There are many reasons why it's a good idea for your business to have an operating agreement (it can also be called a shareholder agreement depending on the type of business you're running). When you are creating a solid legal foundation for your business, you want to make sure you've got all of your documents in order. At the start of your business, you may not always have the end in mind, but you should. It's common to see stories in the news of business founders "cashing out" and receiving millions of dollars when their business is sold to another company. However, more common is a business that has run its course and finds that it is time to close its doors. When that time comes, there is a legal process called a "Corporate Dissolution" that is used to shut down the business.
Types of Corporate Dissolutions
Corporate dissolutions fall into one of two categories: Voluntary and Involuntary. There are really three types of dissolutions that your business is likely to confront:
- Voluntary Dissolutions - you are choosing to close down your business
- Involuntary Dissolutions due to unpaid taxes or filing fees
- Involuntary Dissolutions as the result of a lawsuit
I've previously examined involuntary dissolutions and what they mean for your business. But when it comes to your operating agreement, if you have the correct provisions in your documents, you'll be able to avoid involuntary dissolution and focus on a voluntary dissolution. The difference is that a voluntary dissolution allows you to control the process, as opposed to a judge deciding the fate of your company.
Dissolutions and Operating Agreements
If you don't have a dissolution provision, then your business will be following the laws of your state of incorporation. For many businesses, this can be a way to proceed. Even though you don't have a specific plan, the laws of your state already created one for you to follow. But for many businesses, it's a better option to have a provision in your agreement about dissolutions. For example, your provision could lay out the events that would trigger a dissolution, like:
The Company shall dissolve and commence winding up and liquidating upon the first to occur of any of the following (“Liquidating Events”):
- the determination by the Member, that the Company should be dissolved;
- the insolvency or bankruptcy of the Company;
- the sale of all or substantially all of the Company’s assets; or
- the Dissociation of the Member or any other act that causes the Company to have no remaining Members under the Act, provided that any such event shall not be a Liquidating Event if a new Member is appointed, in writing, by the Member’s successor in interest within ninety (90) days of such Dissociation, and if there is more than one successor in interest to the Member, then appointment of a new Member shall be made by the affirmative decision of persons holding a majority of such successor interests in the Company; or
- any event that makes it impossible, unlawful or impractical to carry on the business of the Company.
While it may seem like many of these "events" are pretty standard, your local laws may not treat all of these as events that would trigger a dissolution of a company. By having them spelled out in your agreement, you can be sure that all of the owners of the business are aware of what would cause a dissolution.
Another important provision of your dissolution process is how the proceeds shall be distributed in the case of a liquidation. If the company ends up shutting down and selling off assets, what should happen to the money that the company receives? If you're stuck in a lawsuit, that money will likely be held up until the lawsuit can be settled or all of the owners agree. However, many agreements have provisions that specifically lay out how the proceeds are to be distributed, in what order and to whom they should be distributed.
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- Closing Your Business ~ What to do When it's Time...
If your company is getting started and you don't have an operating agreement, let's set up a Legal Strategy Session to review the next best steps for you and your business.