Heads I Win, Tails You Lose: Should Developers Dissolve Their LLCs After Completing a Project?

Real estate developers typically create limited liability companies (“LLCs”) as their choice of business entity for undertaking development projects. With exceptions, LLCs limit the personal liability of the real estate developer that is the “member” of an LLC. Those making claims against the LLC while it is in existence will generally find that while they may have claims against the LLC, they cannot bring an action against the member or members of the LLC. But what happens after the LLC is dissolved, either “administratively” by the Washington Secretary of State for failure to file an annual report and pay the fee, or by the members of the LLC through the procedures prescribed under Washington’s LLC statute? In other words, do actions against the LLC or its members survive once the LLC dissolves and ceases to exist?

In the wake of several decisions issued by Washington courts since 2005 and of the Washington legislature’s amendment of the Limited Liability Company Act (the “LLC Act”), the short answer is “yes.” For a period of three years after an LLC is dissolved, a claimant may bring an action against either an LLC or its members regardless of whether that claim arises before or after the LLC’s dissolution.1

In the past, a real estate developer could sidestep lawsuits by claimants, and thus the potential liability that could result from claims, merely by dissolving its LLC. This strategy was allowed because, until the Washington legislature amended the LLC Act in June 2006, the law did not allow a legal action to be brought against a dissolved LLC.

Before 2005, there was strong legal authority indicating that an action against an LLC did not survive the LLC’s dissolution. This reality shifted dramatically, however, when the Washington legislature amended the LLC Act in response to a case in which the Washington Court of Appeals reluctantly validated the former strategy of dissolving entities to avoid liability. The court’s reluctance led it to encourage the legislature to revise the statute to correct what it perceived to be an unfair result. The Washington legislature listened, and added a three-year survival-of-actions provision allowing claimants to bring actions against an LLC and its members within the three-year period after dissolution. So today, for a period of three years after dissolution, a claimant may bring an action against either an LLC or its members regardless of whether that claim arose before or after the LLC’s dissolution.

A number of cases issued since the legislature’s amendment of the LLC Act have shaped how the three-year survival statute is interpreted. These cases first hold that under the LLC Act’s amendment, an LLC’s formal dissolution and cancellation through “winding up” or its administrative dissolution and cancellation by the Secretary of State does not bar claims brought against the LLC within the three-year survival period.

These cases also explain that the LLC’s members face important consequences if the members fail to wind up the LLC according to the specific procedures outlined under the LLC Act. Namely, if the members fail to properly wind up the LLC, they may be personally liable to the creditors of the LLC.

Finally, these cases explain that an LLC cannot bring claims against third parties once the LLC ceases to exist. An LLC ceases to exist when it is “canceled,” not when it is “dissolved.” A somewhat confusing three-step process under the LLC Act must take place before an LLC ceases to exist. First, the LLC must be dissolved. The members of the LLC then must properly wind up the affairs of the LLC. Finally, when the members finish winding up the LLC, they then may have the LLC canceled. Although an LLC may still bring claims against third parties after dissolution, it may not do so after the LLC is canceled.

In light of the reality of the three-year survival statute and the cases that have interpreted it, an LLC should consider a few things before dissolving. First, an LLC intending to dissolve, wind up, and cancel should attempt to forecast potential claims that might be outstanding and include in its set-aside as part of winding up the provision of funds or insurance to account for these claims. Second, to minimize personal liability of LLC members, it may make most sense to not dissolve an LLC, at least not until the three-year statute of limitations has run on whatever potential causes of action may be outstanding (e.g., construction defect). Finally, if the members of the LLC decide that they want to dissolve and cancel the LLC, then it is imperative that they properly wind up the LLC. Under the LLC Act, a number of intricate steps must be followed in dissolving, winding up, and canceling an LLC. Following these steps carefully is crucial to avoid liability to creditors of the LLCs. It is best to have legal counsel assist with these procedures to ensure compliance with the law.

The story does not end here, however. The Washington Supreme Court earlier this year accepted consolidated review of two court of appeals decisions that have shaped current law on the survival of actions against LLCs and their members, and on an LLC’s authority to prosecute actions against third parties after dissolution. Oral argument is scheduled before the supreme court on November 18, 2008. Stay tuned for the outcome. We will report again when this new case is decided.

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1RCW 25.15.303.