Hello, my name is Justin Sterling. I am an Attorney and the Founder of The Sterling Firm.

We are discussing how to dissolve a corporation.

Many times business owners want to stop doing business together. This is what is typically

called the "business divorce." When you decide you want to close your business, you will

need to do what is called "dissolving" and "winding up" your company. Dissolution is

the process of officially ending the existence of the state-registered business entity, which

will put it beyond the reach of creditors and claimants. A corporation can be dissolved

either voluntarily or involuntarily. The dissolution process is governed by state law. This publication

focuses on California law.

I. VOLUNTARY DISSOLUTION

Voluntary proceedings for winding up the corporation can be commenced upon the adoption of a resolution

by the shareholders or the directors of the corporation or by written consent of the shareholders.

In California, it is not specifically required that the board of directors take action before

the shareholders vote. However, it is common that the board of directors will submit a

proposal to the shareholders to dissolve the corporation and will then call a shareholders

meeting to vote. The corporation's Articles of Incorporation or Bylaws may designate the

specific procedure for dissolution. Upon voluntary dissolution, the board will still act with

the full powers to wind up and settle the affairs of the corporation. The "winding up"

process allows the corporation to exist in order to take care of the final matters, which

include: (1) paying all known corporation debts and liabilities; and then (2) distributing

the remaining assets.

A. AUTHORITY TO VOLUNTARILY DISSOLVE CORPORATION

The shareholders holding at least 50% or more of the voting power must vote to voluntarily

wind up and dissolve the corporation. The shareholder representing the requisite voting

power can protect his investment by dissolving the corporation, so long as all alternative

methods were exhausted, no unfair advantage is secured over the other shareholders, and

no rights of third parties will be adversely affected. However, the right to dissolve the

corporation is not absolute. Equity will not allow for dissolution to proceed in furtherance

of defrauding the other shareholders, freeze out the minority shareholders, or to sell

the corporate assets at an inadequate price. Moreover, shareholders who oppose the dissolution

can force the 50% shareholder to sell his shares to the opposing shareholders. Also,

particularly concerning corporations that are closely-held (that is, corporations that

have less than 35 shareholders), shareholder approval consisting of 90% of the voting power

must be given as to the terms of the sale of corporate assets in exchange for cash after

dissolution proceedings have commenced when the buyer controls or is controlled by the

seller.

In addition, in situations when the requiring shareholder approval of dissolution would

serve no purpose, the board of directors is permitted to solely elect to dissolve. Such

situations include: (1) when the corporation has been adjudged bankrupt; (2) when the corporation

has disposed all of its assets and has not conducted business for five years; and (3)

when the corporation has issued no shares.

B. PROCEDURE TO VOLUNTARILY DISSOLVE CORPORATION

In California, the voluntary dissolution of a corporation is initiated pursuant to California

Corporations Code section 1900. A Certificate of Election to Wind Up and Dissolve must be

filed with the Secretary of State. However, if a Certificate of Election is not filed,

a corporation can be considered to be de facto wound up and dissolved.

C. POWERS OF DIRECTORS AND OFFICERS DURING VOLUNTARY DISSOLUTION PROCESS

Pursuant to California Corporations Code section 2001, the board of directors and officers,

or other persons appointed by the Court when it has assumed jurisdiction over the dissolution

process, have specific power and authority to perform acts for the corporation after

the dissolution process has commenced. Such acts include: (1) electing officers and employing

agents and attorneys to liquidate or wind up the corporation's affairs; (2) performing

contracts and settling debts and claims; (3) pursuing lawsuits in order to collect money

or property owed to the corporation; and (4) selling or disposing of the assets of the

corporation.

D. PETITION FOR COURT SUPERVISION OF VOLUNTARY DISSOLUTION

In order to protect the interests of any parties, the Court may take jurisdiction over the winding

up upon petition of: (1) the corporation; (2) shareholder(s) holding at least 5% of

the outstanding shares; (3) any shareholder of a close corporation; or (4) three or more

creditors. To note, a close corporation consists of less than 35 shareholders. It is up to

the discretion of the Court whether it will accept jurisdiction over the winding up process,

and therefore the petitioner must allege the specific facts and actual controversy which

warrants the Court's supervision. Shareholders are not considered parties to the proceeding

unless they are named as defendants from which the petition seeks relief or the shareholders

intervene in the proceeding in order to protect their own interest.

E. CERTIFICATE OF DISSOLUTION

Once the corporation is completely wound up without Court proceedings, a majority of the

board of directors must sign and verify a Certificate of Dissolution to be filed with

the Secretary of State. This is also referred to as the "Articles of Dissolution." Within

the Certificate of Dissolution an affirmation is made that the final franchise tax return

has been or will be filed for the corporation - this is considered to be "tax clearance."

Once the Certificate of Dissolution is filed, the corporation's legal powers, rights, and

privileges cease to exist. Moreover, the business name will be available for others to use after

the corporation has been dissolved.

F. PETITION FOR ORDER DECLARING CORPORATION WOUND UP AND DISSOLVED

The board of directors may also file a petition in the name of the corporation with the Court

for an order declaring the corporation to be completely wound up and dissolved. The

Court will also require that notice of its order be served on all creditors, claimants,

and shareholders so that they can show cause as to why an order should not be made declaring

the corporation wound up and dissolved.

II. INVOLUNTARY DISSOLUTION

A verified complaint for involuntary dissolution of the corporation may be filed with the Court

by: (1) one half or more of the board of directors; (2) shareholder(s) of not less than 33% of

the outstanding shares; (3) shareholder of a close corporation; (4) any shareholder if

the grounds for dissolution is the termination of the period of the corporation's existence;

or (5) any party expressly authorized in the Articles of Incorporation.

The proper grounds for an involuntary dissolution include: (1) the corporation has abandoned

its business for more than a year; (2) the corporation is deadlock in that it has an

even number of directors who are equally divided and therefore cannot adequately manage the

corporation; (3) the corporation is deadlocked in that there are two or more dissenting factions

of shareholders and therefore the corporation's business cannot be conducted; (4) those in

control of the corporation have committed fraud, mismanagement, or abuse of authority

and therefore the corporation's property is being wasted by its directors or officers;

(5) liquidation of a close corporation is necessary to protect the interests of the

shareholders; or (6) the period of the corporation's existence has terminated.

A. INTERVENTION BY SHAREHOLDERS AND CREDITORS IN INVOLUNTARY DISSOLUTION ACTION

The term "intervention" refers to the procedure by which a third person, not the original

party to the lawsuit, can claim an interest in the subject matter and become involved

in the lawsuit in order to protect his right or interpose his claim. At any time prior

to the trial of an action for involuntary dissolution, a shareholder or creditor may

intervene. If a default judgment is obtained against the corporation in an action for involuntary

dissolution, shareholders or creditors are not prohibited from intervening in order to

assert their claims - the only effect of a default judgment is an acknowledgment that

grounds exist to wind up and dissolve the corporation.

B. COURT APPOINTMENT OF PROVISIONAL DIRECTORS AND RECEIVER IN INVOLUNTARY DISSOLUTION ACTION

If the grounds for involuntary dissolution is due to a deadlock amongst the board of

directors, the Court may appoint a provisional director to break the deadlock pursuant to

California Corporations Code section 1800(b)(2). In doing so, the Court will attempt to avoid

the dissolution of the corporation by breaking the deadlock.

In addition, if the Court believes that the interests of the corporation and its shareholders

will suffer during the course of the dissolution process, the Court may order the appointment

of a receiver to manage the business affairs and preserve the property of the corporation

pending the dissolution action.

C. DUTIES OF DIRECTORS DURING INVOLUNTARY DISSOLUTION ACTION

Once an involuntary dissolution action has commenced, the board of directors must wind

up the corporation affairs. The Court will supervise the winding up process and the Court

may impose restrictions on the directors. The Court does not serve as a rubberstamp

to the directors, and in fact the Court can revoke any actions taken by the directors.

Moreover, the Court has the discretion to appoint a receiver.

D. POWER OF THE COURT

During the involuntary dissolution process, the Court has the general authority to make

orders, decrees, and issue injunctions. In addition, the Court has the power to do the

following: (1) require proof and make determinations concerning all claims against the corporation,

including those claims that are contingent and unliquidated; (2) make determinations

concerning the classification and rights of shareholders to the corporation's assets;

(3) oversee the accounting of the directors concerning the winding up process; and (4)

remove and replace any director due to dishonesty, misconduct, negligence, or abuse of trust

concerning the winding up process.

A certified copy of the Court's decision must be filed with the Secretary of State once

the corporation is completely dissolved by Court order, decree, or judgment.

III. CESSATION OF BUSINESS

Pursuant to California Corporations Code section 1805(c), once the dissolution process has

commenced, the corporation must cease carrying on its business except to the extent necessary

to wind up. During the winding up process, the corporation must close out the business

bank account and cancel the business credit cards. However, it is advisable to wait a

few weeks or months to close out the business checking account because it is likely that

bills and unknown debts will need to be paid. An additional exception to the requirement

to cease business exists during the time necessary for the corporation to preserve its goodwill

and going-concern value pending the sale of its business assets.

Upon cessation of business, the corporation will no longer need the business ID number

and it can therefore be cancelled. The corporation's federal employer identification number can

be deactivated by writing to the IRS. The EIN Assignment Notice should be included with

the letter to the IRS. The state tax agency should be contacted in order to close the

corporation's state tax account. It is recommended that all tax documents be maintained for at

least seven years after cessation of business.

IV. NOTICE OF DISSOLUTION

In addition, written notice of the dissolution action must be given by the directors to all

known creditors and shareholders. Creditors generally include but are not limited to suppliers,

lenders, service providers, and utilities. Providing adequate notice limits the time

for which the creditor can bring a claim against the corporation. Moreover, in some jurisdictions,

notice to creditors must also be published at least once a week for three consecutive

weeks in a local newspaper within the county of the Court's jurisdiction. If creditors

and claimants do not present claims and proof within the Court's designated time period,

the claims may be barred and denied any distribution of the corporation's assets.

V. STATUTORY BUY-OUT PURCHASE OF SHARES TO AVOID DISSOLUTION

California Corporations Code section 2000(a) creates a statutory buy-out right. The corporation,

or the shareholders of 50% or more of the voting power, may avoid the dissolution and

the Court's appointment of a receiver by purchasing for cash the shares owned by the shareholders

initiating the dissolution process. The purchase of the shares must be for the fair market

value, which is determined by the current liquidation value. On application to the Court,

the winding up and dissolution process may be stayed in order to ascertain the fair market

value. The Court will appoint three disinterested appraisers to appraise the fair market value

of the shares.

VI. PAY TAXES BEFORE DEBTS

The corporation's first obligation is to discharge liabilities such as paying business taxes

and all known creditors. It is highly advisable that the business owners retain the services

of an accountant or a tax specialist.

A. FEDERAL TAXES ARE PRIORITY

First priority should be given to federal taxes withheld from employees' paychecks,

such as income tax withholding, social security, and Medicare taxes. If the business had employees,

the final payroll tax and employment taxes must be filed timely. Both the state and federal

tax authorities must be informed that the corporation is dissolving. The federal unemployment

tax return (IRS Form 940 or 940EZ) and the employer's federal tax return (IRS Form 941)

must indicate that there will not be future tax returns filed. Also, the state withholding

and wage reporting return must also indicate that there will not be future returns filed.

The final wage and withholding information must be issued to employees on Form W-2 entitled

Wage and Tax Statement by January 31 of the year after the business closes. The information

must then be reported to the IRS using Form W-3 entitled Transmittal of Income and Tax

Statements. If payroll taxes are not paid, the Internal Revenue Service can hold the

shareholders personally liable and satisfy the obligation from their personal assets.

B. OFFER IN COMPROMISE OR INSTALLMENTS

If the corporation cannot pay its tax obligations to the Internal Revenue Service, the corporation

may be able to pay less than what is owed by making an offer in compromise or negotiating

to pay installments to the IRS. IRS Form 656 entitled Offer in Compromise should be filed

with the IRS. IRS Form 433A entitled Collection Information Statement should be filed to obtain

an installment payment plan.

C. INCOME TAX

In addition, state and federal income taxes must be filed. The corporation must file a

final income tax return with the IRS and the state indicating that this is the final return

to be filed. IRS Form 1120 entitled U.S. Corporation Income Tax Return should be filed indicating