Question: If a California LLC distributes all of its assets to its members and dissolves without paying a creditor, can the creditor collect the unpaid debt from the former members?
Answer: Yes, but only to the extent of the value the member received. The California Court of Appeals case of CB Richard Ellis, Inc. v. Terra Nostra Consultants, 178 Cal.Rptr.3d 640 (Cal. Ct. App. Oct. 7, 2014) confirmed this concept.
Jefferson 38, LLC, a California limited liability company, signed a listing agreement in 2004 with real estate broker CB Richard Ellis, Inc. (“CBRE”) to sell its land. The LLC sold it land for $11,800,000, but CBRE was not paid anything. In 2006 CBRE exercised a clause in the listing agreement to arbitrate the dispute over the commission. CBRE won an arbitration award of $960,649.30. The arbitration award was confirmed and judgment entered in the amount of $985,439.80 by the Los Angeles Superior Court. The judgment was affirmed on appeal.
When the real estate was sold in 2005, the net proceeds of the sale were distributed to the members of the LLC shortly thereafter and the LLC ceased to engage in business. On February 27, 2006, Jefferson 38, LLC, filed a certificate of cancellation with the California Secretary of State indicating that all of its members voted for the dissolution.
At this point in time the members of the LLC had caused the LLC to distribute all of the LLC’s assets to its members and legally dissolved the LLC while an outstanding claim was pending. This is a scenario California LLC law attempts to prevent and that is disfavored by the courts.
Because the events that gave rise to this case occurred before January 1, 2014, the effective date of the California Revised Uniform LLC Act, the California Court of Appeals applied prior California LLC law to the case. Former Section 17355(a)(1) provided:
“Causes of action against a dissolved limited liability company, whether arising before or after the dissolution of the limited liability company, may be enforced against any of the following:
(A) Against the dissolved limited liability company, to the extent of its undistributed assets. . . .
(B) If any of the assets of the dissolved limited liability company have been distributed to members, against members of the dissolved limited liability company to the extent of the limited liability company assets distributed to them upon dissolution of the limited liability company.”
The defendants argued that they should not be liable for the debt owed by the LLC to CBRE because they were paid long before the actual dissolution of the LLC. The Court of Appeals rejected this argument because if that were the law LLC members could easily distribute assets to members rather than creditors and avoid personal liability simply by making the distributions long before the technical dissolution of the LLC.
Current California LLC law with respect to California LLCs making distributions to members is stated in Cal. Corp. Code § 17704.05, which states:
(a) A limited liability company shall not make a distribution if after the distribution either of the following applies:
(1) The limited liability company would not be able to pay its debts as they become due in the ordinary course of the limited liability company’s activities.
(2) The limited liability company’s total assets would be less than the sum of its total liabilities plus the amount that would be needed, if the limited liability company were to be dissolved, wound up, and terminated at the time of the distribution, to satisfy the preferential rights upon dissolution, winding up, and termination of members whose preferential rights are superior to those of persons receiving the distribution.
Warning to Members of California LLCs: Do not clean out your LLC’s assets and leave any unpaid creditors. The general rule of prior and current LLC law that members of a California LLC are not liable for the debts, obligations, or other liabilities of the limited liability company does not apply when the members are paid before the LLC’s creditors.