Timely Dissolution Can Protect Shareholders

When a California corporation dissolves, it continues to exist for the purpose of defending claims against it (and prosecuting claims in its name), though a claim by a creditor against a shareholder to recover assets distributed in the distribution must be filed within four years of the date of dissolution, or the claim will be barred. Delaware has a similar rule, but the corporation must be sued within three years of the date of dissolution.  What happens when a lawsuit is filed against a dissolved Delaware corporation in California more than three years after the corporation is dissolved?

In Greb v. Diamond International Corporation (2010) 184 Cal. App. 4th 15, this question arose. The plaintiff argued that the California Corporations Code should apply. California Corp Corporations section 2010 provides that “A corporation which is dissolved nevertheless continues to exist for the purpose of winding up its affairs, prosecuting and defending actions by or against it… .” This section has no time limit. Since the lawsuit was filed within four years of the date of dissolution, a successful claim against the corporation would allow the plaintiffs to pursue shareholders for assets distributed in the dissolution.

California, like most states, has routinely held the law of the state of incorporation determines the consequence of a corporate dissolution. California Corporations Code section 102 provides that, with certain exceptions not applicable here, the provisions of the Corporations Code apply to domestic corporations only, and that application to other corporations is permitted only “to the extent expressly included in a particular provision of this division.” Unlike some other sections, Corporations Code section 2010 makes no mention of foreign corporations.

Accordingly, the court held that the Delaware time limit of three years applied, and the claim of the plaintiffs was barred by the passage of time.

Lessons Learned

When the business of a California corporation is wound up, the shareholders should formally dissolve the corporation. A California corporation must pay a minimum franchise tax of $800 every year whether it conducts business or not.  Only dissolution will stop the accrual of this tax. In an effort to save on legal fees, many closely-held corporations with wound up businesses are simply abandoned, rather than formally dissolved. After a number of years of not paying the annual tax, the corporation is suspended by the state. Some incorrectly view this as equivalent to dissolution. This can be a costly  mistake.

Sometimes a claim needs to be brought in the name of the corporation, but a suspended corporation can not maintain a lawsuit. That’s one of the consequences the legislature has imposed on a corporation for being suspended. To bring a claim, a suspended corporation must be revived. And to do that, all the back taxes along with penalties and interest must  be paid to obtain a certificate of revivor from the Franchise Tax Board. If the suspended corporation had been  properly dissolved, back taxes would not have accrued, and the shareholders could bring the action in the name of the corporation without having to obtain a certificate of revivor.

More importantly, not dissolving formally means that the four-year period for claims against shareholders of a dissolved corporation never starts to run. Claims against shareholders of a suspended corporation can be brought until barred by some other statue of limitations.

Finally, observing corporate formalities, which includes dissolving a corporation formally, is a factor courts use in determining whether to pierce the corporate veil.

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