Kentucky Finds Sole Member Not Personally Liable on Lease That LLC Entered into While Administratively Dissolved

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Kentucky Finds Sole Member Not Personally Liable on Lease That LLC Entered into While Administratively Dissolved

Administrative dissolution is a remedy that states use to enforce their annual-fee and annual-report requirements for LLCs. The dissolved LLC must wind up and liquidate its business, but can be reinstated if it pays the back fees and files its report. The reinstatement will then relate back and take effect as of the date of the dissolution. If the LLC waits too long, typically three or five years, it can no longer be reinstated.

Administrative dissolution is common. It often happens by inadvertence, and when an LLC’s management learns of the problem it will usually act quickly to reinstate the LLC if there is still time to do so. In those cases the unplanned dissolution results in no change to the LLC’s operations, since management is at first unaware of the problem and then fixes it as soon as possible.

This common scenario played out in a recent Kentucky case. A Kentucky LLC was administratively dissolved and later entered into a real estate lease. The LLC subsequently defaulted on its lease, and the landlord sued both the LLC and its single member. Shortly after the lawsuit was filed, the LLC applied for and was granted reinstatement by the Kentucky Secretary of State.

The landlord’s theory was that the single member was liable either because the dissolution stripped her of her statutory immunity as a member, or because she was an agent and lacked authority to act for the LLC. The trial court and the Court of Appeals found that the LLC’s member was not personally liable on the LLC’s lease, and the Supreme Court affirmed in a lengthy and detailed opinion. Pannell v. Shannon, 425 S.W.3d 58 (Ky. March 20, 2014).

Member Liability. The Kentucky LLC Act provides that an LLC’s member or manager is not personally liable for the LLC’s obligations merely by reason of being a member or manager. Ky. Rev. Stat. Ann. § 275.150(1). (All state LLC statutes have a similar provision.) The landlord, however, pointed out that Section 275.300(2) requires a dissolved LLC to not carry on any business except that appropriate to wind up and liquidate its business and affairs, and argued that an LLC member that violates that prohibition loses its limited liability protection even if the LLC is later reinstated.

When an LLC is reinstated after administrative dissolution, “the reinstatement shall relate back to and take effect as of the effective date of the administrative dissolution, and the limited liability company shall resume carrying on business as if the administrative dissolution had never occurred.” Ky. Rev. Stat. Ann. § 275.295(3)(c) (repealed in 2011, but in force when the events in this case occurred). Reinstatement literally undoes the dissolution. Pannell, 425 S.W.3d at 68.

The landlord argued that the word “resume” in the statute implies that the LLC had to have ceased doing business while administratively dissolved. The court acknowledged that “resume” appears to create some ambiguity, but read “resume” in context as a reference to the retroactive nature of reinstatement. The court also supported its interpretation with an analysis of subsequent statutory revisions which clarified that an LLC’s dissolution does not take away the limited liability protection of an LLC member or agent, using the in pari materia canon of construction. Id. at 70-72. (In pari materiarefers to the principle of statutory construction that if a subsequent statute on the same subject clarifies language in a prior statute, the court may be guided by the legislative clarification.)

The court found that it would be illogical to enforce the winding-up-only limits on a dissolved LLC if the LLC was not intended to be wound up, as would be the case with an administratively dissolved LLC whose owners and management were unaware that it had been dissolved. And if the LLC were strictly barred from taking any non-winding-up activities, it would be prevented from filing the paperwork to end the administrative dissolution, a classic catch-22. Id. at 74.

The court also emphasized the LLC Act’s strong preference for limited personal liability, positing that an LLC’s liability shield for members should not be lost through an LLC’s failure to pay a $15 annual fee or submit an annual report. The court found this conclusion to be consistent with the general rule in most jurisdictions that LLC members are not personally liable for actions taken during a period of dissolution followed by reinstatement. Id. at 76.

Agent Liability. The court saw this as a two-part issue: did Ann Shannon, the LLC’s only member and its only manager, have personal liability (1) by reason of merely being an agent of the dissolved LLC, or (2) because she acted as an agent without authority?

After distinguishing several cases from other jurisdictions, the court concluded that “[t]he retroactivity of the reinstatement statute, when read with the provision making the company exist even after dissolution and the statutes creating immunity for agents, makes an agent immune if personal liability is alleged solely because the agent is an agent.” Id. at 80.

The landlord contended that Shannon lacked the authority to act on behalf of the LLC because it did not exist when she executed the lease on behalf of the LLC. But the LLC Act is clear: “A dissolved limited liability company shall continue its existence…” Ky. Rev. Stat. Ann. § 275.300(2). The landlord contended that the statute’s limit on acts other than winding-up activities limited Shannon’s authority, but the court again pointed out that if that were true, the LLC would not be able to seek reinstatement, because an LLC can only act through an agent. Pannell, 425 S.W.3d at 83.

The landlord also took the position that because the LLC was reinstated only after he filed suit, the court’s reading of the statute would have an inequitable result. The court, however, saw reinstatement as being only between the LLC and the state. “[The landlord] cannot be allowed to take advantage of the LLC’s failure to file its report and pay what amounts to a tax to bypass the LLC and hold its owners or agents liable, at least not once the failures have been remedied.” Id. at 84.

The Supreme Court accordingly affirmed the dismissal of the landlord’s claim against the LLC’s sole member.

Comment. You can’t help smiling when you read some opinions, from the sheer pleasure of reading a careful, scholarly, and well-written opinion. This is one. The Shannon opinion not only reaches the right result, but does so by carefully disposing of the several legal theories raised by the landlord. The court’s analysis recognizes

  • the primacy of limiting the liability of LLC members and managers,
  • that a dissolved LLC continues to exist,
  • that the statutory requirement for winding up a dissolved LLC does not apply to an unintentional dissolution such as an administrative dissolution, and
  • that dissolution is not a creditor’s-rights issue but is between the LLC and the state (in the case of an administrative dissolution) or between the LLC and the members (in the case of an intentional dissolution).

And a tip of the hat to Thomas E. Rutledge, a Kentucky lawyer and the current chair of the Committee on LLCs, Partnerships and Unincorporated Entities of the Business Law Section of the American Bar Association. Tom has written extensively on LLC law, and his writings are cited several times in the Shannon opinion.

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