De Facto Dissolution: Everything You Need to Know
De facto dissolution refers to the dissolution of a corporation and the liquidation of all its assets. 3 min read updated on September 19, 2022
De facto dissolution refers to the dissolution of a corporation and the liquidation of all its assets.
What Is De Facto Dissolution?
A company that goes into dissolution suspends all of its business transactions and liquidates the assets of the company. Dissolution of a company often brings up a lot of questions and financial concerns. The company and its members may wonder if they are liable for legal actions against the company after it has already been liquidated. There are a lot of factors that go into the legal consideration against a de facto dissolution company.
De Facto Dissolution of an LLC Does Not Terminate Members' Fiduciary Duty
A recent legal decision claims that the LLC fiduciary responsibility is not forgiven simply because the company has been liquidated. Additionally, if members of the liquidated LLC continue to do business through the LLC name or if they create a separate but similar business, they are liable for any financial responsibilities.
De Facto Dissolution of a California LLC
California takes a unique stance on the legal liability of LLCs after liquidation. According to California law, members of an LLC are not personally liable for any debts or financial obligations. However, there are exceptions to this rule. Exceptions include:
- The liability of a member under the equitable alter ego doctrine.
- Co-signing for debt incurred under the LLC business name.
- The guarantee of performance with a contract agreement.
- Liability for the personal actions of an LLC member, whether or not they were acting on the behalf of the business LLC.
- A lack of disclosure when entering into a contract agreement.
- The removal of LLCs assets in a malicious intent.
- If the LLC has undistributed assets (i.e., in the form of an insurance policy).
- If assets were distributed to the members of LLC after liquidation, but before formal dissolution. The responsible liabilities, however, are limited to the amount received after the liquidation.
In order to evaluate whether or not an LLC is liable for financial responsibilities after dissolution requires that an exact date of dissolution is specified. In most cases, the only public record that has this information is the statement of dissolution that is filed with the state. This document, however, does not always determine the exact date of the dissolution.
According to the California Revised Limited Liability Company Act, a company is considered dissolved when one of the following occurs:
- An event takes place on a specific date, and that is specified in the Articles of Organization.
- If 90 days have passed and the LLC has no remaining members.
- There is a judicial statement of de facto dissolution.
- The members vote to dissolve the company and its assets.
In many cases, assets are already distributed before any of these events occur. By the time a judgment is made, there are no remaining assets left to pay them. This is where things can get complicated. The judge must determine if the previous actions occurred before the assets were distributed and if the financial obligations are payable.
Tax Consequences of De Facto Liquidations
Many also wonder if there are tax liabilities on a liquidated LLC company. If an LLC is liquidated for income tax purposes, there will likely be tax consequences for the company and its former members. The exact de facto liquidation date is important when determining tax liabilities, too. The date of the liquidation will determine the liable tax year. Some businesses take many years to fully liquidate, and this can make it difficult to establish a liable tax year.
Generally speaking, the most important factor to consider is whether or not the company was solvent at the time of full liquidation. Additional factors that are taken into account include:
- Gains to the fair market value of any property.
- Materially appreciated assets (if any are present).
- The net operating losses of the company.
- Whether or not the liquidating company is involved in foreign investments.
The factors that determine liability vary depending on the individual features of the business. It is important that tax professionals are always aware of the implications of de facto liquidation businesses, both in a domestic and foreign setting.
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