Understanding Share Classification in a Private C Corp with Two Shareholders
In the context of a private C Corporation with only two shareholders, the question often arises: if there is no shareholder agreement, are all shares classified the same? The answer to this depends on various legal and procedural frameworks, primarily the company’s charter and, to a lesser extent, any shareholder agreements that may exist. This article aims to demystify the concept of share classification in such companies, focusing on the role of the charter and the impact of shareholder agreements.
Role of the Charter
The primary document governing the classification of shares in a corporation is the charter. In Delaware, this is known as the Certificate of Incorporation, while in other jurisdictions, it might be referred to as the Articles of Incorporation. The charter provides the foundational structure for the corporation, detailing the rights, preferences, limitations, and restrictions of any shares that the corporation may issue.
When a corporation is formed, the founders can choose to issue different classes of shares, such as common shares and preferred shares. Each class of shares may carry specific rights and obligations, such as different voting rights, dividend preferences, and liquidation rights. However, the mere existence of the charter is not enough to classify shares; the charter specifies the terms and conditions under which different classes of shares will operate.
The Importance of Shareholder Agreements
While the charter is the primary document that defines the rights of shares, a shareholder agreement can provide additional layers of specificity and control. A shareholder agreement is a contract between the shareholders themselves and can go beyond what is specified in the charter. It can include clauses that regulate how shares are to be managed, transferred, and voted on.
Even in the absence of a shareholder agreement, the charter can still provide some basic rights and protections for shareholders. However, in a two-person corporation without a shareholder agreement, it is likely that the charter will specify only a single class of shares. This is because there is no inherent reason for one group of shares to come with different rights or obligations than another, especially when there are only two shareholders involved.
Classifying Shares: Common vs. Preferred
The classification of shares into common and preferred is a common practice, but it is not a universal requirement. A company can choose to classify its shares in any manner it deems fit, either informally or as part of a formal shareholder agreement. For example, a company might define different classes based on the nature of the investment or the performance of the shareholder.
In a two-person corporation, without a shareholder agreement, the charter may automatically classify all shares as common shares. This is because the owners may not have detailed their specific needs and expectations through a detailed agreement. However, they can still define this informally or through a formal agreement if they wish to differentiate the rights and obligations of the shares.
Conclusion
Understanding share classification in a private C Corporation with only two shareholders requires a clear distinction between the legal framework provided by the charter and the flexibility offered by shareholder agreements. The charter is a foundational document that sets the stage for share classification, while shareholder agreements can add more specific terms and conditions.
Without a shareholder agreement, a private C Corporation with two shareholders is likely to have only one class of shares, commonly referred to as common shares. This is due to the lack of need for differentiating rights or obligations between shareholders, as the corporation is managed with minimal external constraints.