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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.'

 

§ 202. Restrictions on transfer and ownership of securities.

(a) A written restriction or restrictions on the transfer or registration of transfer of a security of a corporation, or on the amount of the corporation's securities that may be owned by any person or group of persons, if permitted by this section and noted conspicuously on the certificate or certificates representing the security or securities so restricted or, in the case of uncertificated shares, contained in the notice or notices sent pursuant to § 151(f) of this title, may be enforced against the holder of the restricted security or securities or any successor or transferee of the holder including an executor, administrator, trustee, guardian or other fiduciary entrusted with like responsibility for the person or estate of the holder. Unless noted conspicuously on the certificate or certificates representing the security or securities so restricted or, in the case of uncertificated shares, contained in the notice or notices sent pursuant to § 151(f) of this title, a restriction, even though permitted by this section, is ineffective except against a person with actual knowledge of the restriction.

(b) A restriction on the transfer or registration of transfer of securities of a corporation, or on the amount of a corporation's securities that may be owned by any person or group of persons, may be imposed by the certificate of incorporation or by the bylaws or by an agreement among any number of security holders or among such holders and the corporation. No restrictions so imposed shall be binding with respect to securities issued prior to the adoption of the restriction unless the holders of the securities are parties to an agreement or voted in favor of the restriction.

(c) A restriction on the transfer or registration of transfer of securities of a corporation or on the amount of such securities that may be owned by any person or group of persons is permitted by this section if it:

(1) Obligates the holder of the restricted securities to offer to the corporation or to any other holders of securities of the corporation or to any other person or to any combination of the foregoing, a prior opportunity, to be exercised within a reasonable time, to acquire the restricted securities; or

(2) Obligates the corporation or any holder of securities of the corporation or any other person or any combination of the foregoing, to purchase the securities which are the subject of an agreement respecting the purchase and sale of the restricted securities; or

(3) Requires the corporation or the holders of any class or series of securities of the corporation to consent to any proposed transfer of the restricted securities or to approve the proposed transferee of the restricted securities, or to approve the amount of securities of the corporation that may be owned by any person or group of persons; or

(4) Obligates the holder of the restricted securities to sell or transfer an amount of restricted securities to the corporation or to any other holders of securities of the corporation or to any other person or to any combination of the foregoing, or causes or results in the automatic sale or transfer of an amount of restricted securities to the corporation or to any other holders of securities of the corporation or to any other person or to any combination of the foregoing; or

(5) Prohibits or restricts the transfer of the restricted securities to, or the ownership of restricted securities by, designated persons or classes of persons or groups of persons, and such designation is not manifestly unreasonable.

(d) Any restriction on the transfer or the registration of transfer of the securities of a corporation, or on the amount of securities of a corporation that may be owned by a person or group of persons, for any of the following purposes shall be conclusively presumed to be for a reasonable purpose:

(1) Maintaining any local, state, federal or foreign tax advantage to the corporation or its stockholders, including without limitation:

a. Maintaining the corporation's status as an electing small business corporation under subchapter S of the United States Internal Revenue Code [26 U.S.C. § 1371 et seq.], or

b. Maintaining or preserving any tax attribute (including without limitation net operating losses), or

c. Qualifying or maintaining the qualification of the corporation as a real estate investment trust pursuant to the United States Internal Revenue Code or regulations adopted pursuant to the United States Internal Revenue Code, or

(2) Maintaining any statutory or regulatory advantage or complying with any statutory or regulatory requirements under applicable local, state, federal or foreign law.

(e) Any other lawful restriction on transfer or registration of transfer of securities, or on the amount of securities that may be owned by any person or group of persons, is permitted by this section.

8 Del. C. 1953, § 202; 56 Del. Laws, c. 50; 56 Del. Laws, c. 186, § 11; 64 Del. Laws, c. 112, §§ 19, 20; 72 Del. Laws, c. 123, § 4.;

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