If you are considering the addition of a co-shareholder to your medical or other professional practice, it may not be as simple as you think. While you may not mind sharing the profits with the new partner, allowing him to have input on business decisions affecting your practice may be quite another matter. As a result of a New Jersey statute long overdue for an amendment, you may be forced to hand over the controls to your new partner.
The law governing professional service corporations (N.J.S. 14A:17-6) specifies that where an entity has two shareholders, both “shall be” the directors. The terms of the statute appear to require that not only must the shareholder be a second director, but that he becomes a “minority partner” as well, which means that he will have half of the control regardless of his percentage of shareholdings. To illustrate, let’s assume you add John Smith as a 10% shareholder of your practice. He will be entitled to a 50% say in your practice’s business decisions, regardless of the fact that he only gets 10% of profits.
Why? It’s actually the unintended result of an unfortunate historical anachronism. At the time the Professional Service Corporation Act was going through the NJ Legislature in the 1960s, business corporations had to have three directors. The statute, recognizing that professional corporations would often be made up of only one or two practitioners, provided relief by requiring only 2 directors. The business corporation law was subsequently changed to require only one director, but for whatever reason the Professional Service Corporation Act was never amended. So what can a sole shareholder do to resolve this dilemma? There is one possible solution.
It’s time to blow the dust off that certificate of incorporation. The Business Corporation Act contains a provision, section 5-21(2), that permits a corporation’s certificate of incorporation to eliminate the board of directors and vest all of the board’s power and authority in a single individual. So if you’d like to add a shareholder but not give up control of your practice you would need to amend the certificate of incorporation, make a notation on the stock certificates, and explain to the new shareholder the limits of his participation in decision making.
It should be pointed out that the statute governing professionals does not explicitly contain a provision similar to section 5-21(2), although The Professional Service Corporation Act contains express linkage to the business corporation statute: “The Business Corporation Act of New Jersey shall be applicable to a professional corporation….except to the extent that any of the provisions [of the professional act] are interpreted to be in conflict with the provisions of the [business act], and in such event the provisions and sections of [the professional act] shall take precedence with respect to a professional corporation.” This would seem to support the suggested plan.
Your business attorney should be consulted to guide you through these transactions.