Washington’s LLC Act limits the time period for filing lawsuits against a dissolved LLC. In 2010 the LLC Act was amended so that the limitations period does not start until the dissolved LLC files a certificate of dissolution with the Secretary of State, and the Court of Appeals recently had to decide whether that change applied retroactively. Houk v. Best Dev. & Constr. Co., No. 31163-5-III, 2014 WL 997225 (Wash. Ct. App. Mar. 13, 2014).
In 2004 William and Janice Houk moved into a new home they purchased from Nicholas & Shahan Development, LLC (NSD). There were multiple defects in their home, and in December 2010 they sued NSD for their damages on theories of breach of contract, breach of warranties, negligence, and violations of Washington’s Consumer Protection Act.
NSD moved for summary judgment dismissing the claims on the grounds that they were time-barred because the lawsuit was filed more than three years after NSD’s dissolution. NSD had been administratively dissolved in October 2006 by the Secretary of State for noncompliance with the LLC Act’s administrative requirements (e.g., not paying the annual fee or not filing an annual report).
The trial court denied NSD’s motion because of a 2010 amendment to the LLC Act that took effect before the Houks filed their lawsuit. The amended LLC Act required (as it does now) that a certificate of dissolution must be filed in order to start the three-year limitations period, and NSD had not filed a certificate of dissolution. Although three years had elapsed since NSD’s dissolution, the trial court applied the new filing requirement retroactively and allowed the Houks’ suit to go forward.
The three-year post-dissolution statute of limitations was added to the LLC Act by an amendment in 2006: “The dissolution of a limited liability company does not take away or impair any remedy available against that limited liability company, its managers, or its members for any right or claim existing, or any liability incurred at any time, whether prior to or after dissolution, unless an action or other proceeding thereon is not commenced within three years after the effective date of dissolution….” Wash. Rev. Code § 25.15.303 (2006) (emphasis added).
Section 303 was again amended in 2010 so that the three-year limitations period only begins to run when and if the dissolved LLC files a certificate of dissolution with the Secretary of State. Wash. Rev. Code § 25.15.303. An LLC can dissolve by a vote of its members and is not required to file a certificate of dissolution, but if it does so, the filed certificate makes the dissolution a matter of public record. Wash. Rev. Code § 273(1).
The Court of Appeals pointed out that statutory amendments are presumed to be prospective “unless there is a legislative intent to apply the statute retroactively or the amendment is clearly curative or remedial.” Houk, 2014 WL 997225, at *1 (emphasis added) (citing Johnson v. Cont’l W., Inc., 99 Wash.2d 555, 559, 663 P.2d 482, 484 (1983)).
The court explained that a statutory amendment is curative if it clarifies or technically corrects an ambiguous statute. Id. at *3. Section 303 had previously been held by the Supreme Court to be unambiguous, so the Court of Appeals found that the amendment was not curative. Id. (citing Chadwick Farms Owners Ass’n v. FHC LLC, 166 Wash.2d 178, 207 P.3d 1251 (2009)).
A statutory amendment is remedial if it relates to practice, procedure, or remedies, and does not affect a substantive right. Id. NSD had a legal right to assert the statute of limitations under the 2006 version of Section 303. The 2010 amendment, if retroactively applied, would have denied NSD the right to assert the statute of limitations as a complete defense. The court accordingly found that the 2010 amendment affected a substantive right and was not remedial.
Having determined that the 2010 amendment was neither curative nor remedial, the court followed the presumption that the statute is prospective, and reversed the trial court and granted summary dismissal of the Houks’ suit.
Comment. For lawyers who work with LLCs, the result in Houk is important less for what it teaches about whether statutory changes are retroactive, and more for its lesson on the importance of certificates of dissolution for dissolved Washington LLCs. The three-year statute of limitations in Wash. Rev. Code § 25.15.303 can be very helpful in a dissolved LLC’s winding up, but under the current LLC Act there is no special limitations period for a dissolved LLC unless it files a certificate of dissolution.
LLC members and managers sometimes decide to dissolve an LLC by simply ignoring its administrative requirements and letting the Secretary of State administratively dissolve the LLC. That works, but the benefits of a reasonably short three-year statute of limitations are so significant that the certificate of dissolution should almost always be filed. The certificate of dissolution is a simple one-page document, Wash. Rev. Code § 25.15.273, and there is no filing fee, Wash. Admin. Code § 434-130-090(11).
Although it played no part in the Houk case, the LLC Act also provides a method for a dissolved LLC to dispose of known claims on an accelerated basis, if the LLC has filed a certificate of dissolution. Wash. Rev. Code § 25.15.298. The LLC can give notice of its dissolution to known claimants, who must then assert claims within 120 days or their claims will be barred. If after receiving the notice a claimant asserts a claim that is then rejected by the LLC, the claimant must sue on the claim within 90 days or the claim will be barred. This “fish or cut bait” process has risks and may not be desirable in particular circumstances, but in some cases it can be a highly useful way to bring matters to a head.
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.
Is it a distribution or a misappropriation when a managing member of an LLC withdraws funds from the LLC for his own use? That was the dispositive issue in Mostel v. Petrycki, 885 N.Y.S.2d 397 (N.Y. Sup. Ct. Sept. 2, 2009). It was dispositive because the answer to that question determined which of two different statutes of limitations applied.
Mostel had a judgment against Fulcrum Global Partners, LLC, a Delaware LLC (Fulcrum), from a prior lawsuit. Fulcrum went out of business and Mostel was unable to recover from Fulcrum on his judgment, so he brought a lawsuit against Petrycki, the founding member and CEO of Fulcrum. Mostel claimed that a $300,000 withdrawal from Fulcrum by Petrycki was a fraudulent conveyance under New York’s Debtor and Creditor Law, N.Y. Debt. & Cred. Law §§ 273, 273-a, 276 and 276-a.
According to Mostel, Petrycki’s withdrawal was a fraudulent conveyance because it was without consideration, and rendered Fulcrum insolvent and without assets to satisfy the judgment against it. If the withdrawal was a fraudulent conveyance, Mostel’s judgment against Fulcrum could reach the $300,000 in Petrycki’s hands.
Petrycki, however, asked for Mostel’s suit against him to be dismissed on grounds that his $300,000 withdrawal was a distribution to him by Fulcrum, and the lawsuit was therefore barred by the three-year statute of limitations in the New York Limited Liability Company Act and the Delaware Limited Liability Company Act.
Mostel riposted that the six-year statute of limitations applicable to the fraudulent conveyance claim should apply. (Mostel’s suit was filed more than three years and less than six years after the withdrawal.) Mostel argued that the $300,000 withdrawal was not a distribution because Petrycki did not have authority to withdraw the funds and had applied them for his personal use.
Since Fulcrum was a Delaware LLC, the court examined both the Delaware and New York LLC Acts. Both statutes provide that if a member receives a distribution that causes the liabilities of the LLC to exceed its assets, and if the member knew of the resulting insolvency at the time of the distribution, then the member is liable to the LLC for return of the distribution. Both statutes also provide that a member’s liability for receiving a wrongful distribution will end three years after the distribution, unless a lawsuit is brought on the claim before the end of the three years. N.Y. Ltd. Liab. Co. Law § 508; Del. Code Ann. tit. 6, § 18-607. Finding no difference between the two states’ laws, the court said it need not decide which state’s law governed – the result would be the same in either case. Mostel, 885 N.Y.S.2d at 399 n.1.
The New York courts had previously determined that in the case of an LLC distribution which is both wrongful under Section 508 of the LLC Act and a fraudulent conveyance under the Debtor and Creditor Law, the three-year limitations period of the LLC Act overrides the six-year limitations period of the Debtor and Creditor Law. O’Connell v. Shallo, 323 B.R. 101 (S.D.N.Y. 2005). So if the $300,000 withdrawal was a distribution, the three-year limitations period of the LLC Act would apply, and Mostel’s claim would be barred. If it was a misappropriation and therefore not a distribution, Mostel’s suit could go forward.
The New York LLC Act defines “distribution” as “the transfer of property by a limited liability company to one or more of its members in his or her capacity as a member.” N.Y. Ltd. Liab. Co. Law § 102(i). Fulcrum’s Operating Agreement gave all members the right to request a return of their invested capital, subject to the approval of the managing member. The agreement did not provide for any additional procedures when a managing member seeks a return of its own invested capital.
Mostel’s complaint conceded that Petrycki was the managing member and that his $300,000 withdrawal was a return of his capital contribution, so the court rather straightforwardly concluded that the withdrawal was an authorized distribution to Petrycki. The three-year limitations period applied and Mostel’s claim was time-barred. Mostel’s complaint was dismissed.
The lessons from this case? Apart from the obvious, of course – don’t delay filing a lawsuit for so long that a statute of limitations bars the claim – the case underscores the importance of written LLC agreements. It also shows the need for the members to consider carefully the distribution provisions in their agreement. Interim distributions should be authorized by the agreement, and the parties should think about what procedures or approvals will be necessary for different types of distributions. For example, in Fulcrum’s agreement, distributions on request of a member for return of its invested capital were allowed if approved by the managing member, and that provision validated Petrycki’s withdrawal as a distribution.