A Law Update for
Condominium
Developers:
Dissolution and Cancellation of
Limited Liability Companies
Presented by:
Joseph P. McCarthy
Douglas L. Batey
Janet F. Jacobs
Stoel Rives LLP
October 8, 2009
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Very Short History of Limited
Liability Entities
• Legal protection from business risk was not historically
allowed
• Sole proprietorship and partnerships = personal liability
• First Business Trusts Act in late 18th century
• First Corporation Act in North Carolina in 1795
• Uniform Limited Partnership Act in 1916
• First LLC Act in Wyoming in 1977, Florida in 1982,
nowhere else until 1988; everywhere else by 1997
• LLCs are new
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Legal Theories to Protect Creditors of
Limited Liability Entities
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Piercing the veil
Fraudulent transfer
Bankruptcy preference
Personal liability for torts
Personal liability for professionals
Limited Liability Companies Do Not
Provide Complete Protection from
Business Risk
• “Except as otherwise provided by this chapter, the
debts, obligations, and liabilities of a limited liability
company, whether arising in contract, tort or
otherwise, shall be solely the debts, obligations, and
liabilities of the limited liability company; and no
member or manager of a limited liability company
shall be obligated personally for any such debt,
obligation, or liability of the limited liability company
solely by reason of being a member or acting as a
manager of the limited liability company.” RCW
25.15.125.
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Hallmarks of the Residential Real
Estate Business
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Unique product
Capital intensive
High risk
Short life
Project by project finance
Lender requirements for SPEs
The Life Cycle of an LLC
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File certificate of formation (birth)
Conduct business (live life)
Dissolve (in the hospital)
File certificate of cancellation (in the
ground)
Typical Real Estate Business
Structure
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Development SPEs
Developer = manager
Investors = members
Holding company
Typical Real Estate Business
Cycle
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Form it
Build it
Pay debt
Pay investors
Let it lapse
Legal Liability vs. Winding Up and
Paying Off Investors
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Dissolution: a legal status
Dissolution begins the winding up process
Winding up: pay off creditors, distribute profits
What about late-arriving warranty claims?
Warranty claimants will attempt to seek
recovery from the LLC, from the managers,
and from the investors
Response of Washington State
Legislature
• Ballard Square case in 2006
• Perceived unfairness to creditors (read:
consumers)
• LLC survival statute (RCW 25.15.303)
in 2006
• Claims may be filed up to three years
after dissolution of an LLC
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Washington Supreme Court
Weighs In – Chadwick Farms
• Classic condo fact pattern
• LLC formed for a project
• LLC administratively dissolved after first unit
sale
• Suit by homeowners association
• LLC files cross claims two months after
cancellation
• LLC moves to dismiss claims
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What Should a Developer Do?
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Formation of an LLC
• State law governs
• LLC begins to exist when certificate of
formation is filed with Washington
Secretary of State
• LLC exists until a certificate of
cancellation is filed
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Normal Operations
• Legal entity
• Same powers as an individual
– Enter into contracts
– Sue and be sued
• Member relations governed by operating agreement
and statute
• Members generally have limited liability, with
exceptions
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Dissolution
• Change of status
• Begins the winding up – mandatory
• Trigger – written consent of all members, or:
– Dissolution date in certificate of formation
– An event specified in operating agreement
– Five years after administrative dissolution, unless
reinstated
– Unless operating agreement provides otherwise, 90 days
after dissociation of last member, unless assignees have
voted to admit at least one new member
– Decree of judicial dissolution
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Winding Up
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Gradually settle and close the LLC’s business
Prosecute and defend suits
Dispose of and convey property
“pay or make reasonable provision to pay all claims
and obligations, including all contingent, conditional,
or unmatured claims and obligations, known to the
LLC.” RCW 25.15.300(2).
• Distribute remaining assets to members
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Dealing With Liabilities
• LLC must pay or make reasonable provision
for contingent, conditional, and unmatured
claims if known to LLC, even if identity of
claimant is unknown
• If assets are inadequate, LLC must deal with
claimants by priority and ratably within a
priority
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Who Does the Winding Up?
• Manager
• Persons approved by members
• Person winding up has personal liability to
claimants if that person does not comply with
rules about dealing with liabilities
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When Winding Up Is Completed
• Certificate of cancellation must be filed
• LLC no longer exists after certificate of
cancellation is filed
– LLC can no longer act
– What about lawsuits?
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Survival Statute
• The dissolution of an LLC does not impair any
remedy against the LLC, but …
• Action may not be brought against LLC after three
years from dissolution
• What if LLC is cancelled before the three years are
up?
• Recent Washington Supreme Court case: Chadwick
Farms
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Chadwick Farms Owners Association v.
FHC LLC – Background
• Two lawsuits – condo developers
– Chadwick Farms condominiums
– Emily Lane condominiums
• Owners associations sued alleging construction defects
• Chadwick Farms –
– After last unit sold, the LLC did not renew its certificate, so
Secretary of State administratively dissolved the LLC
– Later, after lawsuit for construction defects was started, Secretary
of State cancelled the LLC in mid-lawsuit
– Court of Appeals held that following cancellation, the LLC could be
sued but could no longer sue in its own name (e.g., against
subcontractors)
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Chadwick Farms Owners Association v.
FHC LLC – Background (cont.)
• Emily Lane – members voted to dissolve after
units sold, and cancelled the LLC’s certificate
shortly thereafter
• Later, lawsuit was filed against the LLC
• Court of Appeals allowed lawsuit against LLC
to proceed after cancellation
• Appeals consolidated
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Chadwick Holdings in Supreme Court
• Cancellation ends everything – even in mid-suit
• An LLC may not be sued after cancellation
– existing lawsuits abate
• An LLC may not sue after cancellation
• Why not? Non-existence
• Cancellation trumps the three-year survival statute
• Dissolution triggers mandatory duty to wind up
• Failure to properly wind up = personal liability
• Cancel at your peril
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What, Me Worry?
• Doesn’t having a Limited Liability
Company limit the liability of
members and managers?
• How could they have personal
liability?
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Limited Liability
• Limited liability is predicated on one
simple principle:
– The LLC is a distinct and separate legal
entity from its members
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RCW 25.15.125
• “Except as otherwise provided by this chapter, the
debts, obligations and liabilities of a limited liability
company, whether arising in contract, tort or
otherwise, shall be solely the debts, obligations
and liabilities of the limited liability company; and
no member or manager of a limited liability
company shall be obligated personally for any
such debt, obligation, or liability of the limited
liability company solely by reason of being a
member or acting as a manager of a limited
liability company.”
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What Does “Limited Liability” Mean?
• LLC is responsible for debts and liabilities
• Member’s capital contribution is at risk
• Member’s assets outside the LLC are not at
risk
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Loss of Limited Liability Protection
• Liability to LLC or other members
– Improper interim distributions
– Use of LLC’s property or business
opportunity
• Liability to third parties
– Piercing leads to loss of limited liability
protection
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Wrongful Non-Liquidating
Distributions
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RCW 25.25.235: no distributions if
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No liability to LLC for unknowing receipt
No liability to LLC after three years for knowing
receipt
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LLC wouldn’t be able to pay debts OR
Amount of liabilities exceeds value of remaining assets
NOTE: liability is to LLC, not to other members or thirdparty creditors
Exceptions to Limited Liability –
Third Parties
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Contracts
Personal torts
LLC torts: “piercing the veil”
Improper wind-up
Exception: Torts
• Personal liability for a wrongful act not
connected with LLC business
– Even if acting in the course of the LLC’s business
– Example: drunk driving while delivering LLC’s
product
• Piercing analysis is used to hold members
responsible for wrongful act connected with
LLC business
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Breach of Fiduciary Duty
• Under the Condominium Act, the Board
of Directors owes fiduciary duties to
condo owners
– Developer as board member
– Duties of loyalty, good faith, and high standard of
care
– Prioritize interests of condo owners, not LLC
members
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Fraudulent Concealment
• Five elements:
– A residential dwelling with a concealed defect
– Developer knows about the defect
– Defect is a danger to the property, health, life of
purchaser
– Purchaser doesn’t know about the defect
– Purchaser wouldn’t discover defect even on
careful inspection
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Fraudulent Concealment (cont.)
• Fraudulent concealment finding
 Economic Loss Rule
• Damages limited to contract remedies
• Contrast actual fraud…
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Fraudulent Transfer Elements
• Elements:
– Antecedent debt
– Transfer of assets out of the LLC
• to an insider
– No “reasonably equivalent value” for the transfer
– LLC is unable to pay the debt after the transfer or
is functionally insolvent
– Intent to prevent or delay payment of debt
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Fraud
• Elements:
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Representation of an existing fact
Which is material
And false
The person making the statement knows it’s false or doesn’t
know if it’s true
The speaker wants the listener to rely on the statement
The listener doesn’t know it’s false
And relies on the truth of the statement to reach a decision
And is entitled to rely on it
And suffers damages as a result
Consumer Protection Act
• Elements:
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An unfair or deceptive act
In the conduct of trade or commerce
That has an impact on the public interest
And injures plaintiff’s property
And there’s a causal link between the
unfair/deceptive act and the harm done
Improper Winding Up
• RCW 25.15.300
– Proper winding up  no personal liability to LLC
claimants
• Proper winding up
– Reasonable provision for known claims and
obligations
– Court-blessed plan of winding up?
– Chadwick Farms: personal liability for improper
wind-up
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Practical Advice for Real
Estate Developers
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Heads Up – Proposed Legislation
• Once the LLC is dissolved, the LLC may optionally file a
certificate of dissolution
– Certificate of dissolution may be revoked for 120 days
• If a certificate of dissolution is filed, LLC may give written
notice to holders of known claims, who must respond within 120
days
• If LLC rejects the claim, claimant must file suit within 90 days
• Claims against LLC must be brought within three years of filing
of certificate of dissolution, regardless of when certificate of
cancellation is filed
• Certificate of cancellation does not terminate LLC’s existence
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Issue: What Is a Known Claim Or
Obligation?
• The Act requires provision for “claims” and
“obligations”
• Does “known” require actual or constructive
knowledge?
• Statutory language suggests “actual”
knowledge – some cases have found
constructive knowledge is enough
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Strategy: Dissolve, Wind Up,
Cancel, Defend
• Triggers three-year claim period
• May be shorter than the statutory warranty
period
• Document the dissolution, so it’s not private
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Suggestions for Wind-Up
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Prepare a wind-up plan
Adopt resolutions
Document assets
Analyze and document potential claims
Document actions
Buy insurance for winder upper?
Guard Against Piercing the
Corporate Veil
• Financially troubled LLC: third party focus
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Under-capitalized for intended business
Failure to follow formalities
No bona fide commercial purpose
Violation of governing documents
Dissolution issues
• Lack of LLC formalities alone is not grounds
for loss of limited liability
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Piercing the Veil (cont.)
• Best practices:
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Adequate capitalization
Strong LLC agreement
Meetings
Diligent record keeping
Separation of assets
Arms-length member/LLC transactions
Document distributions (+ salary)
How to Make Provision for Claims
and Obligations
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Keep reserves
Establish a trust
Buy insurance (sigh)
Go to court?
Strategy: Don’t Dissolve
• Avoids duty to wind up
• Avoids personal liability for
improper wind-up
• Allows LLC to conduct business as
usual
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If Administratively Dissolved,
Reinstate (If You Can)
• Now, five year window
• Simple filing
• Return to active status
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Strategy: Adopt Robust structure
• Use robust warranty disclaimers, as
allowed by Condominium Act
• Avoid member-managed LLCs
• Use an entity as manager
• Consider a separate entity to wind up
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Corporation as Manager
• Manager-managed LLC
• Use a corporation as the manager
– Analogous to using a corporation as the general partner in a
limited partnership
• Possibly use a separate, corporate manager to manage only
the winding up
• Observe all the corporate formalities, put some capital into the
corporation
• When the LLC is dissolved, the corporate manager conducts the
winding up
• Claims of improper winding up would be made against
the corporation, not the members or other managers
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Strategy: Thinking Outside the
Box
• Merge into a corporation before wind up
• Merge into a foreign LLC before wind up
• File suit for court approval of wind up (RCW
25.15.295)
• Limit discretion of manager to make distributions?
• Specify distribution events in the LLC agreement
(RCW 25.15.215 and .230)
• Avoid manager promote: use fees?
• Structure equity as debt or fees?
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Merge Into a Washington Corporation
• Before dissolution, merge the LLC into a corporation
• Dissolve and wind up the corporation
• Corporation procedures are more detailed, provide for
notice to creditors and cutting off creditors’ claims, and
provide procedural safe harbors for dealing with
contingent claims
• Corporation dissolutions begin with public filing
• Corporation is never cancelled
• There may be tax issues, but not necessarily
show-stoppers
• LLC members will have dissenters’ rights
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Legal Side Note:
Things Can Always Get Worse!
“John of Craumford fled to the church of Bamburgh
and there confessed to highway robbery, and abjured
the realm in the presence of William of Bamburgh,
who was then coroner. He had no property. Witness
has been borne that the entire town charged him with
highway robbery and wanted to arrest him, but he
escaped from their hands to the aforesaid church, as
related above; accordingly the village is to be fined.”
In re John of Craumford, Assize Court of Northumberland
County, Northumberland Assize Roll, 40 Henry III (1256).
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Thank you!
Questions?
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