Administrative Dissolution of Corporations and LLCs

The following is an e-bulletin that I authored and that was published on October 9, 2018, by the Corporations Committee of the Business Law Section of the California Lawyers Association.

On September 22, 2018, Assembly Bill No. 2503 was signed into law (and became Chapter 679). This law creates a new form of dissolution, administrative dissolution, for California domestic corporations, as defined in Corporations Code Section 167, and California domestic limited liability companies, as described in Corporations Code Section 17701.02(g) & (k). The law provides for two types of administrative dissolution, involuntary and voluntary.

These laws are intended to address the status of corporations that have ceased operations and have no assets. Frequently, the owners of these corporations simply “walk away” from the accruing tax, interest, and penalties due rather than incur the expenses associated with voluntarily dissolving the corporation.

Involuntary Administrative Dissolution

After December 31, 2018, a California corporation may be administratively dissolved if the corporation’s corporate powers have been suspended by the Franchise Tax Board (“FTB”) for 60 consecutive months.

Before dissolving the corporation administratively, the FTB must notify the corporation of the pending administrative dissolution by mailing a notice to the last known address of the corporation. If the FTB does not have a valid address for the corporation, the FTB will notify the Secretary of State, which will provide 60 days’ notice of the pending administrative dissolution on its website by listing the corporation’s name and the Secretary of State’s file number. The Secretary of State will provide instructions for a corporation to submit a written objection of the pending administrative dissolution to the FTB before the expiration of the 60 days.

If the FTB does not receive the corporation’s written objection to the administrative dissolution during the 60-day period, the corporation will be administratively dissolved.

If the FTB does receive the corporation’s written objection to the administrative dissolution during 60-day period, the corporation will have 90 days from the date the written objection is received by the FTB to (1) file returns, (2) pay all accrued taxes, penalties, and interest, (3) file a current Statement of Information with the Secretary of State, (4) fulfill any other requirements to be eligible, and (5) apply for a certificate of revivor. If all the foregoing conditions are satisfied, the administrative dissolution will be canceled, but if not, the corporation will be administratively dissolved. The FTB may extend the 90-day period one time.

If the corporation is dissolved administratively, the corporation’s liability for the minimum franchise tax, interest, and penalties, will be abated, as well as the penalties for not filing a statement of information, and no administrative or civil action will be taken or brought to collect those liabilities. An administrative dissolution will not, however, discharge the corporation’s liability to creditors.

An administrative dissolution also will not discharge any liability of the directors or shareholders of the corporation or its transferees. Therefore, if there was an illegal distribution by the corporation or a fraudulent transfer prior to the dissolution, the liability of the directors or shareholders of the corporation or its transferees would not be affected by the dissolution.

Like provisions apply to California limited liability companies.

Voluntary Administrative Dissolution

After December 31, 2018, certain California corporations may apply to be administratively dissolved. The benefit of applying for voluntary administrative dissolution is that eligible corporations need not pay the minimum annual franchise tax, interest, or penalties that relate to years in which the corporation did not do business.

Two types of California corporations are eligible for this treatment:

  1. A corporation that never did business in California at any time after the time of its incorporation.
  2. A corporation that did business in California but that has ceased to do business and has filed all required California income tax returns for the tax years in which it did business.

In applying for this benefit, the corporation must certify under penalty of perjury that it has ceased all business operations and that it has no remaining assets. Any abatement would be conditioned on a certificate of dissolution first being filed with the Secretary of State.

The abatement of taxes, interest, and penalties would not apply to any year prior to the cessation of doing business in California.

If the corporation that was voluntarily administratively dissolved continues to do business or has remaining assets that were not disclosed at the time of request for abatement, the taxes, interest, and penalties that were abated will cease to be abated and will be immediately due. In addition, a penalty equal to 50% of the total tax abated (plus interest) will be imposed.

Additional Points

The FTB is authorized to prescribe regulations to implement these new provisions.

Like provisions apply to California limited liability companies.

An earlier statute (Ch. 363, Stats. 2015) established similar administrative processes to dissolve domestic and foreign nonprofit public benefit, mutual benefit, religious corporations, and foreign nonprofit corporations that have qualified to transact intrastate business in California.

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Buy-Sell Agreements in the Articles of Incorporation

Under the Corporations Code, if there is a suit for involuntary dissolution, or if there is an election to dissolve voluntarily by shareholders representing only 50% of the voting power of the stock, the dissolution of the corporation and the appointment of a receiver can be avoided by purchasing the shares owned by the shareholder (or shareholders) initiating the dissolution. The purchase can be by the corporation or by other shareholders owning 50% or more of the stock.

The ability to avoid dissolution by a purchase can be eliminated by a provision in the articles of incorporation. Effective January 1, 2018, the Corporations Code section 2000 was amended to allow such provision in the articles to be simply “a reference to a separate written agreement between two or more shareholders pertaining to the purchase of shares.” In other words, the provision in the articles that eliminates the ability to avoid dissolution by a purchase need not spell out the terms of a buy-sell agreement. It can simply refer to a separate buy-sell agreement that eliminates the ability to avoid dissolution by a purchase (and thus make the terms of the buy-sell agreement controlling).

The principal reason for this change was to eliminate the need to spell out in the articles the terms of a buy-sell agreement that would control in the event of a dissolution.

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Business Law Attorney Richard Burt Helps Draft New Corporate Law

A corporation is typically dissolved when the shareholders holding shares that have 50% or more of the voting power elect to dissolve. When an order for relief has been entered under Chapter 7 of the U.S. Bankruptcy Code, the board of directors can elect to dissolve the corporation. But after a corporation files for bankruptcy, the shares of the corporation are normally cancelled, and the corporation’s board of directors is replaced with a court-appointed representative who is responsible for liquidating the corporation’s assets and paying creditors.  So there are neither shareholders nor a board of directors to elect to dissolve.

The Insolvency Law Committee of the State Bar of California wanted to propose that the California legislature add a provision to the Corporations Code to allow the court-appointed representative to file a certificate of dissolution in cases where the court-approved plan did not authorize dissolution. The Insolvency Law Committee asked the Corporations Committee for help with the legislative proposal, and the Corporations Committee asked me, a senior adviser to the Corporations Committee, to join in providing that help. I was pleased to help, and I was one of the principal drafters of the amendments that were proposed to the California legislature.

With some modifications, the proposal was adopted by the legislature (Senate Bill 340). Corporations Code section 1401 is amended and a new section 1401.5 is added to the code by Chapter 267, Statutes of 2017, which takes effect January 1, 2018.

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LLC Bound by Contract Even Though Contract Was Outside Its Purpose and Signatory Was Technically Not a Manager

The following is the text of an e-bulletin that I authored on apparent authority and that was published by the Corporations Committee of the Business Law Section of the State Bar of California.

In  Western Surety Co. v. La Cumbre Office Partners, LLC  (February 2, 2017), a California Court of Appeal held that a California limited liability company was bound by an indemnity agreement that was outside its business purpose and that benefitted only an affiliate of its sole manager. The court relied on a statutory presumption in the LLC Act that contracts signed by a sole manager are conclusively deemed authorized by the limited liability company.

The court reached this conclusion even though the signature block for the person who signed as manager identified him as an individual when he was not individually the manager but was instead the managing member of an entity that was the sole manager of the LLC.

Facts

La Cumbre Office Partners, LLC (“La Cumbre”), was a California limited liability company, whose purpose was to acquire and operate, and perhaps redevelop, a medical office building at 200 N. La Cumbre Road, Santa Barbara. Its articles of organization, filed in 2006, provided that the company would be managed by one manager. The sole manager was Melchiori Investment Companies, LLC (“MIC”), which owned about 9.6% of La Cumbre.

The managing member of MIC was Mark J. Melchiori (“Melchiori”), and he owned half of MIC. Melchiori was also part owner of another LLC that owned about 17.8% of La Cumbre. Melchiori personally was not a member of La Cumbre. Melchiori was also the president of Melchiori Construction Company, Inc. (“construction company”).

La Cumbre’s operating agreement stated that MIC, its sole manager, would have full and exclusive authority to manage and control the business of the company and to perform all acts incident to the management of the company’s business.

In February 2008, to obtain surety bonds from Western Surety Company for his construction company, Melchiori signed an agreement agreeing to indemnify Western Surety. Melchiori signed on his own behalf, his construction company, and seven other parties. One of the signatories was La Cumbre.

The only business La Cumbre had ever engaged in was the ownership of its office building. La Cumbre had no reason to enter into an agreement to indemnify a surety company for a bond issued for Melchiori’s construction company for projects that had nothing to do with La Cumbre’s business. La Cumbre had no business, economic, or other connection to the construction company. Entering into the indemnity agreement was never discussed or approved by members of the company before the agreement was signed.

In 2009 and 2010, the surety company issued bonds to guarantee the performance of the construction company’s contractual obligations in several construction projects, none of which had any relation to La Cumbre’s business. The construction company defaulted, and the surety company paid claims amounting to over $6 million.

La Cumbre refused to reimburse the surety, and the surety company sued La Cumbre on the indemnity agreement.

Governing Law

The complaint in this case was filed in November 2012, more than one year before the California Revised Uniform Limited Liability Company Act became effective, and so the Beverly­Killea Act governed the matter.

Authority to Sign

The underwriter for the surety company prepared the indemnity agreement, and he directed that La Cumbre be named as a party and he directed how the signature block for it would appear. The underwriter testified that Melchiori had said he was the managing member of La Cumbre and could “bind the company” but the underwriter took no steps to verify Melchiori’s authority.

Melchiori testified to the contrary, that he had never told the surety company that he was La Cumbre’s managing member and that he had no idea why La Cumbre was named as an indemnitor.

There was ample evidence to the effect that the indemnity agreement was not (and would not have been) authorized by La Cumbre.

Apparent Authority

Corporations Code § 17157(d) provides, in the case of a limited liability company whose articles of organization state that it is managed by only one manager, that “[A]ny . . . contract . . . or other instrument in writing . . . executed or entered into between any limited liability company and any other person, when signed by [a sole manager] is not invalidated as to the limited liability company by any lack of authority of the signing … manager in the absence of actual knowledge on the part of the other person that the signing … manager had no authority to execute the same.” (In the case of a limited liability company managed by more than one manager, the signature of at least two managers is sufficient to bind the company.)

The California Revised Uniform Limited Liability Company Act is to the same effect (Corporations Code § 17703.01(d)).

As La Cumbre did not claim that the surety company had actual knowledge that Melchiori lacked authority to sign the indemnity agreement on La Cumbre’s behalf, the court held that Corporations Code § 17157(d) bound La Cumbre to the agreement provided it was signed by La Cumbre’s manager, MIC.

Incorrect Designation of Manager

When Melchiori signed on behalf of La Cumbre, he signed as “Mark J. Melchiori, Managing Member.” But Melchiori, as an individual, was not La Cumbre’s manager. MIC (of which Melchiori was the managing member) was the manager of La Cumbre.

The signature block for La Cumbre on the indemnity agreement apparently read:

La Cumbre Office Partners, LLC

By: ______________________________
      Mark J. Melchiori, Managing Member

The signature block for La Cumbre should have read:

La Cumbre Office Partners, LLC
By:  Melchiori Investment Companies, LLC,
its manager

        By:______________________________
               Mark J. Melchiori, managing member,
.              Melchiori Investment Companies, LLC

The signature block that was used to sign the indemnity agreement was incorrect because Melchiori, as an individual, was not the managing member of La Cumbre, and as an individual, he had no authority to act for La Cumbre.

La Cumbre argued that, as a result of the designation of Melchiori (as an individual) as La Cumbre’s managing member, the manager that the statute designates as having the power to bind the company by virtue of apparent authority (MIC (of which Melchiori was the sole manager)) did not sign the agreement on La Cumbre’s behalf. La Cumbre argued that Melchiori, as an individual, did not benefit from the statute’s conclusive presumption of authority, only MIC would, and therefore Melchiori’s signature in his individual capacity did not, and could not, bind the company.

Incorrect Designation of Authority

A similar issue had arisen in the corporate context. In Snukal v. Flightways Manufacturing, Inc. (2000) 23 Cal.4th 754, the California Supreme Court held that Corporations Code § 313 “applies even when the other party should have, but does not have, actual knowledge of the officers’ lack of authority, that party is relieved of the burden of establishing justifiable reliance upon the authority of the executing officers.” Id. at 783.

Corporations Code § 313 provides that:

any … contract … or other instrument in writing … executed or entered into between any corporation and any other person, when signed by [two of the officers specified in the section] is not invalidated as to the corporation by any lack of authority of the signing officers in the absence of actual knowledge on the part of the other person that the signing officers had no authority to execute the same.

In Snukal, Lyle executed a lease on behalf of the corporation, Flightways. Lyle was president, chief financial officer, and secretary of Flightways, but he signed the lease showing his office only as president. For a party dealing with the corporation to take advantage of Corporations Code § 313, a contract or other written instrument must be signed by a person holding at least one corporate office in each of two separate categories of offices specified in the statute. The office of president is in one category, while the offices of chief financial officer and secretary are in another category. Thus, for Flightways to have been bound by the apparent authority of Lyle under Corporations Code § 313, both the president and the chief financial officer (or both the president and the secretary) had to have signed the lease.

The Snukal court rejected Flightways’s claim that the statute applies only when two officers holding the offices specified in the statute execute an instrument and name the corporate offices held (whether the requisite offices are held by the same person or held by two persons). The court held that Corporations Code § 313 does not contain any language requiring the signing officers to be separate individuals or requiring the signing officers to specify the office or offices they hold.

In Snukal, id. at 780, fn. 8, the court stated that “when the corporate officer’s actual authority to execute the agreement has been established or is not in doubt, the circumstance that he or she does not specify the office held does not invalidate the agreement as to the corporation,” citing Greve v. Taft Realty Co. (1929) 101 Cal.App. 343 and other cases.  The Snukal court held that Corporations Code § 313 “provides a conclusive, rather than a merely rebuttable, evidentiary presumption of authority to enter into the agreement on the part of the specified . . . officers.” Id. at 782.

Under this reasoning, La Cumbre would have been bound by the indemnity agreement if Melchiori had simply signed his name without indicating any official position. The court of appeal in this case stated that the fact that the indemnity agreement mistakenly designated Melchiori as the managing member was a distinction without a difference. MIC was a legal entity and therefore could sign the indemnity agreement only through the signature of a natural person (and Melchiori was “the only living person in the world” who could sign on MIC’s behalf). The natural person authorized to sign on MIC’s behalf was its managing member, Melchiori, and Melchiori signed the indemnity agreement.

It followed, therefore, that La Cumbre was bound even though the indemnity agreement’s signature page mistakenly identified Melchiori individually as its sole manager (instead of as the managing member of MIC, the sole manager of La Cumbre).

The failure of the surety company to exercise due diligence to assure that Melchiori was in fact La Cumbre’s managing member was irrelevant according to the court of appeal because Corporations Code § 17157(d) does not require the third party to be diligent.

Comment

Melchiori testified that he had never told the surety company that he was La Cumbre’s managing member and that when he signed the indemnity agreement, he did not even notice that La Cumbre was listed as an indemnitor. As noted above, La Cumbre had nothing to do with the surety bonds, and a person signing an agreement for a project might well believe that the agreement did not involve an entity that had nothing to do with the project.

While the foregoing facts were insufficient in light of Corporations Code § 17157(d) to establish that the signature of Melchiori did not bind La Cumbre, they might be sufficient to establish a defense of mistake.

If a natural person mistakenly signs a contract or other written instrument, there is no question of authority (as there could be in the case of a signature on behalf of an entity), but the fact that the person did not know that what he was signing was a contract or that he was under a misapprehension as to the subject of the contract might provide a defense on the basis of mistake. An entity is entitled to the defense of mistake as well.

But the apparent failure of Melchiori to read the signature blocks on the contract that he was signing could be fatal, however, to the defense of mistake. The opinion is silent on the defense of mistake, and it is not apparent whether the issue was litigated in the trial court.

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Ownership of Passive LLC Interest in Manager-Managed LLC Not “Doing Business” in California

The following is the text of an e-bulletin that I authored and that was published by the Corporations Committee of the Business Law Section of the State Bar of California.

In Swart Enterprises, Inc. v. Franchise Tax Board  (Jan. 12, 2017), a California court of appeal held that an out-of-state corporation whose sole connection with California was a 0.2% ownership interest in a manager-managed California limited liability company was not obligated to file a California corporate franchise tax return and pay the $800 minimum franchise tax due on that return.

–Franchise Tax

California imposes a franchise tax on every corporation that is incorporated in California, qualified to transact business in California, or actively doing business in California. The minimum liability for all corporations subject to the tax is $800 per year.

An out-of-state, or foreign, corporation is subject to the California franchise tax if it is “doing business” within California, whether or not it is incorporated, organized, qualified, or registered under California law. Rev. & Tax. Code § 23151(a). The phrase “doing business,” for purposes of the franchise tax, means “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.” Rev. & Tax. Code § 23101(a); Cal. Code Regs., tit. 18, § 23101 (Regulation 23101).

–Factual Background

Swart Enterprises, Inc. (“Swart”), was a small family-owned corporation that operated a 60-acre farm in Kansas, where it occasionally fed cattle for beef sales in Nebraska. Its place of business and headquarters were located in Iowa. Swart had no physical presence in California, such as real or personal property or employees; it did not sell or market products or services to California. Swart was incorporated in Iowa and was not registered with the California Secretary of State to transact interstate business.

In 2007, Swart invested $50,000 in Cypress Equipment Fund XII, LLC (“Cypress LLC”) and acquired a 0.2% membership interest, Swart’s sole connection with California. Cypress LLC was manager-managed, as opposed to member-managed. Under Cypress LLC’s articles of organization and operating agreement, the sole manager of the company was given “full, exclusive and complete authority in the management and control of the business of the Fund ….”

Swart was not involved in any way in Cypress LLC’s operations or management. In fact, members other than the manager were prohibited from taking part in the conduct or operation of the company. Members had no authority to execute an instrument on behalf of Cypress LLC or to otherwise act in any way on its behalf.

The FTB concluded Swart was doing business in California based on the facts that it held an ownership interest in Cypress LLC, and that Cypress LLC, which was doing business in California, had elected to be treated as a partnership for purposes of federal income taxes. The FTB demanded that Swart file a California corporate franchise tax return and pay the $800 minimum franchise tax due on that return. Swart paid the tax (and penalties and interest). It then contested the obligation and sued for a refund.

–Analysis

The court of appeal rejected the argument that the LLC’s election to be classified as a partnership for federal income tax purposes resulted in all members of the LLC being considered general partners for all tax purposes.

The court of appeal cited Appeals of Amman & Schmid Finanz AG (1996) 96 SBE 008 [1996 Cal. Tax LEXIS 62] for the proposition that the business activities of a partnership cannot be attributed to limited partners. In Amman & Schmid, foreign corporations that were limited partners in partnerships were held not to be doing business in California simply because the general partners were doing business in California on behalf of the partnerships.

The Attorney General attempted to distinguish a limited partnership interest from a membership interest in a manager-managed limited liability company and cited a legal ruling issued by the FTB (Cal. Franchise Tax Bd., Legal Ruling No. 2014-01 (July 22, 2014) [2014 Cal. FTB LEXIS 2]. The court of appeal disagreed with the analysis in the FTB’s ruling and noted that the ruling contradicted a position previously taken by the FTB in Technical Advice Memorandum No. 200658 (Dec. 22, 2000) (TAM) [2000 Cal. FTB TAM LEXIS 28].

The court of appeal held that a corporation that passively holds a 0.2% membership interest in a manager-managed LLC, with no right to act for or control the LLC, is not “doing business” in California and therefore is not required to file a California corporate tax return or pay the California minimum franchise tax.

–Constitutional Issue

Having disposed of the case on the basis of statutory interpretation, the court did not address the constitutional arguments made by Swart.

FTB Acquiescence

The time for the FTB to appeal has expired, and the FTB is reported to be working on guidance to release to taxpayers.

Statutory Amendment

As described below, the definition of “doing business” in Rev. & Tax. Code § 23101 was expanded, effective 2011, but because the franchise tax at issue in the case was imposed for Swart’s tax year ending June 30, 2010, the statutory expansion of the definition of “doing business” did not apply to Swart.

For tax years beginning in or after 2011, Rev. & Tax. Code § 23101(b) declares a taxpayer to be doing business in California if the taxpayer’s sales, property, or compensation paid exceed certain limits set forth in the statute (with the dollar amounts to be revised annually by the FTB).

If the taxpayer’s California sales for the taxable year exceed the lesser of $500,000 or 25% of the taxpayer’s total sales, the taxpayer is doing business in California. For this purpose, sales of the taxpayer include sales by an agent or independent contractor of the taxpayer.

If the taxpayer’s real property and tangible personal property in California exceed the lesser of $50,000 or 25% of the taxpayer’s total real property and tangible personal property, the taxpayer is doing business in California.

If the amount of compensation paid in California by the taxpayer exceeds the lesser of $50,000 or 25% of the total compensation paid by the taxpayer, the taxpayer is doing business in California.

It is doubtful that the expansion of the definition of “doing business” would have changed the result in Swart, but the expanded definition could ensnare out-of-state entities that are not actively engaging in any transaction in California for the purpose of financial or pecuniary gain or profit.

 

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Individualized Promissory Note Held Not To Be a Security

The following is the text of an e-bulletin that I authored and that was published by the Corporations Committee of the Business Law Section of the State Bar of California.

In People v. Black (Feb. 16, 2017), the court of appeal held that a single promissory note, negotiated one-on-one, to fund an investment in real property was not a security under the California Corporate Securities Law even though the note offered a share of profits to the lender as an alternative to fixed interest.

The promissory note at issue was written on the letterhead of “Atherton LLC, a land development company” and listed Atherton, LLC as “borrower” and Bronic Knarr as “lender.” In the note, the borrower promised to pay the lender the amount borrowed ($124,456) together with interest that would be calculated as follows:

  1. If the real property were sold by the borrower, the amount of interest would be a percentage of the profits from the sale.
  1.  If the borrower developed the real property, the lender would receive two lots chosen by the lender.

If the property were neither sold nor developed within one year, the principal, along with interest at the rate of 10%, would be due at the election of lender.

The note further stated that “Charles Black who is executing this Note has agreed that his separate property shall be bound hereby and that resort may be had to such separate property for the payment and enforcement of this Note.” The note was signed only by Black as “managing member” of Atherton, LLC.

Subsequently, the note was amended to reflect that Knarr had increased his loan and that Knarr would receive one residential acre, not two lots, if the property were developed. The maturity date of the note was extended several times.

Two other individuals separately gave money to Black for the deal. James McGuire, a real estate agent who knew Black from prior dealings, partnered with Black and invested about $160,000. David Faye gave Black $20,000 toward the deal but was unsuccessful in attempts to follow up with Black about his investment.

Trial Court Proceedings

The Santa Cruz County District Attorney filed an information charging Black with three counts of theft by false pretenses and three counts of making false statements in the offer or sale of a security. After the preliminary hearing, the magistrate found insufficient evidence of a false pretense but held Black to answer the charges of using false statements in the offer or sale of a security. Thereafter, the information was amended twice, and Black moved to dismiss on the ground that the promissory note was not a security.

The trial court concluded that the promissory note was not a security under either the risk-capital test or the Howey test.

Court of Appeal Opinion

On appeal, the People did not argue that the promissory note qualified as a security under the risk-capital test.

The court of appeal noted that Corporations Code section 25019 defines “security” to include “any note; stock; . . . bond; . . . evidence of indebtedness; certificate of interest or participation in any profit-sharing agreement; . . . investment contract….” Citing the California Supreme Court’s opinion in People v. Figueroa (1986) 41 Cal.3d 714, 734, the court of appeal noted that the definition of “security” is not applied literally. Rather, “the ‘critical question’ . . . is whether a transaction falls within the regulatory purpose of the law regardless of whether it involves an instrument which comes within the literal language of the definition [citations omitted].”

Black argued that the promissory note was not a security because it was a unique agreement that was negotiated one-on-one between the parties and was not designed to be publicly traded, citing Marine Bank v. Weaver (1982) 455 U.S. 551, which held that a unique agreement not designed for common trading might not be an “investment contract” or other type of security under federal law. The court of appeal noted that there was no prospectus or other indication that the arrangement with Knarr “could have been traded publicly” and thus the note at issue was not an instrument intended for wide distribution.

Black also argued that repayment to Knarr was not contingent on the success of the enterprise because Knarr had the right to be repaid the principal plus interest, whether or not the Idaho deal succeeded, and that the evidence was insufficient to show that Black would not have been able to fulfill that obligation. Knarr testified that he would not have invested with Black if the fixed repayment obligation not been included in the promissory note, and Black was unequivocal that he owed Knarr the money. The court noted that the fixed repayment obligation, together with the provision binding Black’s separate property, “inserted an element of redress that would be unlikely to come within ‘the ordinary concept of a security’ [citations omitted].”

Although the court of appeal rejected the notion that all one-on-one contracts are excluded as a matter of law from the definition of a security, it held that the individualized nature of the transaction is one factor that must be considered in determining whether that transaction comes within the regulatory purpose of the securities laws. Accordingly, the court of appeal held that the promissory note offered for Knarr’s investment in the real estate development scheme was not a security within the meaning of the Corporate Securities Law.

 

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BOE Tax Clearances

When a business that sells or leases goods at retail owes sales taxes to the California Board of Equalization (BOE), the buyer of the business can be responsible for paying the BOE the amount owing if the seller does not pay them.

The liability applies to any person who is a successor or assignee of someone who sells out his business or stock of goods or quits the business, not just a buyer. This post assumes that the purchaser is buying assets from someone selling his business or at least selling all his inventory.

Under the law, unless the seller produces a certificate from the BOE stating that no amount is due, the purchaser must withhold enough money to cover the amount owing by the seller. If the purchaser fails to do that, the purchaser will be personally liable to the BOE for paying the amount due from the seller. These obligations are imposed on the buyer by Revenue & Taxation Code sections 6811 and 6812.

The buyer’s liability is limited to the purchase price of the assets acquired. Thus, if a seller’s liability to the BOE is $100,000 and the business is sold in an arm’s-length transaction for $12,000, the buyer is only liable to the BOE for $12,000. But that’s $12,000 more than the buyer was expecting!

How to avoid this pitfall?  The purchaser can submit a written request to the BOE for a certificate of tax clearance. The purchaser of a business will be released from the obligation to withhold money from the purchase price if the purchaser obtains a certificate from the BOE stating that no taxes, interest, or penalties are due from the seller. This is customarily referred to as a tax clearance certificate.

The BOE has 60 days to issue a tax clearance certificate. The failure to issue a tax clearance certificate 60 days of the date the BOE receives the written request releases the buyer (assuming the sale has not already closed). Obviously, if a statement indicates that money is due the BOE, the buyer should make sure it is paid.

To avoid delay, the buyer (or escrow company) should request a tax clearance certificate as soon as possible.

If the business has more than one location and the purchaser is buying one or more locations (but not all), the purchaser should request a clearance for each location. If the business has more than one location and the purchaser is buying all the locations, only one clearance is needed.

Whether or not the BOE issues a tax clearance certificate, the seller remains liable for any amount due to the BOE.

There is no need for a tax clearance certificate if the buyer is buying stock of a corporation (or a membership interest in an LLC) because the underlying assets remain owned by the entity and are not transferred to the buyer. The entity remains liable for its obligations to the BOE.

For information about Franchise Tax Board Tax Clearance Certificates, see https://richardburtlaw.com/franchise-tax-board-tax-clearance-certificates/.

For information about Employment Development Department Tax Clearance Certificates, see https://richardburtlaw.com/edd-tax-clearances/

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EDD Tax Clearance Certificates

When a business is an employer that owes contributions, interest, or penalties to the California Employment Development Department (EDD), the buyer of the business can be responsible for paying the EDD the amount owing if the seller does not pay them.

By the way, the statute applies to any person who “acquires” the business (or substantially all the assets of an employer), not just a buyer. This post assumes that the seller is an employer and that the acquirer is a buyer of assets.

Under the law, unless the seller produces a certificate from the EDD stating that no contributions, interest, or penalties are due, the buyer must withhold in trust money sufficient to cover the amount of any contributions, interest, and penalties owing by the seller and pay the EDD that amount at the closing. If the buyer fails to do that, the buyer will be personally liable to the EDD for the payment of the contributions, interest, and penalties due from the seller. These obligations are imposed on the buyer by Unemployment Insurance Code sections 1731 and 1733.

The buyer’s liability is limited to the purchase price of the assets acquired. Thus, if a seller’s liability to the EDD is $100,000 and the business is sold in an arm’s-length transaction for $12,000, the buyer is only liable to the EDD for $12,000. But that’s $12,000 more than the buyer was expecting!

How to avoid this pitfall?  Either the buyer or the seller can submit a written request to the EDD for a Certificate of Release of Buyer (DE 2220). The request is made on Form DE 2220R (Release of Buyer Request Form). The certificate is customarily referred to as a “tax clearance certificate.”

The EDD has 30 days to issue a certificate stating that no contributions, interest, or penalties are due or a statement showing the amount of any contributions, interest, and penalties claimed to be due. The failure to issue such a certificate or statement within 30 days is legally equivalent to the issuance of a certificate stating that no contributions, interest, or penalties are due. Obviously, if a statement indicates that money is due the EDD, the buyer should make sure it is paid at closing.

To avoid delay, the buyer or the seller should request a tax clearance certificate as soon as possible after agreeing on the sale.

Whether or not the EDD issues a tax clearance certificate (or statement showing the amount due) within the 30-day period, the seller remains liable for any amount due to the EDD.

There is no need for a tax clearance certificate if the buyer is buying stock of a corporation (or a membership interest in an LLC) because the underlying assets remain owned by the entity and are not transferred to the buyer. The entity remains liable for its obligations to the EDD.

For information about FTB Tax Clearance Certificates, see:  https://richardburtlaw.com/franchise-tax-board-tax-clearance-certificates/

For more information about Board of Equalization tax clearances (sales tax liability), see https://richardburtlaw.com/boe-tax-clearances/

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New LLC Statement of Information Form

Every two years, a California limited liability company must file a statement of information with the California Secretary of State. The same is true for  a limited liability company formed in another state but registered to do business in California.

In the past, if there was no change to the information in the statement of information from the prior filing, the LLC checked a box on Form LLC-12 to report no change. Now there is an additional form. If there is no change to the information from the last complete statement of information, the LLC can report that on LLC-12NC. Or it can complete all the blanks on the Form LLC-12 and file that.

The filing fee for either the initial statement or the biennial update is $20.

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Perils of Dissolution, or Hey, FTB, Where’s My Dough?

Sometimes a California limited liability company (LLC) or California corporation dissolves and files a final tax return which shows it has a refund coming, but the refund is $800 short. How could this happen? It’s because the Franchise Tax Board (FTB) may deduct $800 and apply it to next year’s taxes.

Let’s say that a business entity files a tax return and has a refund coming. In that case, the FTB computer looks to see if the business entity had paid the tax for the next year (estimated tax for a corporation). If the next year’s tax payment is past-due, the FTB may take $800 out of the refund and apply it to the next year’s tax. The intent is to help the taxpayer avoid penalties and interest for late payment of the tax for the next year.

But if the entity is dissolving and filing its final tax return (and the appropriate box on the tax return is marked to show that it’s the final tax return), there shouldn’t be a next year for the entity, let alone a tax for that next year.

Here’s the rub. Although a California LLC or corporation files a tax return marked “Final,” the termination of the entity for tax purposes does not occur until the proper paperwork is filed with the California Secretary of State. In the case of an LLC, the minimum paperwork is ordinarily a certificate of cancellation. In the case of a corporation, the minimum paperwork is ordinarily a certificate of dissolution. In some cases, additional paperwork might be needed, particularly if the entity has been delinquent on its filings with the Secretary of State.

If the paperwork is not timely filed, the business entity continues to exist for tax purposes until the next tax year. (And it will continue until it files the correct paperwork with the Secretary of State.) In that case, it incurs the next year’s taxes. This applies even if the tax return filed was marked “final.”

Once the Secretary of State notifies the FTB that the correct paperwork has been filed, assuming the correct paperwork has been timely filed, the FTB should remit the $800 balance to the taxpayer (less, of course, any other amount that may be owing).

But if the taxpayer neglects to file the paperwork on time or never files the paperwork with the Secretary of State, then the $800 deducted from the tax refund will be consumed by being applied to the next year’s tax. And the business entity will probably incur penalties and interest in succeeding years if the paperwork is not filed before the end of the next year.

Filing the correct paperwork with the Secretary of State prior to filing the final year’s tax return may avoid this problem. There are other pitfalls to terminating a California entity, and it can pay to have competent legal assistance in the process.

If you have a California business entity to wind up, dissolve, or terminate, I can help.

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