June 28, 2012

Environmental Liability May Survive Corporate Dissolution

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For various reasons, the life of most business entities ultimately comes to an end. It may be for any reason from a successor’s purchase of assets to shutting down a family business because it is just time to retire. Many businesses owned or operated real estate during their functioning years – possibly a construction yard, a manufacturing facility, a warehouse or an office building.

When the time comes to end a corporation’s existence, the recommended approach is to follow the statutory procedure for formally dissolving the corporation. This involves a notice to creditors, a published notice, and a two year waiting period. It also involves some cost, though it is not dreadfully expensive.

Sometimes, however, there is a temptation to shortcut this procedure either to save the cost or to avoid calling public attention to the end of a corporation’s existence. If a corporation simply fails to file its biennial entity reports with the Indiana Secretary of State for two filing cycles, the Secretary of State will administratively dissolve the entity. In many respects, the effect is similar to a voluntary dissolution. In at least one important respect, though, it is very different.

There are some liabilities that entities face that may not surface for many years. Environmental liability can be one of these. If a business entity owned or operated property that was contaminated (whether or not by its own hand), years later that corporation could be tagged as a potentially responsible party who may be liable for an environmental clean-up. If this happens, and if the corporation has gone through the formal dissolution process following the statute, there is a very good chance that the corporation will be deemed free of any such liability. This formal dissolution protection exists even though significant distributions may have been made to the shareholders on dissolution of the company. Assuming that shareholders are not otherwise personally liable under the environmental laws (as could be the case to the extent that the shareholders were themselves involved in the contamination of the property even if acting solely in the capacity of corporate officers or agents), they will likely be entitled to keep those distributions, free of any claims for environmental responsibility.

On the other hand, the former shareholders of the entity that was just allowed to be administratively dissolved will not likely be so lucky. Case law and our practice experience, particularly with environmental cost recovery for cleanup sites, suggests that administrative dissolution, unlike statutory dissolution, does not bar creditors from pursuing the corporation much as though it still existed. These creditors could track funds distributed by the corporation to its shareholders upon that dissolution. Even if no funds were distributed, insurers of the entity will likely be sued, dragging in the former shareholders and employees for environmental cost recovery litigation. This litigation might have been barred had a regular statutory dissolution been undertaken.

There will be times when administrative dissolution works as effectively as statutory dissolution at the end of a corporation’s life. Careful analysis should be made, though, as to whether that corporation during its operating years was engaged in any conduct which may expose it to slow-developing liability. If an entity ever owned or operated real estate where there is any chance of contamination, a long-tail environmental cleanup claim is a real possibility. In that case, shortcutting the dissolution process could prove to have been very cost ineffective.