Transfer Of Shares

Corporate Formalities Matter in the Transfer of Shares of Family-Owned Businesses Family Business Perspectives

For businesses across America, especially small, family-owned businesses, shares in family-owned businesses are often transferred between family members, whether through a sale or gift during a shareholder’s lifetime or through inheritance after an owner’s death. The parties to such a transfer should make sure it is properly documented to reflect the intention to transfer the shares. This reality is something business owners neglect and fail to have a plan in place for any transfer until it is too late. Typically, the documentation for any such transfer is done through the transferor’s delivery of a signed share transfer instrument and the company’s issuance of a share certificate in the new holder’s name. In the absence of proper documentation, the transferee may not have a valid claim to the share ownership. Even worse, the company may find itself in the middle of an ownership dispute if the transferee has attempted to acquire the shares through fraud or deceit.

Courts are starting to take consistent positions on this matter across the United States. A California Court of Appeal recently faced such a situation in Patel v. Clocktower Inn, Inc. The company owned a hotel in California. The hotel was managed by members of the Patel family. One owner, lets call the owner “Owner A,” owned 12 of the shares of the company’s stock, equaling 50%, while three of Owner A’s nephews, collectively, owned the other 50%. Owner A’s two sons worked for the company but did not own any shares. Owner A was in his late seventies and did not read English. Instead, he relied upon the nephews to explain company matters to him Unfortunately, as the Court later noted, “formal corporate procedures were rarely used [and] [b]usiness decisions were often made orally and without formal board of directors meetings [and recorded minutes”] to properly justify sanctioned corporate action.

Owner A either told his sons or led them to believe that Owner A’s shares in the company would pass to them upon his death. According to the Court, however, the nephews did not want to wait until Owner A’s death to claim some of the stock.  In order to do so, the nephews caused the company to hold a shareholders’ meeting pursuant to signed waivers and a notice of consent. The minutes created in connection with that meeting stated that the shareholders “were informed” that Owner A had agreed to transfer three shares each to the nephews “as a gift” and instructed the company’s secretary to issue new shares. Owner A signed the shareholder meeting minutes at the nephews’ urging but without reading or understanding its contents.

The company’s by-laws required an endorsement to effectuate a transfer of any company shares. It was undisputed, however, that Owner A never signed any stock transfer certificate. Instead, when Owner A finally learned from one of the sons that six of his shares were being transferred, Owner A objected and refused to make any transfer. Nonetheless, based upon the supposed transfer, Owner A’s nephews, now ostensibly holding a majority of the company’s shares, took over the management of the company. Owner A then filed a declaratory judgment action against the nephews, and the company, asserting that he never intended to transfer any of his shares and that the claimed transfer to his sons was therefore ineffective.

At trial, the court rejected the nephews’ contention that the shares were effectively transferred through the statement in the shareholder meeting minutes that Owner A had transferred the shares “as a gift.” The trial court also noted that, “[b]eing gratuitous and without consideration, the intention stated in the minutes could not constitute an enforceable contract.” Instead, Owner A “remained free to change his mind until the transfer was completed.” Where Owner A never signed any transfer certificate/assignment and stated that he never intended to transfer the shares to his sons during his life, the transfer was never completed. The trial court thus entered declaratory relief in Owner A’s favor, providing specifically that the minutes did not alter the share ownership and that the allocation of shares remained as it had been before the minutes were created, with Owner A continuing to own 50% of the company’s shares.

The nephews tried to argue that the meeting minutes were an enforceable contract; however, Owner A could not read the minutes nor were they translated for him before he signed the minutes; that Owner A never agreed to transfer his shares to anyone during his lifetime; and that the nephews deceived Owner A into signing the minutes of the shareholder meeting.

This case serves as a reminder that corporate formalities matter when transferring shares of family-owned businesses. Not only do you have to keep the formalities (be certain you have intercompany agreements and keep track of minutes and resolutions), but if the by-laws or other governance documents require delivery of specific signed documents to the company in order to effect a transfer, both the company and the transferee should make sure the transferor has signed and delivered all such documents in accordance with the necessary requirements. Also, while children of family- business owners may wish to speed up their expected inheritance of certain shares in the company, they should not try to avoid the required corporate formalities for a transfer through deception or other maneuvers designed to give the appearance of a present intent to transfer where none exists. Corporate formalities will reign supreme as a method to keep consistency in corporate practice for disputes. Such misconduct will increase the risk that the supposed transfers will be deemed invalid if later challenged by the shareholder of record. It is also entirely likely that, in the face of such misconduct, the shareholder will reconsider his or her estate plan and disinherit the offending heirs entirely.