Friday, November 18, 2011

Martin v. Pack’s Inc.

Martin v. Pack’s Inc.:  The Court of Appeals
Adds Uncertainty and Risk to Dissolution

      Martin v. Pack’s Inc. involved a claim for construction services rendered by Pack’s prior to the administrative dissolution of Southeastern Construction, Inc.  After the administrative dissolution of Southeastern, Ed Martin, on the corporation’s behalf, entered into two agreements with Pack’s, Southeastern’s creditor, for resolution of that debt.  Southeastern failed to perform.  Pack’s then sought to enforce the debt against not only Southeastern but also Ed Martin and Jeff Collinsworth, Southeastern’s shareholders.  Granting summary judgment to Pack’s, the trial court held, and the Court of Appeals affirmed, that each of Martin and Collinsworth are personally liable on the debt.  Martin v. Pack’s Inc., 2011 WL 3207947 (Ky. App. 2011) (To Be Published). 
     IMHO, the grounds for that determination were erroneous.
The (Flawed) Understanding of the Effect of Dissolution on Shareholder Limited Liability
                One basis upon which the Court of Appeals affirmed holding Martin liable on the obligation to Pack’s was that the agreement for the resolution of the corporation’s debt was entered into after the corporation’s administrative dissolution, the court reasoning that after dissolution there was neither a corporation nor the consequent limited liability.  Id. at *5. “To reiterate, Martin cannot be shielded from personal liability by virtue of the statute, (sic) because his corporation was dissolved at the time of his actions.”  The Court said, in effect, that dissolution abrogates the rule of limited liability.
It appears there was not identified to the Court, and that its own research did not unearth, the 2007 amendment to the Business Corporation Act enacted in response to and legislatively overruling the Forleo decision (2006 WL 2788429 (Ky. App. 2006)).  That amendment expressly provides that a corporation’s dissolution does not “abate or suspend” the shareholder’s limited liability.  See Ky. Rev. Stat. Ann. § 271B.14-050(2)(i); see also Thomas E. Rutledge, The 2007 Amendments to the Kentucky Business Entity Statutes, 97 Ky. L.J. 229, 243 (2008-09). 
To the extent that the Court of Appeal’s affirmation of the trial court’s ruling was based upon the notion that, subsequent to dissolution, shareholders do not enjoy limited liability, that ruling was directly contrary to the controlling statute.
A (Flawed) Understanding of the Effect of Dissolution on Corporate Status
The second substantive failure of the decision is its assumption that upon dissolution a corporation ceases to exist.  Simply put, that is not the law.
        In a prior age it was the rule that upon dissolution a corporation simply ceased to exist – its property became vested in the shareholders, its debts were extinguished and suits by or against it were terminated.  See, e.g., 16A William Meade Fletcher, Fletcher Cyclopedia of the Law of Private Corporations § 8113; II Stewart Kyd, A Treatise on The Law of Corporations 516 (1794) (“The effect of the dissolution of a corporation is, that all its lands revert to the donor; its privileges and franchises are extinguished; and the members can neither recover debts which were due to the corporation, nor be charged with debts contracted by it, in their natural capacities.”)  Those rules have been long repealed.  See, e.g., Greene v. Stevenson, 175 S.W.2d 519, 523-24 (Ky. 1943).  Under the formula currently employed, a corporation, after dissolution, continues to exist as a corporation.  See, e.g., Ky. Rev. Stat. Ann. § 271B.14-050(1) (“A dissolved corporation shall continue its corporate existence….”).  A dissolved corporation is restricted to activities “appropriate to wind up and liquidate its business and affairs.”  Ky. Rev. Stat. Ann. § 271B.14-050(1). 
     At one time a corporation’s dissolution caused it to cease to exist.  Under the modern system as enacted by the General Assembly, a dissolved corporation continues to exist as a corporation.  See KRS § 271B.14-050(1); id. § 14A.7-020(3).  Ergo, any conclusion based upon the premise “a dissolved corporation no longer exists as a corporation” must fail as the premise is false.
The (Flawed) Understanding of the Winding Up Process
            Dissolution effects a limitation upon the proper activities of the dissolved organization, restricting it to those that are appropriate for its winding up and termination.  See, e.g., Ky. Rev. Stat. Ann. § 271B.14-050(1) (“A dissolved corporation … may not carry on any business except that appropriate to wind up and liquidate its business and affairs….”).  Whether any particular activity is appropriate for the winding up and termination of a particulate venture is a fact dependent issue.  For example, in the winding up and termination of a retail store, it is difficult to contemplate a situation in which the acquisition of additional inventory would be appropriate.  Conversely, in the winding up and termination of a landscaping business, the purchase of additional materials with which to complete a job that is under contract and partially completed likely would be appropriate.  The open and fact dependent nature of this assessment is implicit in the statute’s use of “including” in the description of activities that are appropriate after dissolution.  Id.
      The Martin court makes much of the fact that the agreement with Pack’s was created subsequent to the dissolution.  2011 WL 3207947 at *2-3.  Even accepting that characterization as true, it is not determinative of the outcome.  Rather, nothing in the law of dissolution precludes a dissolved corporation from entering into entirely new obligations.
      In the resolution of claims with creditors, whether they are known or unknown, there will often need to be a new agreement entered into pursuant to which the amount and manner of resolution are agreed upon.  While some of these agreements may constitute only a modification of existing agreements, a claim arising, for example, in quasi-contract will not.  Were the rule espoused in Martin v. Pack’s, Inc. to be correct, then the post-dissolution sale of assets sanctioned in Greene v. Stevenson would have exposed whoever signed the sale agreement to personal liability thereon.  Assume a creditor initiates an action against a dissolved corporation.  Is the corporation precluded from entering into an engagement with an attorney for the purpose of making a defense or even asserting a counter-claim?  That engagement letter with the attorney will be a new post-dissolution obligation.
      Curiously, neither the Court of Appeals nor the trial court explained how the post-dissolution agreement between Southeastern and Pack’s did not fall within KRS § 271B.14-050(i)(c) and its express authorization for a dissolved corporation to “mak[e] provision for discharging its obligations.” 
      The suggestion that a corporation, after dissolution, cannot in its own name and on its behalf enter into agreements in settlement of its debts and obligations is without analytic support and is contrary to the statute. 
A (Flawed) Understanding of the Effort of Dissolution Upon Agency
       A corporation “is an artificial being, invisible, intangible, and existing only in contemplation of law.”,  Trustees of Dartmouth Coll. v. Woodward, 17 U.S. (4 Wheat.) 518, 636 (1819), able to act only through those natural persons who are its agents.  Restatement (Third) of Agency § 3.04, comment d.  As noted above, a corporation continues to exist after dissolution for the purpose of its winding up and liquidation.  During the dissolution process the corporation must act through agents.  Presuming appropriate identification of the principal and that the action is within the agent’s authority, the agent is not a party to and is not personally liable on the agreement at issue.  Restatement (Third) of Agency § 6.01.
        There is currently pending before the Supreme Court a petition for discretionary review.

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