What are the characteristics of a close corporation? My cousins and siblings are collaborating to establish a clothing company. We were advised by our suppliers that we should set up a close corporation. We’d like to know if this is appropriate for our planned business venture. We hope you can advise us on this matter. Thank you!
According to the Corporation Code of the Philippines, a corporation is an artificial being created by operation of law, having the right of succession and the powers, attributes and properties expressly authorized by law or incident to its existence (Section 2, Title 1). From this definition, we can see that the nature and attributes of a corporation are primarily defined and dependent on what the law allows and provides for. That being said, a close corporation is a type of corporation recognized by law that has its own distinct features.
The law defines a close corporation as:
“Section 96. Definition and applicability of title. – A close corporation, within the meaning of this code, is one whose articles of incorporation provide that: (1) All the corporation’s issued stock of all classes, exclusive of treasury shares, shall be held of record by not more than a specified number of persons, not exceeding twenty (20); (2) all the issued stock of all classes shall be subject to one or more specified restrictions on transfer permitted by this title; and (3) The corporation shall not list in any stock exchange or make any public offering of any of its stock of any class. “Notwithstanding the foregoing, a corporation shall not be deemed a close corporation when at least two-thirds (2/3) of its voting stock or voting rights is owned or controlled by another corporation which is not a close corporation within the meaning of this code.
“Any corporation may be incorporated as a close corporation, except mining or oil companies, stock exchanges, banks, insurance companies, public utilities, educational institutions and corporations declared to be vested with public interest in accordance with the provisions of this code.
“The provisions of this title shall primarily govern close corporations: Provided, that the provisions of other titles of this code shall apply suppletorily except insofar as this title otherwise provides” (Corporation Code of the Philippines).
It can be seen from this provision that the salient features of a close corporation are: the restriction on its stocks against being listed in any stock exchange or public offerings; the limitation as to the number of issued stocks, which should not be held by more than 20 stockholders; and the requirement for a restriction against transfer of stocks.
These peculiar features of a close corporation are brought by the manner in which a close corporation is managed. Close corporations are often run by family members wherein the management of the corporation is purposely restricted within the family or a small circle of trusted individuals. While stock holders of a regular stock corporation separately leave the management duties to its board of directors, the stock holders of a close corporation also act as the board of directors since they themselves manage the close corporation. Thus, there exists a common identity between the stock holders and the corporate manager in a close corporation (Hector S. De Leon, The Corporation Code of the Philippines Annotated 2002).
This manner of operation in a close corporation relates to the features found in this type of corporation. The restriction against public offering of the stocks of a close corporation serves to ensure that only those within the circle of trusted individuals maintains a stake in the corporation. The same reason applies as to the limitation on issued stocks which should not exceed twenty (20) stock holders. This is instituted to preserve the close-knit characteristic of the owners of a close corporation. Similarly, the requirement of having a restriction over transfers of the stocks is meant to ensure that the control of the corporation is not easily transferred from one hand to another to avoid substantial change in the management and control of the corporation.
In summary, these features of a close corporations provide the benefit of maintaining the control of the corporation within the close group of people owning and managing it. In addition, establishing a close corporation provides the advantage of having limited liability of a corporation while at the same time entitling stockholders the opportunity to directly manage the affairs. (Jose Jesus G. Laurel, Corporation Law Simplified, 2006) Therefore, incorporating a close corporation is a suitable medium for your desire to conduct business with your family members.
Again, we find it necessary to mention that this opinion is solely based on the facts you have narrated and our appreciation of the same. The opinion may vary when the facts are changed or elaborated.
We hope that we were able to enlighten you on the matter.
Editor’s note: Dear PAO is a daily column of the Public Attorney’s Office. Questions for Chief Acosta may be sent to firstname.lastname@example.org