When Corporate Form of a Closely Held Corporation becomes Headline News -- Talking Corporate Structu

July 9, 2014 by Kristina M. Tridico, Partner
To be a closely held corporation or not to be, and why does it matter? The recent ruling of the Supreme Court of the United States in Hobby Lobby[i] is drawing national and international attention because of the reproductive rights and religious issues associated with the subject matter of the decision.  It is also highlighting a corporate law structure that involves firms in which a small group of shareholders control the operating and managerial policies of the firm. As over 85 – 90 percent of all businesses in the United States are closely held the Hobby Lobby decision has the potential to affect tens of millions of employees in the United States.[ii]
What is a closely held corporation? Generally, the Internal Revenue Service defines a "closely held corporation" as a corporation that:
  • has more than 50% of the value of its outstanding stock owned (directly or indirectly) by 5 or fewer individuals at any time during the last half of the tax year; and
  • is not a personal services corporation.[iii] 
The result of the Hobby Lobby case is that the ruling exempts such "closely held corporations" from providing insurance coverage of contraceptives if such provisions violate the company owners' religious beliefs.  Hobby Lobby is organized as a for-profit corporation under Oklahoma law.[iv]  Research indicates that the majority of closely held corporations are incorporated in the state of its primary headquarters, or, as many corporations, in the State of Delaware.  In the case of Hobby Lobby, the owners of Hobby Lobby receive the benefits of a corporation under Oklahoma law, but retain the ability to determine company policy on the sincerely held religious beliefs of the companies' owners.[v] The majority opinion stated as a basis for its review of the United States Department of Health and Human Services regulations promulgated under the Patient Protection and Affordable Care Act of 2010 that it rejected the HHS argument that the owners of the companies forfeited all Religious Freedom Restoration Act[vi] protections when they decided to organize their businesses as corporations rather than sole proprietorships or general partnerships.

What does that mean for your organization? If you are a closely held corporation and/or a family business (many closely held firms are family businesses, where the link between the family and the business has a mutual influence on company policy and the interests and objectives of the family) you should consider the laws of the State in which you are incorporated to consider if your lawful purpose or act includes the pursuit of profit in conformity with the owners' religious principles. 
In addition, as the Court notes, the "owners of closely held corporations may – and sometimes do – disagree about the conduct of business."[vii]  You can evaluate the possibility of disputes among the owners of the corporation, relating to religion or otherwise, and consider in advance how the owners want to establish the governing structure to resolve those disputes. For instance, addressing the concerns in the certificate or articles of incorporation of the company or in the by-laws.  "Courts will turn to that structure and the underlying state law in resolving disputes."[viii] Even if your organization does not intend to claim a religious exemption from providing coverage of contraception, the Hobby Lobby case provides a nudge to consider how your owners will address disputes and consider your mission in advance of a difficult profit maximization discussion.
For additional information please contact Kristina M. Tridico at kristina.tridico@icemiller.com or any member of Ice Miller LLP's Business Group.

[i] Burwell, Secretary of Health and Human Services, et al. v. Hobby Lobby Stores, Inc. et al., No l3-354, June 30, 2014, 573 U.S. __ (2014). Together with No. 13-356, Conestoga Wood Specialties Corp. et al. v. Burwell, Secretary of Health and Human Services, et al., on certiorari to the United States Court of Appeals for the Third Circuit.
[ii] See How Many People Could the Hobby Lobby Ruling Affect http://www.state.com/blogs/moneybox/2014/06/30/hobby_lobby_supreme_court_ruling and Closely Held Corporations
[iii] See OMB Study 1545-1432,  http://www.irs.gov/Help-&-Resources/Tools-&-FAQs/FAQs-for-Individuals/Frequently-Asked-Tax-Questions-&-Answers/Small-Business,-Self-Employed,-Other-Business/Entities/Entities-5; see also IRS Instructions for Schedule PH (Form 1120) for more information and a list of exemptions.  Generally a "personal service" corporation is one where an employee-owner substantially performs the service, such as accounting, actuarial science, architecture, consulting, engineering health/veterinary services, law firms and the performing arts.
[iv] Conestoga Wood Specialties Corp. is organized under Pennsylvania law as a for-profit corporation.
[v] Hobby Lobby, pg. 1. While many commentators are noting that religious beliefs need not be "sincerely held" to be protected under the laws of the United States, the Opinion of the Court uses this terminology.
[vi] 107 Stat. 1488, 42 U.S.C. §2000bb et seq.
[vii] See Hobby Lobby, pg. 30, 1 Treatise of the Law of Corporations §14:11.
[viii] See Hobby Lobby, pg. 31.

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