LLC Dissolution vs. Termination

Businesses open and close all the time. The U.S. Small Business Administration reports that between March 2021 and March 2022 about 1.2 million small businesses opened and approximately 834,000 closed.

If you’re faced with closing your Limited Liability Company (LLC), there are steps you’ll need to take to make sure it’s done legally. Failing to do so can cost you money and result in negative consequences down the road.

While the words dissolution and termination are often used interchangeably when referring to closing an a business, they have different legal meanings and refer to two different actions. If you’re shutting down your business, you’ll need to both dissolve it and, after winding up all the affairs of the business, terminate it.

Simply stated, dissolution is the process of ceasing business operations. The business continues to exist, but only for the purpose of winding up affairs and shutting down. Dissolving the LLC is a step toward termination. Termination occurs after the dissolution is completed and all the affairs of the business have been settled.

Let’s explore this topic further. We’ll start by looking at some different types of dissolutions, then explore dissolution and termination in greater detail.

Types of LLC Dissolutions

There are various types of business dissolutions, some initiated by the owners and others initiated by the state or a court.

• A voluntary dissolution is when members of an LLC agree to dissolve the business. The dissolution could have been planned from the time the business was formed or caused by a triggering event. It’s not unusual for an LLC to be started for a specific purpose and dissolved once the purpose has been fulfilled. Members might form an LLC for the purpose of buying and flipping a house, for instance, with the understanding that the business will be dissolved when the house is sold. Or, a voluntary dissolution can be caused by a triggering event, such as the death of a member or an economic downturn.
• Usually less desirable than a voluntary dissolution is a judicial dissolution, which is when a court employs a legal process to dissolve a business. Judicial dissolutions aren’t common, and when they occur it’s normally for something like breach of fiduciary duty, mismanagement, or fraud. A judiciary dissolution can be initiated by members of the LLC or by a creditor who has not been paid. A state attorney general may initiate a judiciary dissolution in response to complaints. Once initiated, a court will review the matter to determine whether the LLC should be dissolved.
• An administrative dissolution is when the state takes action to shut down a business due to unpaid taxes, unfiled reports, or another reason. LLC members may be able to avoid closure by taking quick action to correct the problem that caused the state to act, but if they don’t the state can permanently dissolve the LLC. Also, the LLC is likely to incur penalties that will need to be settled for it to remain open.
• If you’re a doctor, lawyer, architect, or other professional and have a Professional LLC (PLLC), losing your license to practice can force you to dissolve the PLLC. The reason for the loss of the license doesn’t matter; you are unable to practice without it.

Steps to Properly Dissolve an LLC

If you must dissolve your LLC, your first step should be to consult your Operating Agreement, which, hopefully, addresses the process for doing so. If it doesn’t, you’ll have to follow the default laws of your state’s LLC Act.

Using either the process laid out in the Operating Agreement or the laws of your state, you’ll need to vote to dissolve the LLC. The vote should be taken during a formal meeting, with minutes carefully recorded. There should be a formal document for members to sign following the vote, acknowledging and agreeing to what has taken place. Not documenting the proceedings opens the door to someone claiming in the future that they were misinformed about what happened or excluded from the vote.

Once members have voted to dissolve the LLC, you’ll need to file Articles of Dissolution, if required by your state. The articles generally include basic information about the LLC plus the event that triggered the dissolution. Once the articles have been filed, your LLC is no longer allowed to conduct business and must begin the process of winding up its affairs.

The first step of winding up the affairs of an LLC is normally paying off creditors and settling all debts. That could include payroll for employees, unpaid utility bills, any taxes you owe, outstanding bills for supplies, and others. Other steps include:

• Close all bank accounts, except those needed for future payment of bills.
• File final business tax returns and tax reports.
• Cancel any business licenses, insurance policies, assumed names, registrations, permits, and any other policies.
• If your business is registered in other states as a Foreign LLC, you’ll need to formally withdraw the registrations.
• Distribute any remaining assets among members. Your Operating Agreement should specify how this should be done. If it doesn’t, the Internal Revenue Code of the IRS states how members should be paid.
• File Articles of Termination, if required by your state.
• Record and keep careful records of all activities pertaining to the winding down of the business.

Terminating the LLC

Once all the steps necessary for dissolving the business have been completed, the LLC is considered terminated. Some states require that you file Articles of Termination, sometimes called Articles of Cancellation. If your state requires this document, you’ll need to certify that all debts have been paid off and any remaining assets divided among members.

A Final Word

There are a lot of steps necessary before the existence of an LLC is terminated, and the process can take a long time. Unfortunately, some business owners become frustrated and simply walk away from the LLC without legally dissolving and terminating it.

I cannot state strongly enough what a terrible idea that is, as it leaves the business responsible for all sorts of obligations, such as paying taxes and filing annual reports. Serious legal problems can occur if those obligations aren’t fulfilled, resulting in problems for years to come.

Another possibility is that bad actors discover that the LLC is listed on state records as delinquent or administratively dissolved and take advantage of the situation by stealing its identity and using it to apply for loans or other types of assets in its name.

Shutting down an LLC isn’t as fun and exciting as getting it started, but the process is equally important. If you’re unsure about how to proceed, please contact a qualified professional to help you.