Dissolution of an LLC

Editor: Albert B. Ellentuck, Esq.

State limited liability company (LLC) statutes sometimes require a dissolution of the LLC upon the death, insanity, bankruptcy, or other involuntary removal of any member unless the other members consent to continue the LLC. This creates many issues involving member rights to property, liabilities after dissolution, and dissolution procedures. Dissolution can involve the completion of contracts, payment of creditors, sale of assets, collection or compromise of receivables, and any other act that helps the LLC marshal the assets for payment of creditors and distribution to the members. Procedures for concluding the affairs of the LLC should be included in the operating agreement.

Dissolution events

States may permit modification of the dissolution events listed in the statute (the statute for the state of organization should be reviewed to determine which dissolution events are included). LLC organizers may want to modify the type and number of dissolution events by including other provisions in the operating agreement. It may make sense to provide that some events (such as a member's death) do not constitute a dissolution event since avoiding continuity of life is no longer required to ensure partnership classification.

All LLC statutes permit an LLC to dissolve on an expiration date specified in the articles or operating agreement. This date should be far enough in the future to permit the LLC to accomplish its goals. Where state law permits, organizers should consider providing for an indefinite life. If an indefinite life is provided, some provisions for interim distributions and transfers of interests are necessary.

Notice

The operating agreement should provide for notice to all members and creditors of the LLC's dissolution. All state statutes have provisions for LLCs to provide notice upon actual dissolution. Many also require that notice be provided when a dissolution event occurs. Some state statutes have required notice systems involving mailing notice to creditors and/or publishing a notice of dissolution in newspapers. LLCs complying with the notice requirements generally are relieved from liability for any known or unknown debts after the passage of a designated period of time. The operating agreement should designate the members or managers responsible for filing the proper notices.

Ability to bind LLC during dissolution process

The operating agreement should limit the ability of managers or members to bind the LLC as a dissolution progresses. Generally, the LLC is still liable for goods or services ordered by a member or manager and provided by a creditor, unless that creditor has specific knowledge that the member or manager does not have authority to bind the LLC. If a member or manager without the authority to bind the LLC during the dissolution process enters into an agreement on behalf of the LLC, the manager or member should be required to reimburse the LLC for any damages. Of course, any limitation on the amount of damages should also be included in the operating agreement.

Distributions upon dissolution

The priority of distributions made upon dissolution of the LLC can be specified in the organizing documents. Most state LLC statutes require liquidating distributions to be made first to creditors and then to members according to specific rules. If members have creditor status for unpaid distributions, they usually will have a priority to distributions after outside creditors but before other distributions to members are made. Normally, the LLC then would return the member's capital, and any excess would be distributed either as directed by statutory default or by agreement among the members. Organizers should include any desired modifications to the statutory default in the operating agreement (however, the agreement generally can alter only the distributions to members, not to creditors).

Liquidating distributions in kind

Another consideration for the practitioner is whether the state statute or organizational documents require the LLC to sell assets upon dissolution, or whether the existing assets can be distributed in kind (the default rule of most state statutes prohibits distributions in kind). Organizers may want to prohibit distributions in kind since such distributions raise several legal issues, including spousal rights in the property. However, forced sales of assets to make cash distributions to the members can result in a lower price and are often impractical, particularly for an LLC with significant intangible assets. Whichever path is chosen, the operating agreement should provide guidance on how assets are disposed of upon dissolution.

Accounting to members

The organizers should also consider requiring a full accounting of the dissolution process to all members. This may be particularly important when creditors or other third parties are assignees of members' interests. The member or manager in charge of the dissolution process should be required to provide the accounting within a reasonable time (60 to 90 days) after the dissolution is completed. The operating agreement should also allocate the cost of the accounting among the members.

Consent to dissolve

When the organizational documents or a state statute provides that the LLC dissolves upon the vote of the members, the organizers should consider limiting the members eligible to vote on the dissolution to those who have not assigned their interests or whose interests are not subject to a creditor lien or charging order. This eliminates the possibility that members who have assigned their interests can cause the LLC to dissolve. However, the practitioner should review the applicable state statute before making this suggestion, since some states may prohibit such limitations.

Continuation after event of dissolution

Most LLC statutes allow the remaining members to continue the LLC by unanimous consent after an event of dissolution. This raises a problem if there is a possibility that dissident members may refuse consent, forcing an otherwise unnecessary dissolution. Many states permit the LLC to modify this consent provision in the operating agreement to provide for a lesser consent requirement, which often makes sense. However, most states require that at least a majority of the remaining members consent to the continuation. Accordingly, the operating agreement should establish the consent needed to continue the LLC at somewhere between majority and unanimous consent.

It may be desirable for the organizational documents to require unanimous consent for continuation in closely held LLCs. In many cases, the relationships among the members can be modified so dramatically by a dissolution event, such as the death of a member, that each member should have the right to decide not to continue. Clearly, this is one issue the organizers should discuss during the formation process so the operating agreement reflects the members' desires. When the LLC is conducting a business, the disadvantages of dissolution, particularly the impact on the daily operations, including the right of lenders to call debts, must be weighed against the dramatic modification of member relationships.  

This case study has been adapted from PPC's Guide to Limited Liability Companies, 22nd edition, by Michael E. Mares, Sara S. McMurrian, Stephen E. Pascarella II, and Gregory A. Porcaro. Published by Thomson Reuters/Tax & Accounting, Carrollton, Texas, 2017 (800-431-9025; tax.thomsonreuters.com).

 

Contributor

Albert Ellentuck is of counsel with King & Nordlinger LLP in Arlington, Va. For more information about this column, contact thetaxadviser@aicpa.org.

 

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