A closely held corporation is a corporation which is owned by an individual or small group of shareholders, who are often members of the same family. Shares of a closely held corporation are generally not traded in the securities market(s). Just as in typical corporations, shareholders of a closely held corporation owe each other an implied covenant of good faith and fair dealing.
Because of its small number of owners, a closely held corporation may be significantly affected by the actions of its minority shareholder(s). As a result, causes involving shareholders of such corporations sometimes discuss whether shareholders owe each other a heightened standard of duties. For example, jurisdictions like Massachusetts have held that stockholders in a closely held corporation owe one another substantially the same fiduciary duties as owed between partners in a partnership because of the "fundamental resemblance" between closely held corporations and partnerships. Namely, this standard is that of "utmost good faith and loyalty."
This standard requires that shareholders refrain from knowingly taking actions that would harm other shareholders, in light of the long-term policy understandings among the shareholders. For example, the First Circuit has held that where a shareholder sells his shares for personal benefit, when knowing that doing so would destroy the particular tax status of the corporation and financially harm the corporation and other shareholders, he has breached his fiduciary duties. On the other hand, jurisdictions like California have refused to enforce special duties beyond those owed between shareholders of an ordinary corporation.
Additionally, because of the interest in keeping ownership of a closely held corporation to a select group, transfers of stock are often restricted by means such as buy-sell agreements, which stipulate how and to whom existing shares may be transferred upon the original shareholder's death or exit.
Lastly, minority shareholders in a closely held corporation may file a direct or individual action against another shareholder. This is an exception to the rule that such actions must generally be brought under a shareholder-derivative suit. Courts have the discretion in permitting this type of exception out of recognition that successful derivative suits award the corporation. However, in the context of closely held corporations, where control and compensation between the shareholders and the corporation are closely connected, derivative suits may unjustly benefit the majority shareholders. As a result, allowing individual action between shareholders provides an equitable means for minority shareholders to seek redress.
[Last updated in December of 2021 by the Wex Definitions Team]
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