Here’s an unglamorous, often dealt with but seldom discussed, topic that affects every corporation, LLC or other registered business entity. That is, voluntarily dissolving an entity no longer to be used.
There may be valid reasons not to dissolve an entity, or to delay its dissolution. However, in my experience responsible owners or business administrators and their counsel generally consider formal dissolution a best practice. Worthwhile exceptions are rare. Think of it as relief from potentially gut-wrenching risks of unexpected costs, liabilities or confusion for owners and directors.
When to consider? End-game events.
- During a strategic transaction. For example, going into an M&A sale of all operating assets to a strategic buyer. Dissolution procedure is not applicable in a merger transaction.
- During a breakup. The owners have determined to go their separate ways, and the existing assets are to be sold or distributed in kind, as appropriate, so that there will effectively be nothing left to hold in the entity.
- After a wind-down or business failure. It’s clear that the entity holds or will hold no further assets, and there is no intent to put assets in.
What does dissolution do?
- Definitively ends the legal existence of the entity in applicable state filing and tax records.
- Ends the accrual of reporting requirements, taxes and fees that are inherent to its existence.
- Can provide a cut-off date for the enforcement of debts or other obligations against the entity and against its equity owners.
- Establishes a certain, orderly, and documented process, a timeline and history that reduce the risk of later confusion and unexpected consequences.
What happens if you don’t dissolve?
- The entity continues until involuntary dissolution and forfeiture of the organizing charter.
- Involuntary dissolution looks “messy.” Like someone is not paying attention to business.
- Some states don’t have a revocation procedure.
- Taxes, registered agent fees, and penalties for failing to pay taxes or file reports, may continue to accrue in some states. In Connecticut, for example, the state’s revenue department advises that a state corporation business tax account may not be closed until the entity is dissolved formally.
- The entity may be more likely to be sued, because it’s still in existence.
- Revoked charters can be reinstated, and at least one website (National Corporate Research) reports that there have been reinstatements of revoked charters by persons intending to use the corporate identity of a longstanding entity for fraudulent purposes.
Why Not Dissolve?
- Cost of dissolving. Legal and filing. It varies with the state.
- For example, $400 dissolution filing fee in Delaware, $300 in Texas.
- Legal fees will vary, with the simplest dissolutions probably doable with three hours of work, or less, by counsel who has a responsive and reasonably well-organized business client.
- Letting sleeping dogs lie. Creditors who might do nothing may come forward when they receive a required notice of dissolution.
- Risk of direct claims against and liability to shareholders for distributed assets after dissolution.
- Maybe use the entity again.
- Looks better. Basic good corporate hygiene: clear the record, avoid forfeitures and tax bills. For example, the US Small Business Administration recommends it for LLCs and corporations.
- Start a limitations period for claims that could be asserted against shareholders who may be receiving assets distributed from the wind-down.
- Cut off the expense and hassle of annual filings.
- Stop state franchise taxes and accounts from adding up unnecessarily.
- One New York federal appeals court case indicates that a formal dissolution in Delaware can be used to cut off shareholder liabilities under certain environmental laws (CERCLA). See Marsh v. Rosenbloom, 20017 WL 2416543 (C.A. 2007).
- Avoid unexpected direct liabilities against stockholders and directors (if it’s done right).
- Risks arising from corporate identity theft
- Risk of the business being deemed to have continued under existing corporate owners after a charter was later revoked
- Risks from confused or negligent shareholder or creditor expectations, who don’t understand that the formal dissolution has occurred and are seeking redress from anyone who was connected with the entity or its alleged distributees.
The following gives a general idea of what’s involved. The specifics will vary, for example, from state to state, between LLCs and corporate entities, and according to whether or not a safe harbor or a default dissolution process is used.
- Authorization by owners (members or shareholders) or the board of directors. The specifics will vary somewhat between corporate and LLC statutes. Most state statutes require the owners’ approval or prior agreement to terminate the entity, either by a specific resolution or in a governing document such as an LLC operating agreement that may specify a triggering event.
- Winding up any existing business.
- Collect any assets.
- Pay, settle, discharge or provide for any debts and liabilities (including contingent and unknown claims)
- Consider whether it is desirable or necessary to set aside funds for unknown claimants, such as under TBOC Section 11.352 or in a trust under DGCL 281(b).
- Distribute any remaining assets to the owners
- Obtain tax clearance documentation
- File a certificate of termination or dissolution with the chartering state authority.
- File in any jurisdictions where the entity is formally registered as a foreign corporation.
- In some cases, continue the operation of the entity for the sole purposes of remaining windup activities, if and as permitted by the local state statutes, such as prosecuting and defending litigation, ownership of surviving claims, dealing with unliquidated and/or undistributed assets or other unfinished business affairs.
- Note that Delaware has two alternative dissolution processes for corporations. One is called a “safe harbor” procedure, which involves a notice procedure to possible creditors. The other is the “default” procedure.
- The safe harbor process is more time-consuming and costly, with specific notice to potential and actual creditors, and response deadlines (all of which may encourage the assertion of claims), and court process to determine the sufficiency of security for unknown claims, but that has the advantage of a shorter limitations period for known claims, and shorter reserve periods for unknown claims.
- The default procedure is simpler, and does not require as much formal notification, but it has a longer liability tail, and arguably greater liability risks for shareholders receiving distributions.
On balance, formal dissolution is the recommended termination point for an incorporated business entity or an LLC. When engaging in a strategic M&A transaction, factor in the dissolution process as part selling out an entire entity’s business. When considering the distribution assets from a winding down or breaking up business, consider the requirements for dissolution that may be involved in any projections for timelines and available assets.
Jon Hustis has a legal and executive career extending across a diverse range of information technology businesses: from start-ups seeking seed capital to multi-national Fortune 500 enterprises like Oracle Corporation and Texas Instruments. Building on this strong industry experience, he currently represents small to mid-size technology companies in their formation, financing, corporate, M&A and commercial legal affairs. Mr. Hustis also represents investors and private equity firms in acquiring, selling, and operating technology company portfolio investments. In addition to working with companies on their strategic transactions, he reviews, negotiates and drafts commercial licensing and service agreements, information and communications technology outsourcing agreements, international manufacturing and sales agreements, and other operational documents needed by his clients.
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