“The LLC was dissolved effective 1/21/05 and therefore there is nothing to sue! We did not receive the Notice of Claim prior to the dissolution so we should be clear according to our attorney. Rejoice! Pat”

In 2005, a bookkeeper at the Washington construction firm Colonial Development, LLC expressed relief to the firm’s insurers over having dissolved the business prior to being sued. However, the bookkeeper’s assessment of her firm’s liability turned out to be premature, since Washington law preserves claims against an LLC up to three years after a company dissolves. Moreover, two years later the court ruled that the owners of the firm could be held personally liable because they in fact had failed to properly wind up the company’s affairs.

The decision to quit a venture is never an easy one for an entrepreneur. When the decision is driven by financial reasons, as is often the case in a troubled economy, it can be tempting to simply walk away under the rationale that no new business means the business is dead. The excitement of new projects or the appeal of a fresh start under a new name can overshadow the headaches associated with a failing business. But as cases like Emily Lane Homeowners Association v. Colonial Development, LLC show, maintaining the shell of a company is an all-too-convenient move that leaves owners vulnerable to lawsuits and liability. The failure to properly wind up affairs may lead to a variety of repercussions:

Leaving the Door Open to Liability

A majority vote of the owners recorded either in meeting minutes or via written consent form may be required to dissolve a company. The specific procedure for dissolution will vary according to whether or how a business has been incorporated, but regardless of the procedure, proper termination is a key step in avoiding future liabilities. After a company formally files for termination, creditors and other parties with known claims have a limited window of opportunity to pursue action against the corporation as an entity. This gives business owners the opportunity to resolve outstanding debts or issues, such as money owed to a bank, suppliers, landlord or service provider.

A business that has been officially dissolved can no longer incur business debts. Business owners who passively allow their corporations to lapse are not afforded this finality of resolution, and may be forced to defend suits filed against a corporation that no longer exists. The owners of the defendant construction company in Emily Lane Homeowners Association v. Colonial Development, LLC faced this scenario when they failed to properly dissolve their business and were ultimately held liable as individuals for the corporation’s liabilities. Likewise, in the 2008 case of Matter of Beverwyck Abstract, LLC, a New York appellate court found that the members of an LLC who started a competing venture prior to formal dissolution of the LLC owed the excluded members pre-dissolution profits. The court noted that an informal agreement to no longer work together was insufficient to dissolve the company, since the operating agreement specified that a vote or written agreement would be required.

Tax Consequences

Informally dissolving a business can lead to a variety of tax consequences, both obvious and less obvious. A state franchise tax board can prosecute a business owner for the failure to pay any taxes prior to the date of formal dissolution. Taxes are due unless the company has filed to dissolve, even if the company no longer has any employees or transacts any business. Moreover, if a business owner fails to make final payroll tax deposits, the IRS can hold the business owner personally liable and satisfy the debt from assets such as personal bank accounts or a retirement account. Filing for bankruptcy offers limited protection in this area; the best plan is to avoid tax liability in the first place.

Licenses, Permits & Fictitious Name Registrations

It is important to terminate any licenses, permits or fictitious name permits with the county or state. Failure to do so leaves open the possibility of tax penalties, trade name confusion or liability resulting from fraudulent third-party use.

Avoiding the Pitfalls

It is possible to walk away from an unsuccessful venture without looking back. Taking steps to properly wind down a business enables a business owner to move on without liability or with minimal liabilities.

1. Follow the procedures outlined in the articles of incorporation to dissolve the company, which may include obtaining written agreement from all co-owners.
2. Contact the regional tax board to obtain a certificate of dissolution and file a final tax return with the IRS and state tax agency, as well as all relevant final payroll tax deposits, employment-related paperwork and wages.
3. Contact the state or local government to cancel any licenses, permits or fictitious name permits associated with the business. Close all relevant service accounts in the business name.
4. Inform creditors, customers and employees of the dissolution.Additional measures may also be necessary, depending on how the business has been structured. It may be advisable to consult a legal professional who can tailor a dissolution plan to the needs of the company.

-By Dava Casoni, Annie Lin