This blog is related to the previous blog post of “Setting Aside Fraudulent Transfers” as it relates to a creditor’s efforts to recover from a dissolved corporation or dissolved LLC. Setting Aside Fraudulent Transfers Part I: What to look for when going after officers or successor company discussed how a creditor may go after the successor corporation to set aside a fraudulent transfer. This blog post will discuss a creditor’s rights to go after principals for individual liability when a company has been improperly dissolved.
Dissolution is the process by which the existence of a business entity is legally terminated, which may be before, contemporaneous with, or after the liquidation process. For a voluntary dissolution of a corporation, there are two avenues for dissolution that are based on the status of the corporation. First, if shares have not been issued, the corporation may be dissolved by directors and incorporators alone. Second, if the corporation has issued shares, the shareholders must approve of the dissolution. The dissolution is accomplished by delivery of the articles of dissolution to the department of state corporations division for filing, which can be filed any time before, during, or after the liquidation process. Once dissolved, the corporation may only continue to carry on business to wind up and liquidate the assets. Actions against a dissolved corporation may be brought against a successor entity which is defined in Florida Statutes § 607.1406(15) to include any trust, receivership, or other legal entity governed by the laws of Florida, to which the remaining assets and liabilities of the dissolved corporation are transferred. Note, the statue only permits for this successor entity to exist solely for the purpose of winding up the business of the dissolved corporation.
Upon dissolution, a corporation must deliver written notice of its dissolution to each of its known claimants after the effective date of dissolution for any known claims. Fla. Stat. § 607.1406 (2). The written notice must pertain to the following:
- include a reasonable description of the claim that may be asserted by the claimant;
- state the extent to which the claim is admitted or not admitted in whole or in part and, if admitted, provide the amount that is admitted (which may be as of a given date) and any interest obligation (if fixed by a debt instrument);
- provide a mailing address to which the claim may be sent;
- state the deadline (not less than 120 days after the effective date of the notice) for delivery of the claim to the dissolved corporation or successor entity; and
- state that the dissolved corporation may make distributions thereafter to other claimants, its shareholders, and other interested persons without further notice.
Typically, if all procedures are followed and the corporation winds down properly, directors are not personally liable to the creditors of the dissolved corporation. However, improper distribution of the assets of a dissolved corporation to the detriment of a creditor is a fraudulent transfer which may subject the principal to individual liability.
The dissolution of an LLC is different in procedure but has the same end result as the dissolution of a corporation. An LLC is dissolved when a “triggering event” occurs. These triggering events include the following: a date set forth in the article of organization or the operating agreement; the occurrence of an event as set forth in the operating agreement; by written consent of all the members; or by the entry of an order of dissolution by the court. Once a triggering event occurs, the LLC must file the articles of dissolution. Fla. Stat. § 608.441. A key component of the articles of dissolution is the statement regarding the financial status, which shall state that the LLC has paid or discharged for all of the LLC debts, obligations, and liabilities and the remaining LLC property and assets have been distributed among the LLC’s members according to their respective rights and interests. Fla. Stat. § 608.445. Once the department receives the articles of dissolution, it will issue a certificate of dissolution that effectively ceases the existence of the LLC. At this point in time, the LLC may only carry out business necessary to wind down and liquidate its affairs and assets. The managers, or members if the LLC is member-managed, in office at the time of the dissolution serve as trustees for the creditors of the dissolved LLC. Fla. Stat. § 608.446.
Just as a corporation has certain obligations to known claimants, dissolved LLC’s have similar obligations. The LLC must provide written notice to known claimants that includes the following:
- a reasonable description of the claim to which the claimant may be entitled;
- a statement as to whether the claim is admitted or not admitted in whole or in part and, if admitted, the amount admitted plus any interest due under a debt instrument;
- the mailing address to which a claim may be sent;
- the deadline for sending confirmation of the claim to the dissolved LLC (which must be no less than 120 days from the effective date of the written notice); and
- a statement that the LLC may make distributions after the confirmation deadline to other claimants, members, or former members without further notice.
Managers are not individually liable for the claims of the dissolved LLC unless they fail to distribute the assets in accordance with Chapter 608, Florida Statutes. Managers could be liable to other managers or members of the LLC, as well as outside creditors of the LLC.
The directors of an insolvent corporation and the managers of a dissolved LLC owe fiduciary duties of diligence and good faith to creditors. Beach v. Williamson, 83 So. 860 (Fla. 1920). For a corporation, the basis for the duty is that the property of a corporation is deemed a trust fund for the payment of debts of the corporation so the creditors have a lien on that property or a right of property out of it in preference to any shareholder. Id. Thus, an officer’s or director’s fiduciary duties may extend to a corporation’s creditors when the corporation becomes insolvent or is in the zone of insolvency. In re Aqua Clear Technologies, Inc., 361 B.R. 567 (Bankr. S.D. Fla. 2007). Under such a theory, directors may be liable for their failure to preserve assets for satisfaction of creditors’ claims. Thus, a corporate creditor has a cause of action against a director of an insolvent corporation who received a preferential transfer. Poe & Associates, Inc. v. Emberton, (Fla. 2d DCA 1983).
As an example of how officer liability pans out, in Mansolillo v. Parties by Lynn, Inc., 753 So. 2d 637 (Fla. 3d DCA 2000), the officer and director (“Mansolillo”) of a roofing corporation (Stanley) was held personally liable after the dissolution of Stanley. Stanley ceased doing business around July 1994, which is the same time that the son of Mansolillo began another roofing corporation. Stanley held security interests, including eight trucks, prior to dissolution. Proceedings were initiated against the Stanley by a creditor but the corporation was found to be insolvent. The court discovered that Mansolillo had substantial authority in the creation of the new roofing corporation operated by her son as her signatures were present on checks. Additionally, it was further discovered that Mansolillo knew of the insolvency of the roofing corporation when she transferred the assets and money from selling the assets in the account of the new roofing corporation. As such, Mansolillo was held personally liable as the officer and director for her fraudulent transfers.
As it relates to the Mansolillo case, let’s look at our own hypothetical. ABC Corp., a paving company, dissolves and D, the director in charge of distributing assets, is running the successor entity of ABC Corp. solely for the purpose of distributing assets. Prior to dissolution, D receives notice that a corporate creditor is owed money by ABC Corp. However, instead of distributing the funds, D puts the funds into the account of the successor entity and begins to operate another paving company. The actions taken by D are a breach of his fiduciary duty to the corporate creditor and the corporate creditor has a cause of action against D. The creditor would also have statutory remedies available.
In the LLC context, for example, let’s say ABC LLC is dissolving pursuant to consent of the two managers, D and E. D and E file the articles of dissolution and it appears they followed the appropriate procedures. However, D not only failed to pay the creditor Big Ben, but D received a large distribution in violation of the LLC’s operating agreement. Big Ben could pursue an action against D personally for his acts as the manager of ABC LLC.
In both of the hypotheticals above, what happens now that there is a creditor claim against the individual principal? The judgment creditor may bring a separate cause of action from the original action, known as a proceeding supplementary, which is essentially a continuation of that initial action. In proceedings supplementary, the judgment debtor is brought before the court and questioned with regard to the property subject of a writ or execution. The purpose of this is to provide enforcement of the judgment against the debtor. Therefore, in our corporation example, the corporate creditor would initially bring suit against ABC Corp., and then he would bring in director D in the proceedings supplementary. In our LLC example, Big Ben would initially bring suit against ABC LLC, and then he would bring in manager D in the proceedings supplementary.
In sum, while corporate entities typically shield the principals from personal liability, a principal may lose this shield if he/she improperly winds down the entity or breaches the fiduciary duty owed to creditors upon dissolution.