Part 10- Corporations, Chapter 42: Organization and Financial Structure of Corporations, Doc 1

Here is a summary addressing the client’s concerns about liability, share transferability, and a recommended buy-sell agreement for incorporating a fine art business. 1. Reducing Personal Liability on Pre-Incorporation Contracts Since your client and associates have not yet incorporated, signing contracts to purchase valuable paintings exposes them to personal liability as the business is not yet a legal entity. I recommend they incorporate the business before signing any purchase agreements. This way, the corporation—not the individual promoters —will bear contractual obligations, thereby reducing personal liability. If immediate incorporation is not feasible, they could add a clause in the purchase contracts specifying that liability will transfer to the corporation upon its formation and adoption of the contract. Another approach is to include an automatic novation clause, which explicitly states that the promoters’ liability ceases once the corporation adopts the contract. This mitigates their risk until the corporation formally exists. 2. Share Transferability Concerns Your client is interested in incorporating partly because she believes a corporation’s shares are freely transferable. However, in a closely held corporation (with a small group of shareholders), free transferability is generally limited both legally and practically:   Legal Constraints: State corporation laws for closely held corporations often restrict share transfers to protect the interests of other shareholders. Transfers without shareholder approval could impact the intended management and ownership structure. Practical Concerns: Even if legally permissible, free transferability could lead to control or decision-making disruptions, particularly if a shareholder sells to an outside party not aligned with the corporation’s vision or values. This is especially pertinent for a business that requires trust and shared decision-making in acquisitions and sales. To address these issues, the shareholders should establish a buy-sell agreement to control share transfers. 3. Recommended Buy-Sell Agreement for Transferability Issues A buy-sell agreement outlines the terms under which shareholders can transfer or sell their shares. Here’s a suggested structure for the agreement, addressing key transferability issues:      Right of First Refusal: If a shareholder wants to sell shares, they must first offer them to the other shareholders or the corporation before selling to an outside party. This protects the group from unapproved transfers. Buyout Terms upon Departure: Define procedures for a buyout if a shareholder leaves the business voluntarily or involuntarily (e.g., retirement, disability, or death). This could include valuation methods for shares, buyout schedules, and financing terms. Mandatory Buyout Triggers: Establish specific events that would require the sale of shares back to the corporation or other shareholders, such as bankruptcy, divorce, or the incapacity of a shareholder. Valuation Methodology: Define how the shares will be valued upon transfer. Common methods include fair market value, book value, or an agreed-upon multiple of earnings. A neutral party, such as a certified appraiser, could also determine the share value. Restrictions on Transfer to Third Parties: Limit transfers to outsiders by requiring unanimous board or shareholder approval, ensuring that only approved parties can enter the business. By incorporating these provisions, the buy-sell agreement will ensure the business remains under the control of the original associates, even if one of them decides to sell their interest. This agreement will also clarify exit terms, safeguarding all parties involved.