California Partition Law Blog
LLC’s are perhaps the most common form of business entity in the country on account of their approachability. But their large number means that plenty will and do fail. When this occurs, members of the LLC can file a lawsuit for “involuntary dissolution.”
That said, the non-dissolving members have a way of fighting back: the mandatory buyout. Litigation over buyouts can be fierce, as each member attempts to maximize the value of their interest to secure the largest possible payout. In these instances, the right attorney can make all the difference.
At Underwood Law Firm, our attorneys are knowledgeable in the fields of pass-through entities and real property. If you’re looking to proceed with dissolution, then we’re here to help.
What is dissolution?
Dissolution is an interesting term because it suggests that the business entity terminates itself once dissolution occurs. This is only half right. While dissolution is ultimately connected with the end of the business, it’s actually the formal term for the beginning of the process.
Put differently, once dissolution is approved (by the entity itself or a court), the entity continues to exist so that it can “wind up” its affairs. This process is mainly focused on paying back any company creditors first, and then distributing residue (the remaining entity funds) to the members of the organization.
Under California’s Revised Uniform Acts, this process is substantively the same for LLC’s and Limited Partnerships, and very similar for General Partnerships as well. (Corp. Code §§ 17701.01 et seq., 15900 et seq., 16801 et seq.)
When can an LLC be dissolved?
There are several sets of circumstances that can bring an LLC to an end. In basket number one are those instances where the company dissolves all on its own. For example, if the LLC’s operating agreement states the company will begin winding up affairs after a set amount of time, then there’s little need for court involvement. (Corp. Code § 17707.01 (a).) Alternatively, a majority vote might also dissolve an LLC and, again, avoid the courtroom for the most part. (Corp. Code § 17707.01 (b).)
In basket two are the LLC’s that just never got off the ground. This occurs when an LLC files articles of organization, but never conducts any business. Within 12 months, a majority of members can simply file a certificate of cancellation and begin dissolution. (Corp. Code § 17707.02.)
In basket three, however, is judicial dissolution. As the name suggests, this involves a member or members of the LLC formally filing a lawsuit to dissolve the company. (Corp. Code § 17707.03 (a).)
That being said, there are only a set number of situations that allow for this course of action. Under the Corporations Code, it must be that: (1) it’s not reasonably practicable to carry on the business; (2) dissolution is reasonably necessary in the interest of the members; (3) the business has been abandoned; (4) management is completely deadlocked; or (5) those in control of the LLC are guilty of fraud or abuse of authority. (Corp. Code § 17707.03 (b).)
Can you stop the dissolution of an LLC?
Interestingly enough, the bulk of litigation of LLC dissolution not related the above five factors. Most litigants will not have too much difficulty demonstrating that management is deadlocked or that economic conditions have rendered continuing the business untenable.
Instead, the battle plays out over the Corporation Code’s “mandatory buy out” procedures. The statute makes clear that if any suit for dissolution, the other members of the LCC can avoid dissolution entirely by purchasing for cash the membership interests owned by the “moving parties,” e.g., those seeking the dissolution. (Corp. Code § 17707.03 (c)(1).)
This effectively halts dissolution, provided the purchasing members can actually follow through. The reasoning for such a law is sound. California has an “interest in preserving the corporate enterprise as a going concern if desired by the majority or by the other 50% owners,” and providing a “meaningful alternative” to termination. (Mart v. Severson (2002) 95 Cal.App.4th 521, 524.)
For example, if such a provision did not exist, then an LLC member with a 1% interest or less could effectively end a thriving business if they simply proved management was deadlocked.
How is an LLC Member’s interest calculated?
Under the code, the purchasing members must buy out the moving parties at “fair market value” in cash. (Boschetti v. Pacific Bay Investments, Inc. (2019) 32 Cal.App.5th 1059, 1066.)
“Fair market value” is a term that comes up in various field of law. For instance, the term is the hallmark of litigation over eminent domain. (CCP § 1263.310.) In the field of business entities, however, it can get somewhat complex.
The confusion mainly stems from the fact that buyouts for corporations use the term “fair value.” But these are not the same. (Cheng v. Coastal L.B. Associates, LLC (2021) 69 Cal.App.5th 112, 123.) Fair value refers to the liquid value of a shareholder’s stock (Corp. Code § 2000). Fair “market” value, on the other hand, is the price at which the property would change hands between a willing buyer and a willing seller when neither is under any compulsion to sell. (Cheng, 69 Cal.App.5th at 123.)
Regardless, most litigants will not need to worry about conducting these calculations for themselves. Instead, if the buyout provisions are invoked, the court will appoint appraisers to determine the fair market value on their own.
Does the Buyout Procedure continue if the Dissolution Motion is Dismissed?
Yes. As one court put it, the statutory buyout procedure, once initiated, “supplants” the lawsuit for involuntary dissolution. (Schrage v. Schrage (2021) 69 Cal.App.5th 126, 137.)
While this may seem odd, especially considering that many lawsuits can be snuffed out with voluntary dismissals, the rationale is quite simple. Someone who has filed for involuntary dismissal has threatened to end an entity outright. They cannot, upon seeing the large buyout they’re about to receive, get cold feet.
That said, there actually is a way to stop the buyout: voluntary dissolution. This is because voluntary dissolution (by a majority vote of members) instantly dissolves the LLC. At that point its only function is to wind up, not buy out other members’ interests in the company.
How the Lawyers at Underwood Law Firm Can Help
Winding up an LLC can prove to be a difficult task. Some members will inevitably wish for the relationship to continue, while others may only be looking out for themselves. In these situations, the right attorney can make all the difference.
As each case is unique, LLC members would be well-served to seek experienced counsel familiar with pass-through entities and the winding up procedure. At the Underwood Law Firm, our knowledgeable attorneys are here to help. If you are trying to begin dissolution, wondering whether you can fight one off, or if you just have questions, please do not hesitate to contact our office.