How to dissolve an LLC, and why letting it lapse is the expensive option

The most expensive thing I have ever told a founder about how to dissolve an llc took 6 words. The company is dead, stop paying. He did, and 3 years later the state cancelled the certificate on its own, which is what I had promised. What I had not promised was the bill that was still sitting underneath it. I was wrong, and the wrongness sat in 1 word: free. That was bad advice, given quickly, to somebody who had no reason to doubt it.

Delaware charges 400 dollars a year while the entity is active in its records. Stop paying and the tax does not stop. It grows a 200 dollar penalty and 1.5 per cent a month on the tax and on the penalty together, and the state may sue for it after the arrears have run for 1 month.

I went looking for the actual sections after that conversation, and read all 5 of the winding up provisions rather than a closure checklist. What follows is the 3 separate acts hiding inside the word dissolve, the arithmetic of doing it properly, and the specific date that decides whether you pay 1 year of tax or 2.

Dissolve, wind up, cancel: 3 things, not 1

The statute is precise and almost nobody reads it in order. A certificate of formation is cancelled “upon the dissolution and the completion of winding up” of the company, and a certificate of cancellation is filed with the Secretary of State to accomplish that.

So dissolution is a decision. Winding up is actual work. Cancellation is a filing, and only the filing stops the meter. The 3 can happen inside a fortnight or drag across 2 years, and the state charges the same 400 dollars a year throughout, because its records care about whether the entity is listed and not about whether anybody is doing anything with it.

Founders do the first, skip the second and never reach the third. The company then sits in the register in a state that feels closed from the inside and is fully open from the outside, which is the same trap we described in the file on an LLC not in good standing, arriving from the other direction.

What winding up actually means

The powers are listed. While winding up, the people doing it may prosecute and defend suits in the company's name, gradually settle and close the business, dispose of property, distribute what is left, and, in the statute's words, “discharge or make reasonable provision for the limited liability company's liabilities”.

That last phrase is the one that does work. Reasonable provision is not the same as paying everything, and it is not the same as ignoring what you cannot pay. It is a judgement, and it is the judgement a creditor will attack later if there is anything left to attack.

The order of distribution is also fixed. Creditors first, including any member who is also a creditor. Then members and former members owed distributions. Then whatever remains goes to the members. Pay yourself before the supplier and you have inverted a statutory order, which is a different kind of problem from an unpaid invoice.

And the door does not close at cancellation. After the certificate is cancelled the Court of Chancery may, on the application of any creditor, member or manager, appoint trustees or receivers “to take charge of the limited liability company's property, and to collect the debts and property due and belonging to the limited liability company”. A cancelled company is not an unreachable one.

The 4 documents I would gather before filing anything

Winding up sounds like a legal process and is mostly an administrative one. The parts that actually take time are the parts nobody warns you about, and I have watched all 4 of them delay a closure that everybody had agreed to months earlier.

The bank account is first, and it goes last. You cannot distribute what you cannot move, and a bank will not close a business account with a balance sitting in it, so the final transfer and the final statement have to happen before the filing rather than after. Leaving 40 dollars in an account has held up more closures than any creditor I have met, and it is the sort of obstacle that makes people put the whole thing off for another quarter.

Payroll and contractor filings are second. A company that paid anybody during the year still owes the year's returns, and those obligations do not travel with the entity into cancellation. They stay with whoever signed.

Third is the list of open contracts, which is usually longer than the founder remembers because software renews itself quietly. A subscription that auto-renews after cancellation bills a card belonging to a company that no longer exists, and unpicking that is worse than cancelling it in advance.

Fourth is the members' written decision to dissolve. It runs to a single page and costs nothing. It is also the only document that fixes when the clock started. I would not file a cancellation without it in the folder, because the date of dissolution is exactly what a creditor would ask about later.

The date that costs 400 dollars

Here is the practical core, and it is 1 sentence on a government page: “There is no proration on alternative entity taxes.” The same page sets out when the charge attaches: taxes are assessed “if the entity is active in the records of the Division of Corporations anytime during January 1st through December 31st of the current tax year”.

Read that as a calendar rather than as a rule. An entity that is cancelled on 2 January owes the full 400 dollars for that year, exactly as if it had traded for 12 months. An entity cancelled on 30 December owes the same 400. There is no version of the year in which you owe less, no partial charge for a partial year, and no mechanism for asking, which makes the calendar the only lever a founder has on this number and makes December the month in which the lever works.

So the filing sequence has a cheap version and an expensive one, and the difference is which side of a year boundary you land on. Finish the winding up in the autumn. File the cancellation before 31 December. Do not carry a dead company into January for the sake of a tidy quarter, which is the reason I have heard most often and the most expensive one.

There is 1 piece of good news in the paperwork: Delaware requires no annual report from an LLC at all, only the tax, so the closing file is thinner than founders expect. The filing itself costs 180 dollars, plus 50 for each registered series named in it. Add the final year of tax and the whole thing costs about 580 dollars. Once, and then nothing.

None of this is legal advice and the winding up judgements in particular are not mine to make. A lawyer in the state should look at any company with creditors, open contracts or more than 1 member before anything is filed.

What happens to the money that was left

Most small closures have a small positive balance and a founder who assumes it is theirs. The order in the statute says otherwise, and the order is not advisory.

Creditors come first, and that includes a member who lent the company money, which is the case that trips people up. A founder who put 20 thousand dollars in as a loan and 5 thousand as capital is 2 different claimants in the same person, standing in 2 different places in the queue.

Then come distributions already owed to members and former members. Then, and only then, the remainder is distributed to the members. It is a short list and it is easy to follow. It is also easy to ignore when the balance is 6 thousand dollars and everybody involved is tired.

What the lazy route actually costs

The lazy route has a real ending, and I described that ending accurately: after 3 years of unpaid tax the certificate of formation is cancelled by operation of the statute, effective on the third anniversary of the due date. That part of my old advice was correct.

What I left out is everything underneath. The tax is a debt to the state on which, in the statute's words, “an action at law may be maintained after the same shall have been in arrears for a period of 1 month”. It is also, in the statute's words, “a preferred debt in the case of insolvency”. The state's own cancellation at year 3 ends the entity. It does not end the arrears.

Run it as a model. Year 1 is 400 plus a 200 penalty. Year 2 adds another 400 and another 200 while 1.5 per cent a month accrues on everything already owed. By the third anniversary the number is comfortably over 2,000 dollars on our arithmetic, against 580 for doing it properly, and the company is cancelled either way.

I suspect most of the people who take this route never hear from anybody in 3 years. I have not seen a collection action myself and I am not going to pretend I have. What I have seen is the same balance surfacing years later when a founder wanted a certificate of good standing for a new bank, and discovered that the old company had followed them.

One more thing about the 3 years. It is not a grace period, whatever it looks like from outside. The entity is out of good standing from the first missed payment, which means no certificate for a bank, no filings accepted, and a company that cannot prove it exists while continuing to exist for every purpose that costs money.

A short digression about the word dead

Companies stop trading long before anybody decides they are finished. There is a period, usually 9 to 18 months, when the founders have moved on and the entity has not been told. Nobody files anything during that period because filing means admitting it, and the filing fee is not the obstacle. I find that more interesting than the arithmetic, and slightly sad, and it is not something a statute can fix. Anyway, back to the paperwork.

What I could not establish

How many Delaware LLCs close properly rather than lapse. The state publishes the number of active entities and I have not found a breakdown of exits by cause, which means the ratio of cancellations to forfeitures is not something I can give you.

Whether the state pursues small arrears in practice. My guess is that it rarely does below some internal threshold, because chasing 600 dollars costs more than 600 dollars, but that is a guess and I would not build a plan on it. The statute plainly allows an action after 1 month of arrears, and a rule that is rarely used is still a rule that exists on the day somebody decides to use it.

The detail I keep thinking about is that the cheap path and the correct path are the same path. 580 dollars and an afternoon closes a Delaware LLC completely, and the alternative costs more, takes 3 years and ends in the same cancellation. It still bothers me that nobody I asked could explain why the lapse route is the common one, and the best answer I got was that filing something is a decision while not filing is not, which is true and also the most expensive sentence in this piece.