And the answer is, it depends. When winding down a business, many owners—from private equity firms to individuals—often presume that the business must be dissolved. That presumption is not without a basis. Indeed, the definition of dissolution is “the closing down or dismissal” of a business, so seemingly a predicate to that outcome. In connection with a wind-down of a business, dissolution means that the entity’s legal existence ceases. Whether a corporation, limited liability company or other recognized entity should be formally dissolved when winding down operations, however, depends on the needs and goals of the situation.
The requirements vary by entity and state of incorporation, but to dissolve, generally speaking, a company must obtain the requisite approval of its owners and governing body to initiate dissolution proceedings, which includes filing a certificate of dissolution and providing notice to creditors. In doing so, the company initiates a process for creditors to make claims and enable any distributions to be made, including to shareholders where possible. A company may shorten the period for creditors or other persons to assert certain claims, however, it may still be sued. Moreover, the company may thereafter be unable to transact business outside of winding up its affairs, which may limit the company’s ability to make claims under any insurance policies or sell assets such as real estate.
While circumstances differ, the principal benefits of a formal dissolution are notice to creditors with a shortening of the claims period, creation of a mechanism to make distributions, including to shareholders where possible, minimizing ongoing expenses, and formal and final cessation of the entity’s existence.
These advantages of a dissolution are accomplished often with modest expense, particularly as compared to other alternatives such as bankruptcy. There are limits and disadvantages. They include that requisite owner or board approval must be obtained, the process typically does not discharge claims, the process may encourage parties to pursue or investigate claims, including against persons related to the company, and dissolution may impede the ability to claim continued insurance coverage or transact any remaining necessary business. Moreover, the decision to dissolve or not and the timing of that has tax impacts, including on the potential gain or loss related to any investment in the company.
So, when confronted with a wind-down of a business, carefully undertake an assessment of needs and goals of the company and its owners in choosing whether to dissolve or not. This way you can avoid Hamlet’s proverbial slings and arrows, and sea of troubles.
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