A dissolved corporation ceases to legally exist and the effect this has on its shareholders depends on how it was dissolved. If the corporation is dissolved voluntarily and its assets distributed to the shareholders without paying all remaining corporate debts, the shareholders could become liable for the debts. If the corporation is dissolved involuntary by the court or administratively by the state, the shareholders can incur additional expenses and liabilities. Avoiding these negative financial consequences requires proper dissolution of the corporation.
When a corporation no longer serves its intended purpose, it is best for the shareholders to voluntarily dissolve the corporation, which requires three basic steps: filing the appropriate document with the state; winding up business operations; and liquidating the remaining corporate assets and distributing them, if any, to the shareholders. An important part of winding-up the corporation’s business operations is resolving all outstanding debts and claims, including fees and taxes owed to any government agency. State laws generally provide for an additional period of time after dissolution of the corporation for a creditor to sue the shareholders for failing to pay a corporate debt and wrongfully distributing corporate assets. For example, Delaware has a three-year statute of limitations on such claims and California a four-year limitation period. Even a voluntary dissolution of the corporation will have an adverse effect on the shareholders, if business operations are not properly concluded. In general, a shareholder's liability for any unpaid remaining debts of the corporation is limited to the amount of corporate assets distributed to the shareholder. However, for debts related to tax and payroll obligations, a shareholder may become personally liable, especially if the shareholder was also involved in operating the corporation as an officer or director.
A corporation can be involuntarily dissolved by court order when one of the corporation's shareholders files a lawsuit requesting dissolution. This situation typically occurs when the relationship among one or more shareholders becomes acrimonious and effectively prevents operation of the corporation's business. An involuntary dissolution should be avoided because the end result is financially negative for the shareholders. In addition to incurring legal fees and court costs for the lawsuit, the liquidation of the corporation's assets via a court-ordered auction will most likely cause the assets to be sold for less than fair market value.
Some state laws require that a corporation be dissolved if it fails to adhere to state filing or tax requirements; this is usually referred to as an administrative dissolution. For example, in Arizona Corporation Commission will dissolve a corporation if it fails to file its annual report as required by Arizona law. Such a dissolution means that the corporation ceases to exist, typically without the shareholders' knowledge. Significant adverse consequences will result, such as the shareholders becoming personally liable for all debts and liabilities incurred in the continued operation of the corporation's business. Also, the IRS will treat the dissolution as a distribution of assets to the shareholders, despite the fact that the shareholders did not intend to dissolve the corporation and make a distribution. This will cause the shareholders to incur a tax liability they were not planning for.
Shareholders who properly wind up the business operations of their corporation may still incur future liabilities if they fail to take all the steps necessary to dissolve the corporation. In most cases, the misstep occurs by failing to file articles of dissolution with the state -- which means the corporation still exists and must continue making its annual filings and payment of fees to the state. In states such as California that do not administratively dissolve corporations for failing to make these filings and payments, the corporation is suspended but still in existence. As far as the state is concerned, the corporation stills exists and must continue with its yearly obligations, which will continued to accrue with penalties and interest each year that goes by without articles of dissolution being filed. The shareholders will not be able to file the articles unless all back fees, penalties and interest are paid.
References & Resources
- Sheehan Phinney Bass + Green PA: What Happens When a Massachusetts Corporation is Dissolved?
- Massachusetts Secretary of State: Articles of Voluntary Dissolution
- Richard G. Burt, Attorney and Counselor at Law: Timely Dissolution Can Protect Shareholders
- Gallinger Law: Involuntary Dissolution of California Corporations
- Fryar Law Firm P.C.: Illinois Shareholder Law Resources
- Keyt Law: LLCs vs. Corporations: Which Type of Arizona Entity Should You Form?