Dissolution Agreement for Limited Liability Company by xsz60651


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									         A Law Update for
    Dissolution and Cancellation of
     Limited Liability Companies
                 Presented by:

              Joseph P. McCarthy
               Douglas L. Batey
                Janet F. Jacobs
              Stoel Rives LLP
                October 8, 2009

    Very Short History of Limited
    Liability Entities
    • Legal protection from business risk was not historically
    • Sole proprietorship and partnerships = personal liability
    • First Business Trusts Act in late 18th century
    • First Corporation Act in North Carolina in 1795
    • Uniform Limited Partnership Act in 1916
    • First LLC Act in Wyoming in 1977, Florida in 1982,
      nowhere else until 1988; everywhere else by 1997
    • LLCs are new

    Legal Theories to Protect Creditors of
    Limited Liability Entities
    •   Piercing the veil
    •   Fraudulent transfer
    •   Bankruptcy preference
    •   Personal liability for torts
    •   Personal liability for professionals

    Limited Liability Companies Do Not
    Provide Complete Protection from
    Business Risk
    • “Except as otherwise provided by this chapter, the
      debts, obligations, and liabilities of a limited liability
      company, whether arising in contract, tort or
      otherwise, shall be solely the debts, obligations, and
      liabilities of the limited liability company; and no
      member or manager of a limited liability company
      shall be obligated personally for any such debt,
      obligation, or liability of the limited liability company
      solely by reason of being a member or acting as a
      manager of the limited liability company.” RCW

    Hallmarks of the Residential Real
    Estate Business
    •   Unique product
    •   Capital intensive
    •   High risk
    •   Short life
    •   Project by project finance
    •   Lender requirements for SPEs

    The Life Cycle of an LLC

    •   File certificate of formation (birth)
    •   Conduct business (live life)
    •   Dissolve (in the hospital)
    •   File certificate of cancellation (in the

    Typical Real Estate Business
    •   Development SPEs
    •   Developer = manager
    •   Investors = members
    •   Holding company

    Typical Real Estate Business

    •   Form it
    •   Build it
    •   Pay debt
    •   Pay investors
    •   Let it lapse

    Legal Liability vs. Winding Up and
    Paying Off Investors
    •   Dissolution: a legal status
    •   Dissolution begins the winding up process
    •   Winding up: pay off creditors, distribute profits
    •   What about late-arriving warranty claims?
    •   Warranty claimants will attempt to seek
        recovery from the LLC, from the managers,
        and from the investors

     Response of Washington State
     • Ballard Square case in 2006
     • Perceived unfairness to creditors (read:
     • LLC survival statute (RCW 25.15.303)
       in 2006
     • Claims may be filed up to three years
       after dissolution of an LLC

     Washington Supreme Court
     Weighs In – Chadwick Farms
     • Classic condo fact pattern
     • LLC formed for a project
     • LLC administratively dissolved after first unit
     • Suit by homeowners association
     • LLC files cross claims two months after
     • LLC moves to dismiss claims

     What Should a Developer Do?

     Formation of an LLC

     • State law governs
     • LLC begins to exist when certificate of
       formation is filed with Washington
       Secretary of State
     • LLC exists until a certificate of
       cancellation is filed

     Normal Operations

     • Legal entity
     • Same powers as an individual
        – Enter into contracts
        – Sue and be sued
     • Member relations governed by operating agreement
       and statute
     • Members generally have limited liability, with

     • Change of status
     • Begins the winding up – mandatory
     • Trigger – written consent of all members, or:
        – Dissolution date in certificate of formation
        – An event specified in operating agreement
        – Five years after administrative dissolution, unless
        – Unless operating agreement provides otherwise, 90 days
          after dissociation of last member, unless assignees have
          voted to admit at least one new member
        – Decree of judicial dissolution

     Winding Up

     • Gradually settle and close the LLC’s business
     • Prosecute and defend suits
     • Dispose of and convey property
     • “pay or make reasonable provision to pay all claims
       and obligations, including all contingent, conditional,
       or unmatured claims and obligations, known to the
       LLC.” RCW 25.15.300(2).
     • Distribute remaining assets to members

     Dealing With Liabilities

     • LLC must pay or make reasonable provision
       for contingent, conditional, and unmatured
       claims if known to LLC, even if identity of
       claimant is unknown
     • If assets are inadequate, LLC must deal with
       claimants by priority and ratably within a

     Who Does the Winding Up?

     • Manager
     • Persons approved by members
     • Person winding up has personal liability to
       claimants if that person does not comply with
       rules about dealing with liabilities

     When Winding Up Is Completed

     • Certificate of cancellation must be filed
     • LLC no longer exists after certificate of
       cancellation is filed
        – LLC can no longer act
        – What about lawsuits?

     Survival Statute

     • The dissolution of an LLC does not impair any
       remedy against the LLC, but …
     • Action may not be brought against LLC after three
       years from dissolution
     • What if LLC is cancelled before the three years are
     • Recent Washington Supreme Court case: Chadwick

     Chadwick Farms Owners Association v.
     FHC LLC – Background
     • Two lawsuits – condo developers
        – Chadwick Farms condominiums
        – Emily Lane condominiums
     • Owners associations sued alleging construction defects
     • Chadwick Farms –
        – After last unit sold, the LLC did not renew its certificate, so
          Secretary of State administratively dissolved the LLC
        – Later, after lawsuit for construction defects was started, Secretary
          of State cancelled the LLC in mid-lawsuit
        – Court of Appeals held that following cancellation, the LLC could be
          sued but could no longer sue in its own name (e.g., against

     Chadwick Farms Owners Association v.
     FHC LLC – Background (cont.)

     • Emily Lane – members voted to dissolve after
       units sold, and cancelled the LLC’s certificate
       shortly thereafter
     • Later, lawsuit was filed against the LLC
     • Court of Appeals allowed lawsuit against LLC
       to proceed after cancellation
     • Appeals consolidated

     Chadwick Holdings in Supreme Court

     • Cancellation ends everything – even in mid-suit
     • An LLC may not be sued after cancellation
        – existing lawsuits abate
     • An LLC may not sue after cancellation
     • Why not? Non-existence
     • Cancellation trumps the three-year survival statute
     • Dissolution triggers mandatory duty to wind up
     • Failure to properly wind up = personal liability
     • Cancel at your peril

     What, Me Worry?
     • Doesn’t having a Limited Liability
       Company limit the liability of
       members and managers?
     • How could they have personal

     Limited Liability

     • Limited liability is predicated on one
       simple principle:

       – The LLC is a distinct and separate legal
         entity from its members

     RCW 25.15.125

     • “Except as otherwise provided by this chapter, the
       debts, obligations and liabilities of a limited liability
       company, whether arising in contract, tort or
       otherwise, shall be solely the debts, obligations
       and liabilities of the limited liability company; and
       no member or manager of a limited liability
       company shall be obligated personally for any
       such debt, obligation, or liability of the limited
       liability company solely by reason of being a
       member or acting as a manager of a limited
       liability company.”

     What Does “Limited Liability” Mean?

     • LLC is responsible for debts and liabilities

     • Member’s capital contribution is at risk

     • Member’s assets outside the LLC are not at

     Loss of Limited Liability Protection

     • Liability to LLC or other members
       – Improper interim distributions
       – Use of LLC’s property or business
     • Liability to third parties
       – Piercing leads to loss of limited liability

     Wrongful Non-Liquidating
     •   RCW 25.25.235: no distributions if
         –   LLC wouldn’t be able to pay debts OR
         –   Amount of liabilities exceeds value of remaining assets
     •   No liability to LLC for unknowing receipt
     •   No liability to LLC after three years for knowing
         –   NOTE: liability is to LLC, not to other members or third-
             party creditors

     Exceptions to Limited Liability –
     Third Parties
     •   Contracts
     •   Personal torts
     •   LLC torts: “piercing the veil”
     •   Improper wind-up

     Exception: Torts

     • Personal liability for a wrongful act not
       connected with LLC business
       – Even if acting in the course of the LLC’s business
       – Example: drunk driving while delivering LLC’s
     • Piercing analysis is used to hold members
       responsible for wrongful act connected with
       LLC business

     Breach of Fiduciary Duty

     • Under the Condominium Act, the Board
       of Directors owes fiduciary duties to
       condo owners
       – Developer as board member
       – Duties of loyalty, good faith, and high standard of
       – Prioritize interests of condo owners, not LLC

     Fraudulent Concealment

     • Five elements:
       – A residential dwelling with a concealed defect
       – Developer knows about the defect
       – Defect is a danger to the property, health, life of
       – Purchaser doesn’t know about the defect
       – Purchaser wouldn’t discover defect even on
         careful inspection

     Fraudulent Concealment (cont.)

     • Fraudulent concealment finding
               Economic Loss Rule

     • Damages limited to contract remedies

     • Contrast actual fraud…

     Fraudulent Transfer Elements

     • Elements:
       – Antecedent debt
       – Transfer of assets out of the LLC
           • to an insider
       – No “reasonably equivalent value” for the transfer
       – LLC is unable to pay the debt after the transfer or
         is functionally insolvent
       – Intent to prevent or delay payment of debt


     • Elements:
       –   Representation of an existing fact
       –   Which is material
       –   And false
       –   The person making the statement knows it’s false or doesn’t
           know if it’s true
       –   The speaker wants the listener to rely on the statement
       –   The listener doesn’t know it’s false
       –   And relies on the truth of the statement to reach a decision
       –   And is entitled to rely on it
       –   And suffers damages as a result

     Consumer Protection Act

     • Elements:
       –   An unfair or deceptive act
       –   In the conduct of trade or commerce
       –   That has an impact on the public interest
       –   And injures plaintiff’s property
       –   And there’s a causal link between the
           unfair/deceptive act and the harm done

     Improper Winding Up

     • RCW 25.15.300
       – Proper winding up  no personal liability to LLC
     • Proper winding up
       – Reasonable provision for known claims and
       – Court-blessed plan of winding up?
       – Chadwick Farms: personal liability for improper

     Practical Advice for Real
        Estate Developers

       Heads Up – Proposed Legislation

     • Once the LLC is dissolved, the LLC may optionally file a
       certificate of dissolution
         – Certificate of dissolution may be revoked for 120 days
     • If a certificate of dissolution is filed, LLC may give written
       notice to holders of known claims, who must respond within 120
     • If LLC rejects the claim, claimant must file suit within 90 days
     • Claims against LLC must be brought within three years of filing
       of certificate of dissolution, regardless of when certificate of
       cancellation is filed
     • Certificate of cancellation does not terminate LLC’s existence

     Issue: What Is a Known Claim Or
     • The Act requires provision for “claims” and
     • Does “known” require actual or constructive
     • Statutory language suggests “actual”
       knowledge – some cases have found
       constructive knowledge is enough

     Strategy: Dissolve, Wind Up,
     Cancel, Defend
     • Triggers three-year claim period
     • May be shorter than the statutory warranty
     • Document the dissolution, so it’s not private

     Suggestions for Wind-Up

     •   Prepare a wind-up plan
     •   Adopt resolutions
     •   Document assets
     •   Analyze and document potential claims
     •   Document actions
     •   Buy insurance for winder upper?

     Guard Against Piercing the
     Corporate Veil
     • Financially troubled LLC: third party focus
       –   Under-capitalized for intended business
       –   Failure to follow formalities
       –   No bona fide commercial purpose
       –   Violation of governing documents
       –   Dissolution issues
     • Lack of LLC formalities alone is not grounds
       for loss of limited liability

     Piercing the Veil (cont.)

     • Best practices:
       –   Adequate capitalization
       –   Strong LLC agreement
       –   Meetings
       –   Diligent record keeping
       –   Separation of assets
       –   Arms-length member/LLC transactions
       –   Document distributions (+ salary)

     How to Make Provision for Claims
     and Obligations
     •   Keep reserves
     •   Establish a trust
     •   Buy insurance (sigh)
     •   Go to court?

     Strategy: Don’t Dissolve

     • Avoids duty to wind up
     • Avoids personal liability for
       improper wind-up
     • Allows LLC to conduct business as

     If Administratively Dissolved,
     Reinstate (If You Can)
     • Now, five year window
     • Simple filing
     • Return to active status

     Strategy: Adopt Robust structure

     • Use robust warranty disclaimers, as
       allowed by Condominium Act
     • Avoid member-managed LLCs
     • Use an entity as manager
     • Consider a separate entity to wind up

      Corporation as Manager
     • Manager-managed LLC
     • Use a corporation as the manager
        – Analogous to using a corporation as the general partner in a
           limited partnership
     • Possibly use a separate, corporate manager to manage only
       the winding up
     • Observe all the corporate formalities, put some capital into the
     • When the LLC is dissolved, the corporate manager conducts the
       winding up
     • Claims of improper winding up would be made against
       the corporation, not the members or other managers

     Strategy: Thinking Outside the
     • Merge into a corporation before wind up
     • Merge into a foreign LLC before wind up
     • File suit for court approval of wind up (RCW
     • Limit discretion of manager to make distributions?
     • Specify distribution events in the LLC agreement
       (RCW 25.15.215 and .230)
     • Avoid manager promote: use fees?
     • Structure equity as debt or fees?

     Merge Into a Washington Corporation

     • Before dissolution, merge the LLC into a corporation
     • Dissolve and wind up the corporation
     • Corporation procedures are more detailed, provide for
       notice to creditors and cutting off creditors’ claims, and
       provide procedural safe harbors for dealing with
       contingent claims
     • Corporation dissolutions begin with public filing
     • Corporation is never cancelled
     • There may be tax issues, but not necessarily
     • LLC members will have dissenters’ rights

     Legal Side Note:
     Things Can Always Get Worse!
      “John of Craumford fled to the church of Bamburgh
      and there confessed to highway robbery, and abjured
      the realm in the presence of William of Bamburgh,
      who was then coroner. He had no property. Witness
      has been borne that the entire town charged him with
      highway robbery and wanted to arrest him, but he
      escaped from their hands to the aforesaid church, as
      related above; accordingly the village is to be fined.”
      In re John of Craumford, Assize Court of Northumberland
      County, Northumberland Assize Roll, 40 Henry III (1256).

     Thank you!



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