Washington Upholds Property Transfer by Canceled LLC
What happens to property owned by a canceled LLC? The Washington Court of Appeals had to answer that question in Sherron Associates Loan Fund V (Mars Hotel) LLC v. Saucier, No. 28238-4-III, 2010 Wash. App. LEXIS 1800 (Wash. Ct. App. Aug. 5, 2010). The LLC in Sherron transferred its rights in a judgment after the LLC had been canceled. In the assignee’s subsequent action to enforce the judgment, the judgment debtor claimed that the assignment was invalid because the LLC had been canceled.
At the relevant time in Sherron, Washington’s LLC Act required that a dissolved LLC file a certificate of cancellation on completion of its winding up, and that the LLC’s existence cease on the filing of the certificate of cancellation. See Chadwick Farms Owners Ass’n v. FHC, LLC, 166 Wn.2d 178, 207 P.3d 1251 (2009). Last year I reviewed the Chadwick Farms decision, here. (Washington’s LLC Act has since been amended to eliminate certificates of cancellation. In April I analyzed the amendments, here.)
Sherron developed out of a long-running attempt to collect a debt. In 1998 an LLC obtained a judgment against Robert Saucier for $825,000, for money he borrowed from the LLC. In May of 2002, CES Properties, Inc., a former manager of the LLC, filed a certificate of cancellation in the LLC’s name. The LLC’s sole manager and sole member, GCA Investments, Inc., was unaware of the filed certificate of cancellation.
In October of 2002, GCA transferred the Saucier judgment to Sherron Associates, Inc. (SAI). (The opinion is unclear whether GCA’s transfer of the judgment was on behalf of the LLC as its manager, or as the sole member of the LLC.) SAI began efforts to collect the judgment and in doing so learned about the cancellation of the LLC. SAI attempted to have the LLC reinstated, but the Washington Secretary of State refused on the ground that there was no authority permitting a canceled LLC to be reinstated.
SAI later filed the Sherron lawsuit to extend the 1998 Saucier judgment for an additional 10 years. Saucier defended on the ground that the LLC’s assets could not have been assigned to SAI because the LLC had been canceled before the assignment and did not exist when the purported assignment was made. SAI countered that GCA, the LLC’s sole member, succeeded to the LLC’s assets upon its cancellation and therefore validly transferred the judgment to SAI. The trial court agreed with Saucier’s argument that the judgment could not have been assigned to SAI, and refused to extend the judgment. SAI appealed.
The Sherron court noted that Washington’s LLC Act did not answer the question of what happens to property owned by a canceled LLC. In Chadwick Farms the Washington Supreme Court had ruled that a canceled LLC could not be sued or maintain a lawsuit. From that, the Sherron trial court concluded that a canceled LLC could not take action, such as transferring assets. But, said the Court of Appeals, intangible assets such as a judgment continue to exist even if the canceled LLC could no longer enforce them.
The court pointed out that with both dissolved corporations and dissolved partnerships, the assets go to the shareholders or partners after creditors have been paid, and concluded:
We believe the rule for limited liability companies, a hybrid of partnerships and corporations, should be the same. In the absence of a governing statute, title to LLC-owned property passes to the owner of the canceled LLC subject to creditor claims.
Sherron, 2010 Wash. App. LEXIS 1800, *8. When the LLC in Sherron was canceled, GCA was its sole member. The LLC’s assets therefore passed to GCA, and GCA could in turn transfer those assets to SAI. The result was that SAI was allowed to extend the judgment.
This is not a surprising result, since the assets of a canceled LLC must be owned by someone, and who else would they go to? Escheat to the State? No. In an orderly dissolution and winding up, those assets would have been distributed to the members after all liabilities had been satisfied. Why should the premature filing of a certificate of cancellation change that result?
What I find puzzling about the case is that CES was only a former manager when it filed the certificate of cancellation. It clearly was not authorized to sign and file it. GCA was the sole manager and sole member of the LLC when CES filed the certificate, and GCA had no knowledge of the filing until later. Under the statute in force at that time, “A certificate of cancellation must be signed by the person or persons authorized to wind up the limited liability company’s affairs.” RCW 25.15.085(f) (2008). Since the signature on the certificate was unauthorized, why couldn’t the court rule it invalid? A trial court must deal with a controversy as presented by the litigants, of course, and it appears the issue was simply not put before the court.
Concealment of Breach of Fiduciary Duty Tolls the Alabama Statute of Limitations
Here’s a case for you. Plaintiffs invest $2.5 million in an LLC formed to purchase real estate, and guarantee a $7.5 million loan to the LLC. The LLC buys the real estate for $10 million from Ray Jacobsen, an affiliate of the LLC’s managers and its original investors. No one informs the new-money investors that Jacobsen bought the real estate for $5 million just days before selling it to the LLC for $10 million.
The plaintiffs alleged (a) that the LLC’s managers and original investors (the defendants) were well aware of Jacobsen’s “flip” of the property, (b) that the defendants never disclosed this information to the plaintiffs, (c) that the plaintiffs justifiably relied on the defendants’ silence by forgoing independent investigation, and (d) that the plaintiffs learned of the fraud later by happenstance. DGB, LLC v. Hinds, No. 1081767, 2010 Ala. LEXIS 116 (Ala. June 30, 2010).
The investors sued for damages, claiming fraud and breach of fiduciary duty and asking for dissolution of the LLC. The defendants contended that the claims were barred by the statute of limitations. The trial court dismissed almost all of the investors’ claims, and the plaintiffs appealed.
The defendants argued that the claims were barred by Alabama’s two-year statutes of limitations, Ala. Code §§ 6-2-38(l), 8-6-19(f). The plaintiffs in turn invoked the fraud savings clause of Ala. Code § 6-2-3:
In actions seeking relief on the ground of fraud where the statute has created a bar, the claim must not be considered as having accrued until the discovery by the aggrieved party of the fact constituting the fraud, after which he must have two years within which to prosecute his action.
If applicable, this exception would save the plaintiffs’ claims of fraud and breach of fiduciary duty, because their lawsuit had been filed within two years of their discovery of Jacobsen’s double-dealing, although it was more than two years after the original real estate deal.
The court simply applied the savings clause to the fraud claims, but the fiduciary duty claims were examined more closely. The court ruled that fraudulent concealment of wrongful acts is enough to invoke the fraud savings clause, even if the cause of action was for something other than fraud. DGB, supra, at *15, 16. Since the plaintiffs had alleged concealment of the defendants’ real estate flip, their claims survived.
The court never explicitly discussed what is necessary to make the concealment “fraudulent.” Presumably it means that there was some degree of mens rea, i.e., a guilty mind or intent.
Statutes of limitation are more than mere technicalities. They prevent old, stale claims from popping up many years after the original event. Memories fade, evidence may be lost, and witnesses may die or be missing. But in this case the court’s application of the fraud rule, along with its extension of the time for bringing the lawsuit, was the right result. As the court said, “A party cannot profit by his own wrong in concealing a cause of action against himself until barred by limitation. The statute of limitations cannot be converted into an instrument of fraud.” DGB, supra, at 11, 12 (quoting Hudson v. Moore, 194 So. 147, 149 (Ala. 1940), overruled on other grounds by Ex parte Sonnier, 707 So. 2d 635 (Ala. 1997)).
The investors also asked the court to order the dissolution of the LLC. The Alabama LLC Act allows for judicial dissolution of an LLC “whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.” Ala. Code § 10-12-38. This provision is similar to those of the Delaware LLC Act and the Washington LLC Act. Since dissolution can be granted “whenever” it is not reasonably practicable to carry out the business in conformance with the charter, the court found that there was no basis for applying the statute of limitations to a request for a dissolution. DGB, supra, at *10.
