Keep a keen eye on each state’s obligations for establishing and dissolving business entities
Reproduced with permission of Trusts & Estates magazine (October 2010)
Many of our clients establish business entities for gifting and estate tax planning. Keeping a keen eye on the obligations that each state imposes on these entities can help your clients avoid some serious consequences.
Almost every state requires corporations, limited liability companies (LLCs) and limited partnerships (LPs) organized under its laws to file annual reports with the state and to pay an annual fee. Similar obligations apply to out-of-state entities doing business within a state’s borders. Entities that don’t meet these obligations face administrative dissolution or, for foreign entities, revocation of permission to do business in that state. Although these penalties don’t have the full legal effect of judicial dissolution, two recent cases show how harsh they can be.
No Suit for You!
Administrative dissolution means that your client’s business entity doesn’t exist — and an entity that doesn’t exist may find it difficult to bring a lawsuit.
Georgia’s GC Quality Lubricants, Inc. (GC) learned that lesson the hard way this year.1 In February 2005, GC’s property was damaged in an electrical storm. In July 2005, it was administratively dissolved for failing to pay corporate dues. Three years later, it sued its insurer and the Georgia Power Company, alleging that both the insurer and the power company were liable for the property damage. The defendants moved for summary judgment because the lawsuit was filed after Georgia’s two-year survival statute for a dissolved entity to assert a claim had run.2 The trial court granted the motion, which was upheld on appeal.
GC thought it was “in the clear” because it had successfully applied for reinstatement on April 2009, and Georgia law allows an effective reinstatement to relate back to the date of dissolution.3 It was wrong. Faced with one statute granting an entity two years after dissolution to assert its claims, and another allowing reinstatement to relate back to the time of dissolution, the court invoked the principle that a specific statute must prevail over a general one. The two-year limitation, the court held, took precedence over a general ability to relate back.4
The ruling is a little surprising because Georgia precedent seemed to cut the other way. Though several Georgia cases held that a dissolved entity couldn’t bring suit after the survival statute had run, those cases featured plaintiffs that hadn’t been effectively reinstated. Only one case, Williams v. Martin Lakes Condo. Assn.,5 featured an entity that had been administratively dissolved, brought suit and then effectively applied for reinstatement. In Williams the court held that “because the Association in the instant case was effectively reinstated, it possessed the legal capacity to sue at the time the complaint was filed,” dissolution notwithstanding.6 Williams also approvingly cited similar holdings in several other states.7
What changed between Williams and Doherty? It’s tempting to think that the crucial difference is the Williams plaintiff’s non-profit status, which, if true, would shield many entities established for gift and tax planning purposes from the consequences that befell GC. But the Doherty court grounded its reasoning elsewhere: the Williams decision happened to come during a short window when the Georgia code didn’t contain the two-year survival statute. This highlights the importance of making sure your clients meet their corporate obligations: a quick glance at the case law might conceal the real dangers of lapsing on annual filings and fees.
Dance of the Corporate Veils
A recent Texas case highlights a different peril: An administratively-dissolved corporation might not shield its directors and officers from personal liability. In Taylor v. First Community Credit Union,8 a Georgian automotive company, Texan Automotive (Automotive), got a certificate of authority to do business in Texas in 2003. Later that year, Automotive entered into a dealer agreement with First Community Credit Union (Credit Union). Automotive defaulted on its obligations to Credit Union, but the damages weren’t known until after Automotive became delinquent on its fees in 2004. By the time Credit Union knew what it was owed, Automotive had lost its certificate of authority in Texas.
Credit Union sued Automotive officer and director Luis Taylor for actual damages, fees and interest in 2007. Luis argued that the “relation back” doctrine, long recognized in Texas, tied the damages to 2003, when the underlying agreement was executed and Automotive was still certified to do business in Texas. As such, he couldn’t be held personally liable for debts created by a valid and certified corporation.
The precedent here was far firmer than in Doherty: the court itself noted that Texas case law clearly supported Luis’ position.9 However, there were no supporting court cases decided since the Texas legislature amended its definition of debt in the context of corporate obligations to include the phrase “a certain amount of money.”10 The court held that this addition meant a debt couldn’t relate back to a time before its amount was known, because the debt didn’t then exist — and the obligation incurred by Automotive’s breach wasn’t known until after Automotive forfeited its corporate privileges in Texas. The fact that the definition guiding this reasoning had since been repealed was irrelevant. The court determined that Luis couldn’t claim corporate privileges through the relation back doctrine, and was personally liable for the debt.11
High Stakes, Changing Game
Doherty and Taylor show the serious consequences that can follow from non-compliance. These cases show by no means the only things that can go wrong: a client could, for example, have a lot of trouble selling or financing an entity that’s no longer in good standing. But these cases also highlight a more subtle peril: It can be very hard to tell ex ante just what, if anything, will follow from non-compliance. Both Doherty and Taylor implicate ever-shifting statutes and represent breaks from precedent, albeit to different degrees. Figuring out where the law stands on a dissolved entity entails not just knowing the statutes and case law, but what the statutes were at all times relevant to the action, and at all times relevant to any precedent(s) relied upon. Given the relative simplicity and low expense of staying in compliance, clients should be urged not to neglect their annual filing and fee obligations.
Unfortunately, it’s very common for private companies, especially family business entities, to fail to meet these obligations consistently. When practitioners learn of or establish business entities for clients, even if the entities are only for gifting or estate tax planning, practitioners should make sure that clients know the importance of their annual filing and fee obligations, and have a reliable mechanism in place for satisfying them. If the entity will do business in other states, be sure it has a certificate of authority for each such state. This might be necessary even if the entity holds only passive investments out-of-state, so check the relevant jurisdiction’s definition of “doing business” to ensure your clients are in compliance. Practitioners should also be wary of serving as agent for service of process unless it’s clear they will not be held responsible for ensuring that annual reports are filed and all appropriate fees are timely paid each year. Finally, if you learn that your clients’ business entities are not in good standing because of delinquent filings or unpaid annual fees, strongly encourage them in writing to rectify the situation as soon as possible. These simple steps will help protect your clients, and yourself, from the harsh and unpredictable results of administrative dissolution.
Endnotes
1. GC Quality Lubricants v. Doherty et al., 697 S.E.2d 871 (Ga.Ct.App. 2010).
2. Official Code of Georgia Annotated (OCGA) Section 14-2-1410
3. OCGA Section 14-2-1422(d).
4. GC Quality Lubricants, supra note 1 at pp. 872-3.
5. Williams v. Martin Lakes Condo. Assn., 284 Ga. App. 569 (Ga. Ct. App. 2007).
6. Ibid. at pp. 571, 426.
7. Ibid. at pp. 571, 425-6.
8. Taylor v. First Community Credit Union, 316 S.W.3d 863 (Tex.App. 2010).
9. Ibid. at pp. 868-9.
10. Act of May 30, 1987, 70th Leg., R.S., ch. 324, Section 1, 1987 Tex. Gen. Laws 1734, 1735, repealed by Act of May 2, 2006, 79th Leg., 3rd C.S., ch. 1, Section 5, 2006 Tex. Gen. Laws 1, 23 (effective Jan. 1, 2008).
11. Taylor, supra note 8 at pp. 869-70.
Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and colleagues. If you have any questions about this alert or would like to discuss the topic further, please contact your Foley attorney or the following individuals:
John T. Brooks
Chicago, Illinois
312.832.5182
[email protected]
Gregory F. Monday
Madison, Wisconsin
608.258.4211
[email protected]
Samatha E. Weissbluth
Chicago, Illinois
312.832.4591
[email protected]
Simon N. Johnson
Chicago, Illinois
312.832.4573
[email protected]
