Administrative Dissolution May Breach a Company’s Third-Party Contracts

Administrative Dissolution May Breach a Company’s Third-Party Contracts

By: Pamela E. Szelung

Under Illinois law, corporations and limited liability companies (“LLCs”) are required to file annual registrations with the Illinois Secretary of State and pay any applicable annual taxes and fees in order to maintain their entities in good standing.  Pursuant to Section 35-25 of the Limited Liability Company Act (the “LLC Act”), the Secretary of State may administratively dissolve an LLC if it fails to timely file its annual registration and pay all required fees.  This requirement for LLCs mirrors the requirement imposed upon corporations in Section 12.35 of the Business Corporation Act of 1983 (the “Corporation Act”).

If a company is administratively dissolved under either the LLC Act or the Corporation Act, the company will be reinstated upon the filing of the outstanding annual report(s) and an application for reinstatement, along with payment of all outstanding taxes and fees.  Upon reinstatement after administrative dissolution, the company may proceed with business as usual and the actions made by the company during the period of administrative dissolution are “ratified and confirmed.”  Section 35-40(d) of the LLC Act provides for the following “relation-back” provision: “upon the filing of the application for reinstatement, the [LLC] existence shall be deemed to have continued without interruption from the date of the issuance of the notice of dissolution, and the limited liability company shall stand revived with the powers, duties, and obligations as if it had not been dissolved.”

Recently, Section 35-40(d) of the LLC Act was examined by the Illinois Appeals Court in CF SBC Pledgor 1 2012-1 Trust v. Clark/School LLC, 2016 IL App (4th) 150568 (Sep. 8, 2016).  In CF SBC Pledgor 1 2012-1 Trust, the Plaintiff, a Delaware mortgage trust, assumed a mortgage and security interest in an eight-building apartment complex located in Danville, Illinois which was owned by the defendant, Clark/School LLC.  Under the security agreement, the loan was made on the lender’s reliance of the Defendant mortgagor’s “continued existence”, including “all things necessary to preserve and maintain [its] existence and to ensure its continuous right to carry on its business.”  Violation of this requirement was an immediate event of default under the security agreement with the lender’s remedy being acceleration of all outstanding amounts and foreclosure of the property.  The Defendant, an Illinois LLC, failed to timely file its annual registration with the Illinois Secretary of State, ultimately leading to its administrative dissolution in December 2013.

Because the Defendant was administratively dissolved by the Secretary of State, the Plaintiff initiated a mortgage foreclosure action against the Defendant for breach of the mortgage security agreement.  The Plaintiff alleged that the Defendant’s administrative dissolution was a default under the security agreement since the Defendant was obligated to “preserve and maintain its existence” as an LLC.  “Section 4.14 of [the mortgage security agreement] noted the mortgage loan was being made in reliance on defendant’s continued existence as a limited liability company (LLC).” The lower court determined that the Defendant committed an event of default by failing to maintain its status in good standing and held for the Plaintiff.  The Defendant appealed the trial court’s holding, arguing that the relation-back provision of the LLC Act prevented the Defendant from liability under the security agreement because Section 35-40(d) validated any actions that were taken from the date of the Defendant’s dissolution through the date of its reinstatement by the Secretary of State.

The predicament in CF SBC Pledgor 1 2012-1 Trust was a novel issue under established Illinois LLC law; thus, the Illinois Appeals Court looked to precedent under the Corporation Act.  Prior courts had determined where a third party relied on a corporation’s representation to maintain its corporate existence, a breach of such representation would be an event of default.  The relation-back provision only pertained to ratification of the corporation’s actions; however, it did not automatically protect the corporation from possible breaches under third-party contracts.  Looking to the Corporation Act, the Court found that the relation-back provision will not “impose a legal fiction that belies actual real world facts.” The Illinois Appeals Court determined that the Defendant’s failure to maintain its status as an LLC in good standing was an immediate event of default under the mortgage security agreement, regardless of the relation-back provision in the LLC Act.

In that regard, the Appeals Court upheld the lower court’s notion that a company, either an LLC or a corporation, cannot use the relation-back provision of its respective governing law in order to escape liability for committing a breach in a contractual agreement whereby the contracting party is relying upon the company to maintain its “continued existence” as a legal entity in good standing with the Secretary of State.

A company should pay prudent attention to its required filings and its obligations under its third-party contracts so as not to inadvertently breach such contracts.  Otherwise, as was the case in CF SBC Pledgor 1 2012-1 Trust, the consequences may be harsh.

For more information on this topic or how you can protect your corporation or limited liability company from making the same error in judgment, please contact:

Pamela Szelung at:

pszelung@lgattorneys.com or (313) 368-0100.

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