Date: October 12th, 2009

Currently, major defects exist in Washington’s Limited Liability Company Act (RCW § 25.15 et seq.) that allow, and sometimes even cause a Washington LLC to disappear without properly resolving potential claims against the LLC. These defects were highlighted in April 2009, when the Washington Legislature passed Substitute House Bill 1592. The Bill, which took effect on July 26, 2009, made specific revisions to Washington’s Limited Liability Company Act, affecting the critical “winding up” period that occurs between the dissolution and the cancellation of a Washington LLC.

The proper procedure for shutting down a Washington LLC is a three-step process involving dissolution, winding up and cancellation. Dissolution is typically nothing more than a decision by the LLC’s members to discontinue the business (known as voluntary dissolution). Dissolution can also be imposed by Courts in some circumstances (known as judicial dissolution), or can be imposed by the Secretary of State when the company fails to pay its annual registration fee (known as administrative dissolution). Significantly, the decision by members to dissolve an LLC does not require a filing with the Secretary of State or any public notice. Once an LLC is dissolved, it should begin winding up. The winding-up process is the period between “dissolution” and “cancellation” when the LLC is no longer authorized to conduct business operations and is only permitted to collect accounts receivable, pay its debts, distribute its remaining assets and otherwise resolve its business affairs. Once the winding-up process is completed, the LLC may file a Certificate of Cancellation, which cancels the LLC’s Certificate of Formation and terminates the LLC’s existence.

To fully understand the meaning of the April 2009 revisions, they must be read in the context of the Washington Supreme Court’s May 14, 2009 decision in Chadwick Farms Owners Association v. FHC, LLC. In Chadwick, the Washington Supreme Court held that “under the plain terms of the [Washington Limited Liability Company] Act, a LLC ceases to exists as a legal entity and cannot [sue or] be sued once its certificate of formation is cancelled.” The Chadwick ruling highlighted an internal conflict within the provisions of the Act, specifically between the cancellation provisions and the three-year survival of claims provision found in RCW 25.15.303.

The survival provision of RCW 25.15.303 allows for claims to be brought against a Washington LLC for a period of three years from the date of dissolution. However, where a certificate of cancellation is filed prior to the expiration of the three-year survival period, the Chadwick ruling instructs courts to disregard the remainder of the three-year survival period because there is technically no longer an LLC in existence to sue or be sued. All claims that might otherwise have been rightfully brought during the survival period are automatically abated upon cancellation, which, technically, could occur on the same date as the dissolution. This effectively defeats the purpose of the three year survival period altogether.

As the Chadwick opinion makes clear, this outcome could result in great injustice upon those who might have been injured by the acts of a quickly-cancelled LLC. The Chadwick Court stated, “if the result here is not what the [Washington] Legislature envisioned, it is, nonetheless, what the statute plainly provides. We understand from the house and senate bill reports that a comprehensive review of the [Limited Liability Company] Act is underway. If the result here is not what the [Washington] Legislature wants, it will be in a position to make additional changes deemed necessary.”

Unfortunately, the April 2009 Legislation, passed before the Chadwick ruling, does not address the inconsistencies in the Limited Liability Company Act identified by the court in Chadwick. Indeed, the revisions highlight the Legislatures’ inability thus far to create a coherent statutory scheme that adequately addresses the realities of the three-step process through which an LLC ceases to exist.

Revisions to RCW 25.15.270 and RCW 25.15.290:

The Washington Legislature amended RCW 25.15.270 to extend the winding-up period from two years to five years after the date an LLC is administratively dissolved under RCW 25.15.285 (assuming the LLC is not reinstated). In coordination, the Legislature also amended RCW 25.15.290 to extend the period in which an LLC can file for reinstatement after administrative dissolution from two years to five years after the effective date of administrative dissolution under RCW 25.15.285.

These revisions effectively allow the three-year survival provision of RCW 25.15.303 to run its course during the extended winding-up period, whereas under the previous statutory scheme, the LLC could be automatically cancelled by the Secretary of State two years into the three-year survival period. Nevertheless, the members of the LLC may still elect to file a certificate of cancellation at any time. Under Chadwick, doing so would still cut off the remainder of the survival period, defeating the purpose of the survival period.

NEW SECTION: RCW 25.15 (“Article VIII”) Dissolution

The April 2009 legislation added a new section to RCW 25.15.270 (Dissolution), which provides that a voluntarily-dissolved LLC (i.e., one dissolved by its members) under RCW 25.15.270 may apply to the Secretary of State for reinstatement within 120 days after the effective date of dissolution, and if no application for reinstatement is made within 120 days, the LLC will be automatically cancelled by the Secretary of State.

This provision is troubling for a number of reasons.

First, new Article VIII unreasonably shortens the critical winding-up period for voluntarily-dissolved LLC’s to 120 days. In contrast, where the LLC is administratively dissolved, the LLC has five years to wind up. This disparity is nonsensical.

Second, the 120-day clock clearly defeats the purpose of the three-year survival provision of RCW 25.15.303. When the LLC is voluntarily dissolved and no application for reinstatement is made, the Secretary of State will automatically cancel the LLC after 120 days, ending its existence well before the end of the three-year survival period. Thus, all claims against the LLC would be automatically abated under Chadwick 120 days into the three-year survival period.

Finally, the Legislature fails to recognize that voluntary dissolution of a Washington LLC is a silent event. Voluntary dissolution by the members requires no filing or notice to the Secretary of State or other governing body. Thus, in the absence of accurate and honest record keeping by the members, there is no way for the Secretary of State to know when a Washington LLC has been voluntarily dissolved by the members, and thus no way to know when the 120-day clock should start, or when the three-year survival clock should start. In many instances, by the time the Secretary of State realizes an LLC has failed to pay its annual license fees, the LLC may have long-since been voluntarily dissolved and, presumably, long-since automatically cancelled by the Secretary of State.

To be clear, neither the statutory revisions nor the Chadwick decision disturb existing law that creates personal liability (for members and managers) for the failure to properly wind up an LLC. RCW 25.15.270 describes how the winding up process should occur following dissolution and involves the obligation to “pay or make reasonable provision to pay all claims and obligations, including all contingent, conditional, or unmatured claims and obligations, known to the limited liability company and all claims and obligations which are known to the limited liability company but for which the identity of the claimant is unknown.” Thus, although a LLC may be tempted to consider dissolving and immediately filing a certificate of cancellation in order to frustrate creditor claims, that decision would likely create personal liability for the LLC’s decision-makers to the LLC’s creditors.

Clearly, the Legislature’s statutory revisions are impractical and inconsistent with other provisions of the Limited Liability Company Act. They also further exacerbate and highlight the potential for abuse exposed by the Chadwick ruling, and when applied in a real-world context, are almost impossible to enforce. Members and managers of Washington LLCs can only share the Chadwick Court’s hope that a comprehensive review of the Washington Limited Liability Company Act is underway, and that the Legislature will make substantial and thoughtful revisions to the statute by the Washington Legislature. For now, a Washington LLC can be cancelled at any time after dissolution and completely avoid the three-year survival-of-claims period. Where the LLC is voluntarily dissolved by its members, cancellation will happen automatically 120 days into the three-year survival period. The LLC will be gone, and any claims against it will be gone as well.