In tough times, dissolution may offer the benefits of bankruptcy but without the high costs

Published March 13, 2015 by Ryan C. Day

The economy may be showing signs of improvement, but more than 34,000 businesses still filed for bankruptcy in 2014, according to the American Bankruptcy Institute. Studies indicate, however, that many more financially-distressed, small businesses cease their operations without going through the time and expense of a liquidation under the federal Bankruptcy Code.  Instead, they dissolve under applicable state law. Dissolving a domestic corporation under Virginia law offers largely the same advantages to business owners as a federal bankruptcy filing, but often at a lower cost, in less time, and with potentially greater privacy and control.

An alternative to a federal bankruptcy filing

A small business dissolving under Virginia law typically avoids mandatory court fees and a court-appointed fiduciary — the bankruptcy trustee — present in a bankruptcy liquidation, which together can drain significant sums from the bankruptcy estate’s assets. A state-law dissolution also often can be resolved faster, since the dissolving corporation typically has more control over timing of the marshalling, claims resolution and asset distribution processes, in contrast to a liquidation in bankruptcy where the trustee oversees them.

Furthermore, state dissolutions are typically more private. A federal bankruptcy filing requires extensive disclosure of financial information. The Bankruptcy Code also protects creditors from the debtor, preferring insiders and favored creditors by granting the trustee extensive powers to unwind prepetition actions. In contrast, creditors often find it difficult and costly to uncover detailed information about a distressed corporation’s finances involved in a state-law dissolution. By avoiding a bankruptcy filing, management may be able to avoid strict oversight, as well as control or altogether prevent the flow of potentially sensitive information to creditors.

Dissolution under state law also may present a more robust opportunity for any surplus to be returned to shareholders.  In bankruptcy, shareholders have little hope to receive a distribution due to increased administrative costs and because creditors must be fully paid before equity receives any distribution. In state dissolutions, however, the reduced costs may accrue for the shareholders’ benefit, since creditors may lack incentive to participate due to the relatively small size of their claims.

Lastly, Virginia’s corporate dissolution statute (Va. Code Ann. §§ 13.1-742 to -744) effectively provides for discharge of a distressed corporation’s debts if it complies with the prescribed procedures.

What steps are involved in a Virginia dissolution?

Virginia law provides for a voluntary dissolution — outside of court — by filing articles of dissolution with the Virginia State Corporation Commission. If the Commission finds that the articles comply with the statute and all fees and taxes have been paid, a certificate of dissolution generally will be issued.

Once that occurs, the corporation must actively wind up and liquidate its business. The corporation continues to exist, but it cannot enter into any business transactions other than those necessary to collect and dispose of assets, discharge liabilities and distribute its property. The wind up and liquidation may be accomplished through a bulk asset sale, an assignment for the benefit of creditors, or even by filing a voluntary petition in bankruptcy.

To address known claims against the corporation, it must notify all known claimants of the dissolution in writing. Known claims are barred if the dissolving corporation does not admit their validity and the claimant fails to take appropriate action. A company can address unknown claims by publishing a notice of dissolution in a newspaper. Unknown claims are barred if claimants fail to act within the earlier of three years or the applicable statute of limitations period, or if the corporation posts sufficient security with a court.  Admitted claims (or claims which a court determines are valid after appropriate creditor action) will receive a pro rata distribution of the corporation’s assets after it has been liquidated.

Once a corporation has distributed all of its assets, the corporation must file articles of termination with the Commission.  If the Commission finds that the articles comply with the statute, it will issue a certificate of termination, at which point the corporation’s existence will generally cease.

Personal liability of officers and directors?

Under Virginia law, any liability for corporate debt is not imposed on the directors simply because the corporation has been dissolved. The board is still responsible, however, for marshalling the corporation’s assets and making distributions to creditors and, if a surplus exists, to shareholders; however, this limited duty is easily discharged by winding up and liquidating a company as required by the statute. Generally, there is no personal liability unless directors and officers engage in self-dealing.

What’s next?
Upon successful completion of the dissolution process, the distressed corporation is terminated and its management and shareholders are generally free from any potential liability.  Shuttering a business is never enjoyable, but officers and directors should communicate with experienced counsel at the first signs of financial distress to understand exit options and minimize potential personal liability.
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Ryan C. Day is a partner in the Alexandria  and Washington, D.C., offices of LeClairRyan, where he is a member of the national law firm’s bankruptcy and corporate litigation practice area teams.