Think Twice Before Dissolving
Posted by Garrett Sutton on January 30, 2009 in Incorporation [ 0 Comments ]
n times of uncertainty many owners of corporations and LLCs may consider folding up their operations. CPAs and other advisors may suggest dissolving these entities to save on fees and to be done with it all.
But hold on: The “easy” route of dissolution can have significant negative consequences.
In California, for example, shareholders can be held personally liable for corporate obligations arising before or after a dissolution. The rule is found in California Corporations Code §2011. The same rule exists for LLC members pursuant to California Corporations Code §17355.
The deadline for suing corporate shareholders or LLC members in California is either; 1) the applicable statute of limitations period or, 2) four years after the entity’s dissolution, whichever is earlier. Since many statutes of limitations in a business context can be four to six years in length, you may have four years of worries until you are safe from litigation. And don’t think that because you have a Nevada or Wyoming entity qualified to do business in California you are in the clear. California courts are notorious for applying “their” law to out of state entities doing business in California.
So what is the solution?
Do not dissolve your entity. Keep it alive until the statute of limitations period has run.
Here is an example of why it makes sense to keep your entity alive.
Joe owns Merced Consulting, Inc., a Nevada corporation qualified to do business in California. With a downturn in the economy Joe’s consulting business has suffered. His CPA suggests dissolving the corporation and eliminating the expense of an extra tax return. The CPA says his other consulting client Mary has just dissolved her entity.
But what happens in a downturn? People start to file claims over old business disputes, whether real or imagined. In good times when the money is coming in, grievances may be overlooked. In tougher times people will sue. And with business contract statutes of limitations typically being six long years, plenty of Joe’s clients may be looking for a new pocket to dip into to help pay for their current troubles.
In fact, Joe had provided Tom with project development help on a condo complex. Joe’s projections were based on the real estate market as it existed in 2006. The picture is quite different today, and Tom is suffering for it. Tom hires an attorney to sue Joe, Mary and two other consultants for their “bad” advice.
What are the consequences?
Mary, who dissolved her entity and received a distribution of corporate assets, is now personally liable for Tom’s claim.
Joe, who listened to his attorney and did not dissolve, is still protected by his corporation. While the entity does not hold a lot of assets, if Tom gets a judgment against Joe’s corporation he only gets what is inside the entity. Not much. And Joe’s personal assets are protected from the claim.
Dissolving gives a plaintiff a hopeful shot at your personal assets. Keeping your entity alive until the statute of limitations periods have run discourages plaintiffs from even filing in the first place.
Be careful in heeding the siren call of reduced filing fees and fewer tax returns by dissolving. In our current environment asset protection is more important than ever, and can only be achieved by keeping and maintaining your protective entities in place.
Garrett Sutton, Esq. is a corporate attorney and is the author of “Own Your Own Corporation” and other titles in the Rich Dad Advisor series. His firm forms and maintains corporations, LLCs and other entities and may be reached at www.corporatedirect.com.