Dissolving A Business – Corporate/Commercial Law

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The past two years have been shaped by the COVID-19 pandemic in several ways. Although we have so far avoided a significant economic downturn, some companies have been challenged by new regulatory requirements and changing consumer patterns.

The year 2021 is drawing to a close, and you may have concluded that your business prospects for 2022, financially or otherwise, are not as expected. Closing your business can be a tough decision and companies break up for a variety of reasons, and not all of them are necessarily negative. The proper liquidation of the company ensures that when you start over, you start with a clean sheet of paper.

What is dissolution?

Dissolution is a legal process that ends a company’s existence. If a company is not properly dissolved, it will continue to exist as a legal entity under state law. This means it will continue to be subject to corporate or LLC filing requirements, including with state and federal agencies such as the State Department, Franchise Tax Agency, Tax Agency, in addition to state and local filing requirements such as licenses and permits.

Simply “ceasing business” and failing to perform these continuing obligations can result in fines, taxes, penalties, and possible personal liability for these obligations. Dissolution is a multi-step process that includes filing dissolution documents with the various local, state and federal agencies, as well as internal records in relation to the other owners of the companies and the companies’ creditors.

Step 1 – Ownership Approval

A dissolution of a corporation or LLC generally requires that the shareholders or members consent to the dissolution. Typically, the company’s articles of association or the LLC’s operating agreement will set out the dissolution process, including the necessary approvals from shareholders and members, and the manner and method by which any meetings of shareholders, board of directors, and / or members will conduct this be announced in the first step. Unanimity is not always required. For example, California Corporation Code §1900 provides that a company can voluntarily resolve to dissolve and dissolve it after voting at least 50% of the outstanding shares.

Step 2 – Prepare and cancel dissolution documents

Once the dissolution has been approved unanimously or otherwise, the required forms must be filed with the California Secretary of State and any other state in which your company or LLC is authorized to do business. In California, if the dissolution election is by voting all outstanding shares, the dissolution and dissolution ballot does not need to be submitted to the Secretary of State, but a statement must be made that the dissolution election was made by a vote of all outstanding shares be included in the certificate of dissolution filed with the Secretary of State.

If at least 50% but less than all of the outstanding shares decide to dissolve, the company must either before or at the same time with the form of the dissolution certificate (DISS STK form).

In the event of dissenting shareholders or members, the company’s board of directors (or executive member of the LLC) must send written notice of the commencement of voluntary dissolution to all shareholders except those who have voted for dissolution and all known creditors and applicants who are in the Company records appear.

A word of caution – if you have applied for and received the Small Business Administration’s Economic Injury Disaster Loan program, it is imperative that you review loan agreements including promissory notes and personal guarantees as this may ultimately affect your decision, if at all, with proceed with the dissolution of your company. Unlike Payment Protection Program loans, which have a waiver element, once you have applied for and received EIDL loans, you may have signed a personal guarantee and secured the loan with business collateral including tangible and intangible assets such as inventory and equipment. Typically, borrowers’ restrictions on EIDL loans in excess of $ 25,000.00 include the inability to sell, lease, license, transfer collateral, or cease operations without the prior consent of the SBA. Failure to obtain proper approvals can trigger a default and expediting clause that will result in the entire credit balance becoming due and due immediately.

Step 3 – Allow Cancellations

An often overlooked part of the liquidation process is revoking licenses and permits that the company holds. Because licenses and permits are issued at the federal and multiple levels of state and local government, many cancellations can be required depending on your company’s industry and where you do business.

Step 4 – Tax Returns

The dissolution of a corporation requires the preparation of both state and federal tax returns, as well as possible filings and payments, including sales tax, wage tax, and any applicable local (county and / or council) taxes. You should discuss with your accounting department which documents need to be filled out.

Dissolution & personal liability

Corporations Code §§316 (a), 2004 and 2005 (a) provides that it is the responsibility of the directors or other persons appointed to determine whether or not the Company’s debts and liabilities have been settled prior to the distribution, assets to shareholders were adequately covered. Directors and Shareholders may be held personally liable for unpaid corporate debt when corporate assets are distributed to Shareholders without payment or adequate provision for the payment of corporate debt.

In addition, it is important to analyze potential disputes and the prospect of civil lawsuits, as they can be filed and served against a dissolved company, regardless of whether the cause of action arose before or after its dissolution (California Code of Civil Process, Section 416.20; Corporations Code Section 2011.). (a) (1).) Shareholders can be liable for claims against a dissolved company, regardless of whether they arose before or after the dissolution. However, there are certain limits to the liability of the members in relation to (1) the amount recoverable and also (2) the length of the liability. (California Corp. Code Section 2011 (a) (1) (B); Favila v Katten Muchin Rosenman LLP (2010) 188 Cal.App.4th 189, 213).

As a rule, the liability of the shareholders after dissolution is limited to the total amount of the assets distributed to the shareholders or their proportionate share of the claim – whichever is lower. There are also certain time limits on when claims can be brought against a shareholder of a dissolved corporation, typically either (a) after the applicable statute of limitations for the specific cause of action asserted, or (b) four years after the dissolution of the corporation.

There is a tendency, when the time comes to close a deal, to take short cuts, simply to “get it over with”. While this is understandable, considerations such as personal liability for corporate debt and tax ramifications should lead you to treat the process of ceasing business and winding up your business with the same care as you would when you started your business. When done correctly, it’s a relatively simple and quick process. If ignored, it can haunt you when you least expect it, in retirement or after starting a new business.

Originally published November 8, 2021

The content of this article is intended to provide general guidance on the subject. Expert advice should be sought regarding your specific circumstances.

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