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LLCs, Though Legally Canceled, Still Face Construction Defect Suits – but Cannot Sue Subs
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June 9, 2008
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ConstructionWebLinks.com
Three cases decided by the Washington Court of Appeals offer a cautionary tale to limited liability companies (LLCs) and their members as they seek to manage the risks of construction defect litigation.
Each case concerned the rights and liabilities of LLCs and their members after cancellation of the LLC's existence, either by the LLC or by the Washington Secretary of State. Each LLC had developed a condominium project. The LLCs argued unsuccessfully that their cancellation protected them from construction defect suits brought by condominium homeowner associations.
The Washington court observed that LLCs still are a relatively new type of business entity. The majority of states enacted LLC legislation in the 1990s. Washington's Limited Liability Company Act was enacted in 1994, and the case law interpreting it has been sparse. The law governing such entities still is evolving, the court noted.
Under Washington law, if an LLC fails to complete required filings or pay annual fees, the Secretary of State sends notice that an administrative dissolution is pending. The LLC then has 60 days to correct the basis for the notice. If it fails to do so, the LLC is dissolved. Then, if the LLC does not file for reinstatement within two years, the Secretary must cancel the LLC's certificate of formation. The LLC no longer is a legal entity once it is canceled. In the period from dissolution and up to cancellation, the LLC may wind up or liquidate its business. LLCs also may voluntarily dissolve and then cancel their existence.
The lead case of three decided concerned a 2006 amendment to Washington's Limited Liability Company Act. The amendment provided that suits could be brought against an LLC for three years after its dissolution. The court found that the amendment was intended to remove any incentive for LLCs to dissolve immediately after a project to avoid liability for claims and to encourage them to act in good faith in regards to potential claims.
The court held that the amendment applied retroactively and applied even though the LLC's existence had been canceled. Chadwick Farms Owners Association v. FHC, LLC, 139 Wash.App. 300, 160 P.3d 1061 (2007). As a result, the LLC was subject to liability even though its certificate of formation had been canceled before the amendment was enacted.
The court also held that the amendment did not allow the canceled LLC to bring claims against its subcontractors on the project. As a result, the LLC remained subject to the lawsuit, but its own claims against its subcontractors were barred. The court explained that this result was justified because the LLC had the opportunity to reinstate itself after being sued, which would have allowed the LLC to sue its subcontractors, but the LLC failed to seek reinstatement.
The court held that the plaintiff homeowners' association should be allowed to amend its complaint to assert claims against the LLC's individual managers and members.
The second decision involved an LLC that dissolved itself and filed a certificate of cancellation before it was sued by a homeowners association. Nevertheless, the court held that the LLC was subject to suit for three years as provided in the 2006 amendment. Emily Lane Homeowners Association v. Colonial Development, LLC, 139 Wash.App. 315, 160 P.3d 1073 (2007). The court found no reason to treat that LLC differently from one that was administratively dissolved and canceled.
The court also held that individual members of canceled LLCs can be held personally liable for claims against an LLC if the members failed to properly wind up the LLC. The court noted that Washington's Limited Liability Company Act expressly created a statutory vehicle to pierce the veil of LLCs.
In the third case, the LLC had been administratively dissolved when it was sued by the homeowners association, but the LLC had not yet been administratively canceled. In response to the suit, the LLC sued its construction manager and subcontractors. But, it did not seek reinstatement in order to avoid cancellation of its existence. Instead, the LLC and its construction manager settled with the homeowners association after the LLC had been administratively canceled.
The court again held that a dissolved and canceled LLC no longer was a legal entity and, therefore, had no right to continue its suit against its subcontractors. The court rejected the LLC's argument that its lawsuit against the subcontractors could continue because it was part of winding up the LLC's affairs. Maple Court Seattle Condominium Association v. Roosevelt, LLC, 139 Wash.App. 257, 160 P.3d 1068 (2007).
In addition, the court held that the construction manager for the LLC, which had joined the LLC in settling with the homeowners association, had no right to sue the subcontractors to recover sums the CM had paid in the settlement. The court found that after the LLC was canceled, its lawsuit against the CM also was barred. Moreover, the homeowners association did not sue the CM. Consequently, the only action against the CM was by the LLC, and once the LLC was canceled, it could not maintain that action. Therefore, the court held, the CM's settlement with the homeowners association was gratuitous. Because the CM had no duty to pay the LLC, the subs had no duty to pay the CM, and the CM had no legal basis to seek payment from the subs, the court held. Consequently, the CM's suit against the subs was dismissed.
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