It is a classic horror movie plot line. The good guy finally killed off that scary monster/evil janitor/gremlin. Hooray! Triumphant, the hero turns his back to celebrate with fellow survivors when SUDDENLY the monster/evil janitor/gremlin rises from the dead to take down that one final victim! In the business world, if you do not take the proper steps to terminate your corporate entity and ensure that it is “dead AND buried,” (which I swear is a real term of art) the entity can come back from the grave. The undead entity will then cause all kinds of problems and could even result in potential personal liability for the unwary business owner.
First, termination does not mean a business has failed. Even if your company grows and is successful, there may be a time that you need to terminate its existence. The most common example is when you sell your business. If it is an asset sale, the buyer purchases the real estate, equipment, customer lists, intellectual property, etc., but leaves the corporate entity for the seller to dispose of.
Second, before we get to termination, I assume you have read my other posts and properly incorporated your business. You also should have had your attorney draft the initial corporate documents. These documents will often contain the rules and procedures for the terminating the corporate entity. Following these internal rules and procedures is critical to a successful dissolution and wind-up.
Finally, and without further ado, the following is a list of the 5 most common missteps to avoid when terminating your business:
Mistake #1 – Not consulting with an attorney and an accountant. Termination is not as simple as filing a form with the State of Michigan. There are multiple considerations that control the process and are unique to your business. For example, what do your bylaws or articles of organization say about termination? Do you need unanimous consent of the equityholders or a majority vote enough? Are there tax implications and personal tax liabilities to consider? What about the timing of any liquidation distribution? Only a professional can provide fact-specific counsel for your particular situation.
Mistake #2 – Confusing “dissolution” and “winding-up.” Although both terms refer to the termination of a corporate entity, the processes are different and controlled by different statutory provisions. Dissolution is something that is triggered by an event – for example, a unanimous vote of the LLC members or a bankruptcy as set forth in the bylaws. Winding up on the other hand refers to the process of liquidating the corporate entity. In other words, dissolution is the process of making the company “dead” – whereas winding-up is a process to ensure that it is “buried.”
Mistake #3 – Assuming that dissolution alone protects you from personal liability. Dissolution alone is not enough to protect a business owner from creditors and litigants. In Michigan, the law permits a dissolved corporation to “sue and be sued in its corporate name.” MCL 450.1834(e). Same goes for a dissolved LLC. MCL 450.4805(3). Moreover, improper dissolution could lead a court to conclude that the corporate form was a sham designed to elude creditors, and result in a court order to “pierce the corporate veil.”
Mistake #4 – Failing to follow the statutory requirements. Whether your company is organized as a for-profit corporation, a non-profit, or an LLC, there are specific statutory requirements for the termination process. For example, Michigan law requires an LLC to provide specific information in its certificate of dissolution. MCL 450.4804. This is critical because proper dissolution is a statutory prerequisite to winding up the LLC’s affairs (meaning liquidation). See MCL 450.4805 and 450.4806. In other words, failure to carefully follow the dissolution process risks a subsequent argument that the wind-up process was invalid and the liquidation was illegal. Note also that there are separate laws that govern corporations and LLCs and it is imperative that you follow the correct procedure for your specific type of entity.
Mistake #5 – Neglecting creditors for the benefit of shareholders. Terminating a company does not relieve the company or its equity holders from liability for debt obligations. If you are unable to pay your lender or cannot pay an adverse judgment, then you should consider filing for bankruptcy. In the process of a normal dissolution and liquidation, Michigan law presupposes solvency and mandates that creditors get paid first. MCL 450.4808(1)(a). And of course, government tax obligations must be paid even before the other creditors. MCL 450.4808(2).
Dissolving and winding-up your business is a complex process that requires consultation with a professional. Failure to ensure that the company is “dead AND buried” presents many risks going forward and can even lead to personal liability for the owners.