This week I learned about a now defunct Arizona LLC that was terminated by the Arizona Corporation Commission (the “ACC”) without the prior knowledge or consent of the sole member and manager of the LLC. The Articles of Organization filed with the ACC to create the LLC named Homer Simpson (not the member’s real name) as the member and manager of the manager managed LLC called World Wide Widgets, LLC (not real LLC’s name).
Sometime in 2015 somebody filed Articles of Termination to terminate World Wide Widgets, LLC. The document was not signed by Homer Simpson. It was signed by Bob Faker (not the real name of the signer) who signed as the manager of the LLC. The ACC approved the filing and terminated World Wide Widgets despite the fact Bob Faker was not listed on the records of the ACC as a member or a manager of the LLC.
I notified the ACC about the fraudulent termination of the LLC and this is its response:
“We accept filings at face value, and do not request any verification of authority to act. As you know, we are just a filing agency, not an enforcement agency. We do not investigate or have any authority to enforce any laws with respect to allegations of fraud. We are unable to assist with reinstating this entity. If you were to get a court order requiring reinstatement, we would follow that order”
The fraudulent termination of an LLC could have extremely negative consequences for the members of the terminated LLC. Here are just a few problems that the termination causes:
- The termination would cause the IRS to take the position that the termination caused all of the assets of the terminated LLC to be distributed to the members in the year of the termination. If the value of the distributed assets exceeds the member’s tax basis in the LLC the member has taxable income equal to the value of the distributed assets minus the tax basis. For example, if the LLC’s only asset is a parcel of real property valued at $200,000 and the sole member of the LLC has a tax basis of $100,000, the member has taxable income of $100,000 in the year of the fraudulent termination.
- If the LLC owns assets that have a title, there is no document that evidences a transfer of ownership from the LLC to the member. In the example above, the member would be the beneficial owner of the real estate, but there is no deed signed by the terminated LLC that transfers the title to the land to the member. Because the LLC was terminated, it is not possible for it to sign a deed that transfers title. The member will be forced to file a quiet title lawsuit to get the title changed from the LLC to the member.
- If the terminated LLC has intellectual property such as patents or trademarks those assets will be in limbo.
- The financial history of the terminated LLC will be lost. The member can form a new LLC with the same name, but could not say that the new LLC has been in business since 1995.
I am sure there are many additional problems a fraudulent termination can cause.
Consequence of Filing a False Document with the ACC
Arizona LLC law provides that it is a felony to file a false document with the ACC. Arizona Revised Statutes Section 29-613.A states:
“A person who . . . signs any articles, statement, report, application or other document filed with the [Arizona Corporation] commission that is known to the person as false in any material respect is guilty of a class 4 felony.”
Solution to the Problem
The issue becomes what, if anything, can the members of the terminated LLC do to correct the problem. The answer alluded to by the ACC’s response above is for the members of the LLC to file a lawsuit and ask the superior court to issue an order to the ACC that the ACC reinstate the existence of the terminated LLC and correct its records to reflect that the fraudulent termination of the LLC never occurred.
This sad story reinforces something I have been telling my LLC clients for years: YOU MUST CHECK THE ACC’S WEBSITE AT LEAST ONCE EVERY THREE MONTHS TO CONFIRM THAT ALL THE INFORMATION ABOUT YOUR LLC IS CORRECT. If you find that your LLC was fraudulently terminated then you can file your lawsuit to correct the problem sooner rather than later.
If your LLC was fraudulently terminated, call me at 480-664-7478 or send me an email message at [email protected]
Go the the ACC’s ecorp website to search for your LLC and confirm it exists and all information is correct.