Business Dissolution FAQ

Voluntarily dissolving a California corporation requires following specific procedures under Corporations Code Sections 1900-1905. The process begins with a board resolution recommending dissolution, followed by shareholder approval. For most corporations, dissolution requires approval by a majority of outstanding shares entitled to vote, though articles of incorporation may require a higher threshold. Once approved, the corporation must file a Certificate of Election to Wind Up and Dissolve with the Secretary of State.

The corporation then enters the winding up phase, during which it must notify creditors, settle debts, distribute remaining assets to shareholders, and file final tax returns. After winding up is complete, the corporation files a Certificate of Dissolution. Throughout this process, directors and officers retain their duties and can be personally liable for improper distributions. The corporation continues to exist during winding up for the limited purpose of completing dissolution. Failure to properly dissolve can result in continued liability for franchise taxes and potential claims by creditors.

Winding up a California LLC follows procedures established in the operating agreement and Corporations Code Sections 17707.01-17707.08. Dissolution can be triggered by events specified in the operating agreement, unanimous member consent, judicial decree, or administrative dissolution by the Secretary of State. Once dissolution is triggered, the winding up process begins, during which managers or members must complete existing business, collect debts owed to the LLC, liquidate assets, satisfy creditor claims in order of priority, and distribute remaining assets to members according to their interests.

The LLC must file a Certificate of Cancellation with the Secretary of State, which should include a statement that all known debts have been paid or adequately provided for. The LLC must also file final tax returns with the Franchise Tax Board and IRS. During winding up, the LLC continues to exist only for purposes of concluding affairs. Members and managers who distribute assets without properly paying creditors may face personal liability for unpaid debts.

California law establishes a priority system for paying debts during business dissolution. Corporations Code Section 2004 for corporations and Section 17707.05 for LLCs require debts to be paid in a specific order before any distribution to owners. First, secured creditors must be paid from their collateral, with any deficiency becoming an unsecured claim. Second, priority unsecured claims include employee wages, taxes, and other debts given priority by federal or state law. Third, general unsecured creditors must be paid in full if assets permit, or pro rata if insufficient.

Fourth, after all creditor claims are satisfied, any remaining assets are distributed to shareholders or members according to their ownership interests or liquidation preferences. The business must provide notice to known creditors of the dissolution. For unknown creditors, publishing notice of dissolution can limit future claims. Owners who receive distributions when creditors remain unpaid may be required to return those distributions. Directors and managers can face personal liability for improper distributions under Corporations Code Section 316.

California requires businesses to notify creditors during dissolution to give them opportunity to file claims. For corporations under Corporations Code Section 1904, the corporation should mail written notice to known creditors stating that dissolution has commenced, the deadline for filing claims (at least 120 days from notice), and the address for submitting claims. Unknown creditors should be notified through publication in a newspaper of general circulation once a week for three successive weeks.

For LLCs under Corporations Code Section 17707.06, similar procedures apply, requiring written notice to known creditors and publication for unknown creditors. The notice must state the LLC is dissolving and provide a deadline and address for claims. Creditors who receive proper notice but fail to file timely claims may be barred from later recovery. However, creditors who did not receive notice may have longer to bring claims. Proper creditor notification is essential to limiting ongoing liability and achieving a clean dissolution. Businesses should maintain records of all notices sent and publications made.

Personal liability for business debts after dissolution depends on the business structure and how dissolution was handled. For corporations and LLCs, the general rule is that owners are not personally liable for business debts beyond their investment. However, several exceptions can create personal liability. Directors and managers who approve distributions to owners while creditors remain unpaid may be personally liable under Corporations Code Section 316 and Section 17704.08. Shareholders who receive distributions when debts are unpaid may be liable to creditors up to the amount received under Section 2011.

Personal guarantees on business debts remain enforceable regardless of dissolution. Piercing the corporate veil may impose liability when owners fail to maintain corporate formalities, commingled personal and business funds, or undercapitalized the business. For partnerships and sole proprietorships, owners remain personally liable for all business debts. Fraudulent conveyance laws allow creditors to pursue assets improperly transferred before or during dissolution. Proper dissolution procedures significantly reduce personal liability risk.

Dissolving businesses face several tax obligations under California and federal law. The business must file final federal and state income tax returns, marking them as final returns. For corporations, this includes the federal Form 1120 and California Form 100. LLCs file Form 1065 (partnership returns) or Form 1120 depending on their tax election, along with California Form 568 for LLCs taxed as partnerships. The business must pay any outstanding franchise taxes, and California requires corporations and LLCs to pay the minimum $800 franchise tax for the year of dissolution.

S corporations and LLCs should provide final Schedule K-1s to shareholders and members reporting their share of income, deductions, and credits. Asset sales or distributions may trigger taxable gains. The business should request tax clearance from the Franchise Tax Board before final dissolution. Failure to properly file final returns can result in continued tax assessments and prevent the Secretary of State from accepting dissolution filings. Consult with a tax professional to ensure compliance with all obligations.

Involuntary dissolution occurs when a court orders a business dissolved, typically upon petition by shareholders, members, or creditors. Under Corporations Code Section 1800, shareholders holding 33.3% or more of shares may petition for involuntary dissolution when directors are deadlocked and shareholders cannot break the deadlock, those in control have been guilty of fraud, mismanagement, or abuse of authority, corporate assets are being misapplied or wasted, or the corporation has abandoned its business. Creditors may petition for dissolution when the corporation is insolvent or has suspended ordinary business for lack of funds.

For LLCs, Section 17707.03 allows members or transferees to petition for judicial dissolution on similar grounds. Courts may appoint a receiver to manage the winding up process, protect assets, and ensure fair distribution to creditors and owners. Involuntary dissolution proceedings are often contentious and expensive. As an alternative to dissolution, Section 2000 allows the corporation or remaining shareholders to purchase the petitioning shareholder's shares at fair value, avoiding actual dissolution.

Asset distribution during California corporate dissolution follows a strict order of priority under Corporations Code Sections 2004 and 2007. After all creditors are paid in full, remaining assets are distributed to shareholders according to their liquidation preferences and ownership interests. Preferred shareholders with liquidation preferences receive their stated amounts before common shareholders receive anything. If multiple classes of preferred stock exist, their relative priorities determine the order of payment.

After preferred shareholders receive their liquidation amounts, remaining assets are distributed to common shareholders pro rata based on their share ownership. The articles of incorporation may modify distribution rights, so review them carefully. Distributions must comply with legal capital requirements to protect creditors. Directors who approve distributions that render the corporation unable to pay debts may face personal liability. Before making distributions, the corporation should ensure all known and reasonably anticipated liabilities are satisfied or provided for. Cash distributions are simplest, but in-kind distributions of property may be made at fair market value with appropriate tax considerations.

Business dissolution does not automatically terminate contracts and leases, creating potential ongoing obligations and liabilities. Commercial leases often contain provisions addressing tenant dissolution, which may trigger default or acceleration of rent obligations. Review all leases for assignment provisions, personal guarantees, and dissolution clauses. Negotiate early termination where possible, or assign the lease to a qualified third party with landlord consent. Ongoing service contracts, supply agreements, and customer contracts must be addressed.

Some contracts contain change of control or dissolution provisions triggering termination or payment obligations. Others may require continued performance or damages for breach. Employment agreements should be reviewed for severance obligations and non-compete provisions that may survive termination. Insurance policies should be maintained through the winding up period and may need to be extended through tail coverage for claims made after dissolution. Intellectual property licenses may have transfer restrictions preventing assignment. The dissolving business should inventory all contracts, review their terms, negotiate terminations or assignments where possible, and budget for any termination payments or damages.

The timeline for California business dissolution varies significantly depending on complexity, but typically ranges from several months to over a year. The initial phase involves board and shareholder approval and filing the Certificate of Election to Wind Up, which can be completed in weeks if owners agree. The winding up phase is the longest, requiring time to collect receivables, liquidate assets, notify creditors, pay debts, and address ongoing obligations. Creditor notice periods require at least 120 days for claim filing.

Complex businesses with significant assets, numerous contracts, or disputed debts may take considerably longer. Tax clearance from the Franchise Tax Board can take 6-8 weeks. After all affairs are concluded, filing the Certificate of Dissolution with the Secretary of State typically processes within a few weeks. Administrative dissolution for failure to pay taxes or file statements can be faster but creates different complications. Expediting dissolution by cutting corners often leads to greater liability exposure. Allow adequate time to properly address all obligations and follow required procedures.