Using the Dissolution Statutes to Reduce Claims Against Troubled Businesses
The state law dissolution statutes offer a cost-effective method to minimize claims when a business cannot reorganize. While reorganization is often the goal when a business experiences financial distress, some businesses are fundamentally broken and must be wound up. There are a number of options available to wind up a business. The state law dissolution statutes offer a possible preferred approach to minimizing claims.
Michigan’s Business Corporation Act (the “BCA”), MCL 450.1101 et seq., and Michigan’s Limited Liability Company Act (the “LLC Act”), MCL 450.4101 et seq., each contain an Article 8 addressing a business’s dissolution and the effect of that dissolution on claims against the dissolving entity. MCL §§ 450.1801-1864, 450.4801-4808. Ordinarily, a corporation or limited liability company (“LLC”) is dissolved when a certificate of dissolution[1] is filed with the Michigan Department of Licensing and Regulatory Affairs (“LARA”). MCL §§ 450.1803(2), 450.1804(7), 450.1805, 450.4804.[2] After dissolution, the business takes on a “zombie afterlife” that prohibits it from conducting business but allows it to:
- Collect its assets;
- Sell or otherwise transfer, with or without security, assets which are not to be distributed in kind to its shareholders;
- Pay its debts and liabilities, and
- Do all other acts incident to liquidation of its business and affairs.
MCL § 450.1833.[3] In addition, a dissolved business can sue and be sued during this period. MCL §§ 450.1834(e), 450.4805(3). The “zombie afterlife” continues “only until [the business] has concluded ‘winding up its affairs’” and when its affairs are “wound up”, it ceases to exist for all purposes. Flint Cold Storage v Dept of Treasury, 258 Mich App 483, 495-496 (2009), quoted by Drake v. Plum Hollow Lanes, et al., 2024 Mich App LEXIS 1013, *10 (Feb. 9, 2024). “The general rule is that after … the termination of the existence of a corporation, no action can be maintained against it, and it has no capacity to be sued.” Flint Cold Storage v Dept of Treasury, 258 Mich App at 498.
Importantly, a corporation or LLC may take action through the dissolution statutes to shorten the statute of limitations when claims may be brought against it. The dissolving business may give written notice to its known creditors and/or give unknown creditors notice by publication. MCL §§ 450.1841a, 450.1842a, 450.4806, 450.4807 (collectively, the “SOL Shortening Sections”). The SOL Shortening Sections “afford a dissolving [business] the ability, in the course of winding up its affairs, to cut off its liability for any and all claims that either have arisen (i.e., “existing claims”) or that may arise in the future but are not yet known to the corporation. By implication, the failure of a dissolving [business] to avail itself of either of these options leaves it with the possibility that claims can be brought against it beyond the 6-month and 1-year periods provided under the respective statutory sections.” Drake v. Plum Hollow Lanes, et al., 2024 Mich. App. LEXIS 1013, *16.
Where there are known creditors, the SOL Shortening Sections provide for written notice to the creditors. If a dissolving business gives written notice to its known creditors, then (i) the creditor has not less than 6 months to submit a claim and (ii) if the creditor submits a claim and the claim is denied, then it must commence litigation within three months after notice of denial of its claim. [4] MCL §§ 450.1841a(3), 450.4806(3). If the creditor does not submit a claim within the six month period or commence litigation within the three month period after notice of denial of its claim, then the creditor’s claim is forever barred. MCL §§ 450.1841a(3), 450.4806(3). Notwithstanding use of the known creditor statute, a creditor may commence litigation to collect its claim when the creditor timely files its claim and the dissolving business does not reject the claim.[5]
Where there may be unknown creditors, the SOL Shortening Sections provide for notice by publication. If creditors are given notice by publication in a “newspaper of general circulation in the county where the dissolved corporation has its principal office, or if there is no principal office in this state, its registered office, is or was last located”[6], then creditors have one year from the date of publication to commence proceedings to collect their claims.[7] MCL §§ 450.1842a(2), 450.4807. If litigation is not brought within one year after the publication date, then it is forever barred. MCL §§ 450.1842a(2), 450.4807. However, a creditor with a known claim is not barred from commencing a proceeding to enforce the claim until 6 months after it has actual notice of the dissolution.[8] MCL §§ 450.1842a(4), 450.4807(4).
The Michigan Court of Appeals recently addressed the effect of a dissolving entity’s failure to take advance of the SOL Shorten Sections in Drake v Plum Hollow Lanes, which involved a personal injury claim against the dissolving entities that occurred prior to their dissolution. 2024 Mich. App. LEXIS 1013, *1-2. The dissolving entities knew of the claim because the injury had been reported to its staff when it occurred and an ambulance had been called to their premises. Id. at 14. The businesses dissolved 18 months after the injury by filing their articles of dissolution with LARA, but neither gave their creditors written notice of dissolution nor notice by publication. Id. at 2. The businesses alleged that they were fully wound down and their existence terminated 19 months after the injury occurred. Id. Thirty-six months after the injury, plaintiff sued the dissolved businesses. Id. at 3.
The Court of Appeals concluded that the dissolved businesses were not fully wound down before plaintiff sued because (i) the dissolved businesses had not paid all of their debts and liabilities as required by MCL 1833(c) and “the statute unambiguously includes paying liabilities other than debts in the winding up period”, (ii) the known personal injury claim was a liability of the dissolved businesses that accrued before their dissolution under the applicable tort law, and (iii) the dissolved businesses failed to give written notice or notice by publication which would have reduced the statute of limitation on the claim. Id. at *11-*15. The Court concluded, “Because plaintiff’s claim against [the dissolved businesses] was not contingent[[9]], and [the dissolved businesses] did not act to cut off plaintiff’s claim, or any other potential claim for that matter, in either of the manners provided by the [SOL Shortening Sections], [the dissolved business] could not in fact have wound up their affairs in January 2020. Plaintiff’s suit, having been brought within the 3-year statute of limitation, is therefore viable.” Id. at 16.
While Drake presents a cautionary tale where the SOL Shortening Sections were not used, the SOL Shortening Sections are powerful tools to minimize known and unknown claims against a dissolving business because they compel potential creditors to act much more quickly than they may desire or be barred from any recovery. As a result, the SOL Shortening Sections should be regularly considered when determining the most appropriate method to wind up a business. This is particularly true where neither a chapter 7 bankruptcy nor an assignment for the benefit of creditors (“ABC”)[10] discharges the debtor-entity of its liabilities leaving the debtor-entity open to suit (such as its recovery may be) after the conclusion of the bankruptcy case or the ABC case. 11 USC §§ 727(a)(1), 1141(d)(3). See generally MCL §§ 600.5201-5265. By contrast, a statutory dissolution, done properly, may accomplish that finality.
[1] As a practical matter, a notice of discontinuance and request for tax clearance should be filed with the Michigan Department of Treasury when the certificate of dissolution is filed.
[2] By contrast, a business that is administratively dissolved because it failed to pay its annual fees to LARA is not dissolved within the meaning of Article 8 of the BCA or the LLC Act. See Stott v Stott Realty Co., 288 Mich 35 (1939) (a corporation does not cease to exist upon its charter becoming absolutely void by reason of nonpayment of privilege fees, but it still continues as a body corporate and remains a legally existing corporation for certain purposes).
[3] Michigan’s LLC Act does not contain a provision similar to MCL 450.1833. However, LARA has taken the position that it applies equally to limited liability companies as to corporations: “After a corporation or LLC has dissolved, its existence continues, but only for the purpose of winding up its affairs by collecting its assets, selling assets which are not to be distributed to its shareholders or members, paying its debts and other liabilities, and doing any other activities in the liquidation of its business.” LARA, Dissolution, BCS/CD Pub-8007 (Rev. 04/2011).
[4] From a practical standpoint, creditors that will be involved in the dissolution process generally file proofs of claim within the first month after receiving the notice of dissolution. This helps identify the universe of creditors that may commence a proceeding against the business if their claim is unpaid and those creditors that are unlikely to take any action.
[5] Phillips-Johnson Props., LLC v. Tru Fitness Studios, LLC, 2016 Mich App, LEXIS 299 (Feb. 9, 2016) (recognizing that creditor may only collect from the dissolved entity’s remaining post-dissolution assets, “such an issue relates only to partial collectability, not to plaintiff’s entitlement to a judgment” (Id. at 8) and that the creditor “may not be able to collect fully on its judgment did not mean that it was not entitled to such a judgment.” Id. at *10.
[6] MCL § 450.1842a(2)(a). MCL 450.1807(2)(a), applicable to limited liability companies, is materially identical.
[7] Today, many people do not read a newspaper of general circulation. See Newspaper Fact Sheet, Pew Research Center (November 10, 2023), available at https://www.pewresearch.org/journalism/fact-sheet/newspapers/. As a result, using this method may result in fewer timely claims against the business. This, however, raises an interesting issue regarding whether the statute should be updated to account for the technological shift in how information is communicated to the general public.
[8] This carve-out for known creditors creates an issue of fact regarding when the creditor has “actual notice” of the dissolution. As a result, in appropriate cases, it may be useful to use written notice and notice by publication to ensure the statutes of limitations are reduced for the entire universe of potential creditors.
[9] Rather, the claim was unliquidated: It has accrued, but the amount of the claim has not yet been determined.
[10] McKey v Sewnson, 232 Mich 505 (1925) (“This assignment for the benefit of creditors did not operate as a dissolution of the corporation. The assignment provided for the payment of creditors out of the corporate assets and return to the corporation of any excess.”).