A company’s existence begins when its Articles of Organization or Incorporation are filed with the Secretary of State. Intentionally or not, the life span of that company will vary. Companies cease business operations for a variety of reasons. Maybe there was a sale of substantially all of the company’s assets. Maybe the company was organized but never operated. Maybe the “next big thing” of the company’s business was not really a thing at all. Now what? Legal termination is the end of a company’s existence, but there are different ways to accomplish that end. While this article focuses on limited liability companies (“LLCs”), keep reading if you have a corporation. The corporate terminology and dissolution process are only slightly different, and the strategic considerations for dissolving a corporation are generally the same as those outlined herein for a LLC.
Dissolution – Termination by Process
Dissolution is the formal process of winding-up and preparing a business entity for termination. Dissolution does not end the LLC’s existence, but it does change the LLC’s purpose. A dissolved LLC is no longer operating to conduct business; it exists only to wind up its affairs in anticipation of termination. Dissolution can be court-ordered in a handful of circumstances involving unlawful, nonconforming, or oppressive conduct. However, dissolution typically occurs as the result of a dissolution event promulgated in the LLC’s operating agreement or the unanimous consent of all of the LLC members.
Once an LLC is dissolved, it can only engage in winding-up activities. The LLC must close the LLC’s activities and liquidate its assets, make arrangements to pay its debts and liabilities, and marshal and distribute the assets of the LLC. There may be people or other business entities that claim the LLC owes them money or property. The dissolved LLC can solicit claims by these claimants. If a claimant does not timely submit a claim to the LLC, the claim can no longer be enforced against the LLC. This can be an effective way to bar some claims of the LLC to increase the assets available to pay other claimants or the members of the LLC.
Consider this example. You are closing the doors to your business. The LLC’s only remaining assets are a vehicle worth $30,000 and $10,000 in a checking account. You are ready to liquidate and distribute assets. There are two claimants. One is the bank with a $40,000 balance on the LLC’s line of credit. The bank also has your personal guaranty to secure the $40,000. The other claimant is a contractor that claims he is owed $50,000, but the LLC disputes this claim because the contractor did poor quality work and never submitted a change order for the last $50,000 of work as was required by the construction contract. The LLC can reject the contractor’s claim. If the contractor does not start a lawsuit against the LLC within 90 days, its claim will be barred. This would mean that in a few months all $40,000 would be distributed to the bank, which would eliminate your personal liability on the guaranty.
Once this process is complete, the dissolved LLC can file a statement of termination with the Secretary of State, formalizing its termination and the end of its existence as an LLC.
Administrative Termination – The “Do Nothing” Approach
Not all LLC’s will benefit from a formal dissolution. If the LLC has no claimants, administrative termination may be the most effective way to end the LLC’s existence.
Administrative termination is straightforward. An LLC must file an annual renewal with the Secretary of State each year. If an LLC fails to file its renewal, the State will automatically terminate the LLC, thus causing an administrative termination of the LLC.
Consider this example. You are the sole member (owner) of an LLC that was organized to purchase and own a piece of investment real estate. The LLC granted a mortgage on the property and you personally guaranteed the debt that the mortgage secures. The LLC makes some improvements to the property and pays all of the costs associated with those improvements. You find a buyer for the real estate. The purchase price for the property covers all of the closing costs, pays the mortgage loan in full and leaves the LLC with net sales proceeds to boot. After the transaction closes, the net sales proceeds are distributed to you as the sole member. There are no known claimants of the LLC and the LLC has no assets. You stop filing the annual renewal for the LLC and the State administratively terminates the LLC.
The ease of doing an administrative termination as a means of legally terminating an LLC is appealing and there are cases where administrative termination may be the best strategy to end the LLC’s existence. But before you just stop filing your LLC’s annual renewal, you should consider the LLC’s organizational structure, remaining business assets and claimants. A closer look may reveal that a termination by a formal dissolution is the appropriate way to strategically terminate your LLC.
The attorneys at Sanford, Pierson, Thone & Strean, PLC, represent closely held businesses from cradle to grave. If your LLC’s life is coming to an end, we can help you strategize the most effective way to terminate your business.