Now that we are moving more and more into electronic records, can we dispense with stock certificates? Yes, we can, but for most closely held corporations, it may not be worthwhile to change to certificate-less stock.
The failure to issue stock certificates is sometimes cited by courts as a factor in disregarding the corporate entity to impose liability on a shareholder (called piercing the corporate veil or establishing alter ego liability). But that should not be a factor if the corporation complies with California law that allows a California corporation to issue stock without a certificate if certain requirements are met.
Corporations Code section 416(b) provides, in pertinent part, that “a corporation may adopt a system of issuance, recordation and transfer of its shares by electronic or other means not involving any issuance of certificates.” To do so, a closely held corporation will need to adopt a system in accordance with Division 8 of the Commercial Code.
Implementing a system of certificate-less stock will require a resolution of the board of directors to authorize uncertificated shares. That resolution should make provision for notice to purchasers of stock that will substitute for the required statements on certificates under Corporations Code sections 417, 418, and 1302 as well as any statement required by Department of Financial Protection and Innovation in administering the Corporate Securities Law of 1968.
In addition, a closely held corporation will need to adopt special bylaws to address the fact that the stock will be uncertificated.
The corporation will also have to issue an initial transaction statement (in lieu of a stock certificate), which must be signed by or on behalf of the issuer and sent to the new registered owner (or registered pledgee). If the shares are transferred or the information in the statement is no longer current, the corporation must issue a “written statement.”
Finally, a number of ancillary corporate documents, such as stock subscription agreements, stock purchase agreements, restricted stock agreements, and buy-sell agreements may have to have standard wording that refers to stock certificates changed appropriately to reflect the absence of stock certificates.
The advantage of not having issued stock certificates is that the holders sometimes lose the certificates, and when the time comes for a shareholder to transfer the stock, a declaration of lost certificate and indemnity agreement must be prepared.
The disadvantages of issuing an initial transaction statement in lieu of issuing a stock certificate is two-fold. First, there is the need to change many of the standard corporate documents as noted above. Second, there is the need to educate others as to why there are no stock certificates. Prospective purchasers of stock might balk at not receiving a stock certificate, and subsequent corporate counsel who is not familiar with uncertificated stock might have to charge for the service of becoming knowledgeable about dealing with stock without certificates.
Given the foregoing, the inconvenience of having to prepare stock certificates (typically no more than once or a handful of times in the life of a closely held corporation) is minor. Most lawyers who practice corporate law are set up to prepare stock certificates routinely as part of the organization and maintenance of a corporation. And likewise, the inconvenience of having to prepare a declaration of lost certificate and indemnity agreement if the certificate is lost is minor since most lawyers who practice corporate law have a standard declaration of lost certificate and indemnity agreement that takes only a minute or two to fill out.
So for most closely held corporations, certificate-less stock seems less like a problem solved and more like a solution in search of a problem.
