Since the beginning of the pandemic, one of the main questions I get from struggling business owners is how to dissolve a business or declare bankruptcy. There is a litany of reasons to close your business. The most common problem right now is that company owners get so in debt to their landlords and vendors that, even if business suddenly turned around, they won’t be able to dig themselves out of debt. When faced with that situation, sometimes the only answer is to wrap up the business.
Dissolution vs. Bankruptcy
If you’ve decided to close your business, you might wonder if declaring bankruptcy is a good option for you. For most owners, bankruptcy for the business usually means bankruptcy for them personally. This occurs because most business owners have personally guaranteed the debts of their company. Therefore, if they declare bankruptcy in their business, the debts would simply pass to them personally. Then they would need to either pay the debts themselves or declare personal bankruptcy to avoid the liability. For many owners that is not a good option.
By dissolving the company, an owner still maintains the power to negotiate the debts owed. In many cases, the creditor is willing to negotiate to settle the claim. For example, a landlord will usually agree to settle an outstanding balance if it means terminating the lease. They get some money and, hopefully, a new renter that can actually afford to pay.
I don’t want to give the impression that all creditors negotiate. The fact is that some creditors have been unwilling to work with debtors during the pandemic, and because most of the protections put in place don’t apply to businesses, creditors are not as incentivized to negotiate. For example, there is no moratorium on evictions for commercial spaces.
How do you start a dissolution? Pursuant to 805 ILCS 180/35-1, dissolution can be commenced in one of five ways: (1) upon an occurrence of an event specified in the operating agreement, (2) upon the consent of all members, (3) if there are no members for 180 days, (4) by judicial decree, or (5) if the company has been administratively dissolved.
The most common of the above circumstances is based on consent of all members. Basically, everyone agrees that it’s time to close the business.
What if the owners can’t agree? One member may petition the court to dissolve the company. In that case, the company will be dissolved under the fourth item listed above.
What Happens in a Dissolution?
When you dissolve a company or LLC, you must satisfy all debts to creditors before distributing anything to the owners of the company. Pursuant to 805 ILCS 180/35-10, only after everything is satisfied can the rest be divided among the owners of the company.
That seems fairly straightforward, but in practice this can get a bit messy. For example, what if an owner is also a creditor? If an owner loaned the business money, which happens all the time, that owner may be eligible to receive payment for its loan before a distribution can be made to the owners. This can cause quite a bit of in-fighting among members of a company.
What Can Go Wrong in a Dissolution?
The easy answer is that a lot can go wrong. Obviously, the larger the company and more complex the structure, the more trouble is caused. Generally, if the owners pocket money or assets without observing formalities, they will be liable to other owners and creditors. The dissolution cannot turn into a free-for-all.
In the event formalities are not followed, creditors will likely be able to pierce the corporate veil, which means target owners individually. Therefore, if you don’t follow the rules, you run the risk of being held personally liable for the debts of the company, essentially defeating the purpose of the limited liability company.