not embarrassing to explain to a 2020 buyer's counsel, who has spent a career looking at LLC operating agreements and may never have read a § 350 management agreement.

Where the form still earns its keep, three years shorter than it used

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The narrow-use cases survive, with no new entrants and a familiar cast.

Estate and legacy planning for a closely held operating business whose family wants C-corp character remains the most common reason a sophisticated planner reaches for Subchapter XIV or § 158. The charter-level transfer restrictions survive a shareholder's death without relying on a separate agreement an executor might contest. For a family that has held a Delaware close corporation since the 1970s or 1980s, dissolution would be a taxable event and a governance project nobody wants. The form does what it was designed to do; the cost of leaving is higher than the cost of staying.

IRC § 1202 eligibility on a possible exit is the other durable reason. The qualified small business stock exclusion under § 1202, which lets a non-corporate taxpayer exclude up to 100 percent of gain on QSBS held more than five years (subject to the per-issuer cap of the greater of $10 million or ten times adjusted basis), is a C-corp benefit. A Delaware close corporation that has not elected S status, meets the gross-assets cap of $50 million before and immediately after issuance, and runs a qualified trade or business is a § 1202 issuer. The statute does not care that the charter invokes Subchapter XIV. For a planner building a family-controlled operating business with a conceivable exit horizon, the pairing of close-corp governance with § 1202 treatment is real, if narrow. The five-year holding period is the discipline the planner must sell.

Legacy S-corporations with accumulated-adjustments-account balances or built-in-gains exposure, where the shareholders would rather keep the existing corporate shell, still use close-corp status to run by shareholder agreement without dissolving. The post-TCJA landscape gave this cohort one more reason to sit still: § 1371(f) issues on an S-to- partnership conversion, which were new in 2018 and have not gotten easier.

State-tax quirks still favor the close corporation in a handful of jurisdictions where a close-corp filing draws better franchise, gross-receipts, or business-license treatment than an LLC doing the same activity. Those pockets have not grown. A practitioner in Pennsylvania, Louisiana, or Tennessee still has local reasons to keep the form on the options list; everyone else can skip the chapter.

Failure modes, a decade of the same ones

The sharp edges are where they were.

Delaware's thirty-holder cap and California's thirty-five-holder cap still flip a corporation out of close-corp status automatically when exceeded, with no filing, no notice, no grace period. The corporation whose second generation inherits into thirty-one holders wakes up the next morning a conventional corporation with Subchapter XIV boilerplate stranded in the certificate. The cure under 8 Del. C. § 348 (proceeding to prevent loss of status) is available, but it assumes someone noticed. In practice most do not.

Transfer restrictions still have to be reasonable to be enforceable under § 202. The charter-level notice solves the notice half of the enforceability test; the reasonableness half is fact-specific and has not meaningfully developed in the Court of Chancery since our 2016 piece. A restriction that amounts to an absolute prohibition, or that grants one party unfettered discretion with no cure mechanism, can still be struck.

Inattention remains the single most common way the form decays. A close corporation run by shareholder agreement, with no board and no annual meeting, drifts. Minutes lapse. Officer elections are forgotten. A 1987 shareholders' agreement sits in a drawer until a 2020 buyer's counsel asks for it, and no one can find the counterpart. The form rewards discipline. Small companies are not always disciplined, and multi-generational small companies are usually not disciplined enough.

The question we still get

If a founder walks into a practitioner's office in February 2020 and says someone has suggested forming a close corporation, the practitioner's first question is still why not an LLC. The answer is usually one of three things: the planner expects the entity to hold for a generation and wants C-corp character with charter-level transfer restrictions that survive death; the entity is a legacy S-corp whose shareholders want to stop acting like a conventional corporation without dissolving; or there is a state-tax artifact in a specific jurisdiction that favors the close-corp filing.

If none of those three explains the suggestion, the suggestion is probably wrong for 2020. The LLC has won the broad middle of the market, the 2019 DGCL amendments did not change the close-corp fact pattern, and the § 1202 planning angle is real but narrow. The form is still defensible; it is still not the default; and it is still, on the numbers, a choice that gets made less often every year.

Sources

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