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An Introduction to the Law of Corporations: Cases and Materials
Resource 2 . 6 . 6
4 minutes

DGCL Sec. 202 - Restrictions on transfer of stock

Brian JM Quinn

When a board issues new shares, in addition assigning voting rights to the shares, the board may also, pursuant to §202, place restrictions on the ability of stockholders to transfer or sell such shares.  Requirements for such restrictions to be valid require, first, actual knowledge by the stockholder of such restrictions (conspicuously noting the restrictions on the stock certifcate will be sufficient evidence of actual knowledge) and, second, that the restrictions on ownership or transfer are 'reasonable'. Violations of such restrictions will result in the transferee having no legal or equitable title to the stock.

Restrictions on stock ownership are common in private companies. There are a variety of common restrictions that are often included in the private company context, including rights of first refusal, buy-sell agreements, or automatic sales/transfers. All of these restrictions have the effect of controlling access to ownership of a corporation's stock.

Under §202(c)(5), the certificate may restrict designated persons or classes of persons from owning shares. This kind of restriction is common in closely held private companies where the intention is to ensure control of the company's stock is maintained by a family. Additionally, corporations operating in some business areas (eg. national security, media) may be under legal requirements to ensure the domestic citizenship pr residency of stockholders. Consequently, citizenship requirements on the ownership of stock are not unreasonable for some businesses. Another common restriction prevents accumulation of shares by any one stockholder. For example, the Green Bay Packers restrict any one shareholder from owning more than 5% of the outstanding shares of the corporation.

The ability of boards to design restrictions on the transfer of stock is fairly broad. Of course, this power is not without limits. Such restrictions are subject to 'reasonableness' limitations. Restrictions against selling stock to based on racial or gender categories run afoul of Federal law and thus would not be 'reasonable.'

 

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