When you established your home-based business, you had to choose its initial business structure, which plays a crucial role in your taxation, reporting and operating requirements, and personal risk. Most entrepreneurs choose the default business structure and launch as a sole proprietorship. As a sole proprietor, you and your business share a legal identity. You report your business profits or losses when you file your personal income taxes, and you are legally responsible for all debts acquired by your business. Since this also makes you the defendant in any lawsuits filed against your company, your personal assets could be at risk if you lose the case. The potential risk to their personal assets is the primary reason that many home-based business owners either start out as or convert to a limited liability company, also known as an LLC. Because an LLC has a separate legal identity, you are typically shielded from debts and other liabilities resulting from your business operations. If you dissolve your LLC, however, there are certain situations in which you could find yourself liable for things that happened while your LLC was active.
Reasons for an LLC Dissolution
There are many reasons for dissolving an LLC, and not all of them involve a voluntary action on the company’s part.
1. Administrative dissolutions originate in the office of the secretary of state. They are typically the result of the LLC’s failure to file a mandatory annual report or a different violation of state laws. Because the secretary of state usually has broad powers, however, in many states, the office can dissolve an LLC for virtually any reason it considers justified.
2. Judicial dissolutions are ordered by a court. Although a judge can order a dissolution if the LLC does not pay its taxes or violates state laws, the most common cause of a judicial dissolution is a lawsuit filed by unhappy LLC members who want to sever their ties with the company.
3. Voluntary dissolutions are frequently caused by financial issues. Perhaps the company’s cash flow is too low to continue operations, or the profit margins are unacceptable. The company may have been mismanaged, or it may have been negligent in its accounting practices. Sometimes, the dissolution is the result of a failure to have a succession plan; a key member becomes disabled or dies, and no one else has the experience, knowledge, or skills to be an effective replacement. There is also the possibility that the LLC is bankrupt, or it could have discovered that its products are defective. Sometimes, members of the LLC just want to go their separate ways due to personality conflicts, different visions of where they think the company should go, or the desire to retire.
Particularly in the case of voluntary dissolutions, the reason for dissolving the company can sometimes shed light on the potential for members being held personally liable after the dissolution.
When Might You Be Held Personally Liable for Events Occurring While Your LLC Was Active?
One important fact that you need to remember is that an LLC falls under the jurisdiction of the state, so state laws can vary. Therefore, you should consult a lawyer with experience in the dissolution of an LLC in the state in which you do business. However, the following list details some scenarios in which the liabilities of your LLC could follow you even after dissolution.
1. You failed to dissolve the LLC correctly. Every state has laws that specify the steps that you must follow to dissolve an LLC. For example, in Oklahoma, an LLC must create an operating agreement when it is formed, and this operating agreement will detail the steps required for dissolution. Other states require that you pay all taxes, even if they are not yet due, before you dissolve your LLC, or you may be required to notify creditors of your pending dissolution. If your dissolution is not legally correct, it could be considered as still being active, so you could be personally responsible if the company’s assets have already been distributed to members.
2. You were aware of a pending lawsuit or debt at the time you dissolved your company. For example, suppose a customer placed a large order and paid you half of the total upfront. You did not ship the order, and you did not return the customer’s deposit. Most courts would rule that a “reasonable person” should have known that the customer would seek reimbursement, so you and the other members of your LLC could be pursued personally for payment. In most cases, this will be limited to the amount received when the company’s assets were distributed at dissolution, but this is not universally true.
3. Your LLC conducted fraudulent activities. For example, you accepted payments for orders that you never intended to fill, or you placed deceptive ads to sell your products. You may have doctored the financial statements you submitted to secure a loan or line of credit that you knew your company could not repay.
4. You distributed the LLC’s assets, including its cash, without paying off all creditors. Typically, known creditors are first on the list, then you can return the cash that each member contributed to the LLC. The final distribution of assets is normally the last step in the dissolution process.
5. In some states, personal injury claims can be filed against an LLC even after dissolution. The logic behind this is that people may not show signs of an illness or injury prior to the dissolution, or the illness or injury may not have been connected to the company’s goods or services until some time has passed. This is the concept of “discovery of harm,” which means that the plaintiff must have discovered the harm, or they should at least have known that they had been harmed. If the plaintiff is an adult, the statute of limitations ranges from two years to six years; if the injury or illness happened to a minor, the statute of limitations does not start until the child reaches the age of 18. Personal injury laws vary by state, so if you have reason to suspect that your actions or products may have caused harm to others, you should consult an attorney for guidance.
Is It Possible to Reduce the Potential for Personal Exposure After Dissolving an LLC?
State laws vary, and so do the circumstances of the members of the LLC. Therefore, you should consult an experienced business lawyer before construing the items on the following list as legal advice.
1. Publish a notice of dissolution in a major newspaper circulating in the county in which your central office is located. This can help protect you against unknown claims. Typically, claimants will have to file a claim within three years or be barred from filing.
2. Scrupulously follow every step in the state’s dissolution procedure. Since even filing the wrong form can derail the process, double-check everything.
3. If you are worried about unknown claims or lawsuits, consider keeping your LLC active until the statute of limitations has expired. If you choose this option, be sure that you keep your company in good standing. This means that you will need to continue filing all mandatory reports as well as paying any fees for a business license, maintaining a registered agent, obtaining a virtual business address, and remitting your taxes.