As a prudent business owner, it is important to wonder what, if any, personal liability you will be exposed to when you close up or dissolve your business entity. Is the limited liability protection you enjoyed while the entity was active still applicable? If not, does that mean you are personally liable for post-dissolution claims? Are you only covered for transactions while the entity was active? These are all common questions I hear from clients. My goal is to provide a broad outline of what a business owner should consider before dissolving an entity and what, if any, personal liability exists after dissolution.
(1) Pay Your Known/Existing Creditors Before Paying Yourself: before considering a dissolution, know that you will be required to pay any known and present creditors before any assets can be distributed to the business owners. If you do not pay your known creditors and instead distribute assets to owners first, the owners can be sued by those creditors up to the value of assets they earned as a distribution from the entity. Part of the dissolution process involves the owner sending notice to all known creditors of their intended dissolution. This makes sense—it wouldn’t be fair to allow the business owner to just close up the doors and keep whatever profits remain without paying creditors for known debts. However, on the flip side, if the entity is in debt (money owed to creditors exceeds assets), and no distributions were made to the owners, then a creditor cannot pursue personal assets from the owner. In summary, it will all depend on whether the entity had assets or creditors at the time of dissolution. If so, notice must be provided to creditors before any distributions of assets are made to the owner.
(2) To Dissolve or Not to Dissolve? This presents a question of timing. Each entity’s situation will vary depending on the facts surrounding their dissolution. However, timing is an important consideration. Once you cease business operations and all known/existing creditors have been paid, it is typically a good time to start the process. I was asked once by an owner if he could dissolve his entity for the sole purpose of escaping a lawsuit, then just reopen a new entity under a different name but conduct the same type of business. My answer was a resounding no. To be safe, if a business owner believes there could be a legitimate claim, whether by a creditor or a potential lawsuit, it may be prudent to put off dissolution until the statute of limitations on the potential claim or dispute runs. To determine when the statute of limitations runs on a particular claim, it is imperative to talk to an attorney. These dates can vary greatly depending on the particular claim or suit at issue.
(3) Let Your Company Agreement Rule: Lean on the terms set forth in your company agreement relating to a member’s voting rights and obligations related to dissolution of the entity. If you do not have a company agreement, state statutes will govern voting rights and member obligation for dissolution. Most commonly, company agreements will be drafted to reflect the following order of events in dissolution proceedings: (1) Notices sent to known creditors; (2) Debts paid to creditors; (3) remaining capital, if any, distributed to members per terms of the agreement; (4) file appropriate documentation with Secretary of State and Texas Comptroller of Public Accounts to effectuate dissolution of entity.
(4) Post-Dissolution Dilemma: What happens when entity owners do not know of any creditors or debts and move forward with dissolution, then a year later a claim arises or a lawsuit is filed? Entity owners will still be afforded the entity’s limited liability protection for events arising while the entity was in good standing so long as they did not know about the events giving rise to the claim prior to dissolution. To illustrate—entity is closed in 2018, entity owners have no knowledge of any potential claims or disputes prior to dissolution, and in 2019, owners are served with a lawsuit relating to an event that occurred in 2017. Owners are protected from liabilities of the business that occurred when the entity was active and in good standing in 2017.
(5) You Knew and Dissolved Anyway: If owners are aware of potential liability and dissolve anyway and received a distribution of assets, the owners may be liable for claims up to the amount distributed to them. To illustrate—if owners each received a $500K distribution upon dissolution, they could be personally liable for up to $500K, the amount of the distribution. Again, if no distributions were made to owners upon dissolution, the creditor or individual filing suit will not be able to pursue personal assets of the entity owner.
To summarize, it is imperative to provide adequate notice to known creditors before you start the dissolution process. If possible, the entity needs to pay off known debts before they make distributions to themselves. If the entity is insolvent and no distributions are made to the owners, the creditors may not pursue personal liability against the entity owners. It is always best to consider discussing these matters with legal counsel before moving forward.
Wilder McGee, P.C. has vast experience in this area of law and would be happy to discuss how I can be of service to your business.