Sep 01, 2009

Shutting Down a Floundering LLC

We recently received this question from a reader:

My LLC owes a lot of debts and the business is floundering. If it doesn't improve, can I just close the doors and move on since I'm not personally liable for any debts?

There are really two parts to this question. The first part is: "Can I let my LLC lapse by not paying annual renewal fees to the state LLC office?" Here's the answer: If you don't file LLC dissolution documents with your state, your LLC will keep incurring annual fees and minimum taxes and will get suspended, so you need to file dissolution papers.

The second part of the question seems to be: "Can I close the doors and ignore creditors' phone calls even though the LLC owes debts?" First, if your LLC owes debts, you can't take any LLC cash or assets and give them to yourself or other owners. Only after you have paid all creditors' claims and repaid all loans can you distribute the remaining cash and assets, if any, to the owners. Plus, LLC owners have a statutory duty to pay off the LLC's debts to the extent possible, if it has any assets.

In addition, some states won't allow the LLC to formally dissolve until it has repaid its debts; the state LLC registration lists are full of suspended businesses because so many have debts that can't be paid and yet the LLC can't be dissolved because of the debts.

So, to comply with your state's law, you should try to liquidate the LLC's assets and pay off its debts to the extent possible, either:

  • by doing it yourself
  • going through a business bankruptcy, where the bankruptcy court liquidates the business and pays off its debts to the extent possible, or
  • by assigning the LLC's assets to a company or law firm that specializes in liquidating assets and paying off creditors.

If you decide to liquidate the LLC's assets yourself, you could simply sell the LLC's assets and pay your creditors on a pro rata basis until the business's cash is exhausted. But a better idea is to get a signed release from all of your creditors, releasing the business and its owners from the debt. This prevents you from being hounded by collection agencies and possibly even being sued down the road. If you are sued, you'll at least have to file a response in court, pointing out that you aren't personally liable for the corporation or LLC debt, and you may have to hire a lawyer or appear in court.

Worse, a creditor might even argue that it was really just you running the LLC and that your LLC was just a sham to help you defraud creditors -- this is called "piercing the veil" of the LLC. If the creditor were to succeed in piercing your LLC's veil, you could actually be held personally liable for paying the LLC's debt. Getting settlement releases on all of your debts can avoid this, as can going through bankruptcy or an assignment of assets for the benefit of your creditors.