Close an LLC and Start a New One in Michigan?

When a small business fails, the owner often wants two things at once: to close the old company cleanly and to start over. Michigan law allows both. A Michigan Court of Appeals decision shows what can happen when the fresh start looks too much like the business that just closed.

In Phillips-Johnson Properties, LLC v. Tru Fitness Studios, LLC (Michigan Court of Appeals No. 325570, decided February 9, 2016), a gym’s LLC dissolved owing its landlord about $21,800 in rent. Around the same time, the owner and a partner formed a new LLC, which bought the old gym’s equipment and website and opened a gym nearby. The landlord was offered $1,655.73, which was everything the old company had left. The trial court dismissed the landlord’s lawsuit and called it frivolous. The Court of Appeals directed judgment against the old LLC, revived the landlord’s successor-liability claim against the new LLC, and reversed the fee award.

This post is a companion to our guide to dissolving and winding up a Michigan LLC. That guide covers the steps. This case shows what those steps do not do.

What happened

Tru Fitness Studios, LLC leased space from Phillips-Johnson Properties, LLC to run a commercial gym. The lease ran from February 1, 2013 through April 30, 2014. The gym’s sole owner and manager signed the lease for the LLC but did not sign a personal guaranty. The lease gave the landlord a security interest in certain property under the Uniform Commercial Code.

The gym fell behind on rent almost immediately. In May 2013, a man who later became the owner’s partner in the new gym paid $2,800 of back rent to the landlord by personal check. In July 2013, the landlord received a letter from the gym’s attorney saying the LLC had been dissolved and telling the landlord it could make a claim as a creditor. The landlord submitted a claim for $21,827.95 in unpaid rent.

Around the time of the dissolution, the owner and the man who had paid the back rent formed a new company, TruFit Fitness, LLC. On July 19, 2013, the new LLC bought the old gym’s website domain name for $300. It then leased space near the old gym’s location and began operating a commercial gym.

The landlord had not been paid by March 2014, so it sued the old LLC, the new LLC, both men, and others. Against the old LLC, it claimed breach of the lease. Against everyone else, it pleaded a long list of theories, including fraud, fraudulent conveyance, unjust enrichment, piercing the corporate veil, successor liability, conversion, and tortious interference.

The defendants admitted that the old LLC had breached the lease. Their position was that the landlord’s claim would be handled through the dissolution. The old LLC finished its final accounting on April 8, 2014, after the suit was filed, and said it was willing to pay the landlord, its only creditor that had filed a claim, $1,655.73. That was all of its remaining assets. At the hearing, the defendants’ lawyer told the court that the new LLC had bought the old gym’s equipment at 45 cents on the dollar.

What the trial court did

In September 2014, the Livingston County Circuit Court granted summary disposition to the defendants, a ruling that decides claims without a trial, and dismissed the case. The judge said the owner had followed the dissolution laws and that starting over in the same business with others was not fraud. Asked whether the equipment sale at 45 cents on the dollar raised “some suspicion,” the judge answered, “A little bit.” The judge also noted that the landlord “could have gotten a personal guarantee and that’s what you usually do.”

The court then found the lawsuit frivolous, reasoning that the landlord would have been paid through the dissolution process anyway, and ordered the landlord to pay the defendants $5,200 in attorney fees.

What the Court of Appeals held

The Court of Appeals affirmed in part, reversed in part, vacated in part, and sent the case back to the trial court. Its rulings fall into four parts.

The dissolved LLC still owed the full rent

The defendants argued that the landlord could not show damages because the old LLC was ready to hand over its remaining assets, and that a lawsuit on top of the dissolution claim was a “double dip.” The court rejected that argument. Whether the landlord could collect everything it was owed was a separate question from whether it was entitled to a judgment. That issue, the court said, “relates to partial collectability, not to plaintiff’s entitlement to a judgment.”

The court also pointed to the LLC Act itself. A dissolved Michigan LLC “may sue and be sued . . . in the same manner as if dissolution had not occurred” (MCL 450.4805(3)). The court focused on section 806 of the Act, which bars a claim in two situations: when a creditor who received proper written notice misses the claim deadline, or when a creditor whose claim was rejected in writing fails to sue within 90 days (MCL 450.4806(3)). Neither had happened. Because the Legislature spelled out when claims are barred, the court inferred that claims outside those situations are not. (A dissolved LLC that publishes a newspaper notice under MCL 450.4807 can also start a one-year deadline for some claims, but the court did not address that procedure.)

Since the old LLC had admitted the breach, the court did more than reinstate the claim. It ordered the trial court to enter summary disposition in the landlord’s favor on the breach-of-lease claim.

The new LLC could face successor liability

The bigger issue was whether the new company could be made to pay the old one’s debt. The general rule in Michigan is that a company that buys another company’s assets for cash does not take on the seller’s debts. There are five exceptions, which the court quoted from the Michigan Supreme Court’s decision in Foster v. Cone-Blanchard Machine Co. The buyer can be liable where:

it expressly or impliedly assumed the debts;
the deal amounted to a consolidation or merger;
the transaction was fraudulent;
some elements of a good-faith purchase were missing, or the transfer was made without consideration and the seller’s creditors were not provided for; or
the buyer was “a mere continuation or reincarnation” of the seller.

Relying on an earlier Court of Appeals case, Lakeview Commons v. Empower Yourself, the court confirmed that these rules can apply to LLCs in ordinary commercial disputes such as an unpaid lease.

The landlord’s fraud theory failed. The defendants submitted an affidavit from the old LLC’s accountant, who said he valued the gym equipment after consulting an unrelated retailer of used sports equipment, and that the intangible assets were valued and sold at $300. The landlord offered no evidence that the sale between the two LLCs was fraudulent.

The “mere continuation” theory was different. Under that doctrine, a court looks at whether the new business continues the old one’s management, personnel, location, assets, and general operations; whether the old business stopped operating, liquidated, and dissolved as soon as legally and practically possible; whether the new business took on the obligations needed to keep the old one running without interruption; and whether the new business held itself out to the public as the old one continued.

The court found enough evidence for the successor-liability claim to survive summary disposition and continue on remand. It pointed to these facts:

Both companies ran commercial gyms in the same area.
The new LLC bought the old gym’s website and equipment.
The old gym’s owner held a majority interest in both companies: 100% of the old LLC and 60% of the new one.
A post on the old gym’s Facebook page said the business was moving to a bigger location because it had outgrown its space. The post said nothing about a change in ownership or even a change in the business name. The court said this suggested that the old gym’s members either had their memberships transferred to the new gym or were recruited by it.

The court acknowledged differences. The owner was only a member of the new LLC, while his partner was its managing member and put up most of its starting capital. But the partner had also paid rent for the old gym, and a change in management roles does not automatically defeat a successor-liability claim. Viewing the evidence in the landlord’s favor, the court held that the landlord had made out a prima facie case under the mere-continuation doctrine, meaning enough evidence for the claim to go forward if a factfinder believes it. It vacated the dismissal of the successor-liability claim and remanded for further proceedings. It did not order a trial or decide that the new LLC was liable.

There is another qualification. In Foster, a products-liability case, the Michigan Supreme Court said continuity-of-enterprise liability (its term for making a buyer that carries on the seller’s business answer for the seller’s debts) does not apply when the predecessor remains a viable source of recovery. The theory exists to give an injured party someone to recover from when the original company is gone. The Supreme Court distinguished situations in which the predecessor survives only as a shell or is otherwise underfunded. In Foster itself, the plaintiff had already obtained a $500,000 settlement from the predecessor. Phillips-Johnson did not discuss that qualification; the old gym LLC reportedly had only $1,655.73 remaining.

The court did not reach the improper-distribution argument

The landlord also argued on appeal that the owner was personally responsible because he had taken more than $7,000 in cash distributions from the old LLC, leaving it undercapitalized. The Michigan LLC Act prohibits a distribution that would leave the company unable to pay its debts as they come due or with assets less than its liabilities (MCL 450.4307(1)). A member or manager who approves an improper distribution, or a member who knowingly receives one, can be liable to the company under the conditions in MCL 450.4308.

The landlord pointed to a balance sheet, as of December 31, 2013, that the defendants themselves had filed. But the landlord never made this argument to the trial court. The Court of Appeals declined to consider it for the first time on appeal, noting that the issue had not been briefed or argued below and that the facts needed to decide it had not been developed. It affirmed the dismissal of the claims against the owner without deciding whether the distributions were improper. In a footnote, the court contrasted Florence Cement Co. v. Vettraino, a published 2011 decision in which, after a bench trial, LLC members were ordered to repay distributions they took while the company was insolvent so the company could pay its creditor. That case is discussed in our post on when Michigan courts hold LLC owners personally liable.

The fee award was reversed

Because the breach-of-lease claim had merit and the landlord had offered some evidence for its veil-piercing and successor-liability theories, the Court of Appeals held that the trial court clearly erred in calling the suit frivolous. It reversed the $5,200 fee award and ordered each side to bear its own attorney fees. The court did note that several of the landlord’s other claims were never supported or were improperly pleaded.

What the court did not decide

Whether the new LLC is actually liable for the old one’s rent. The court held only that there was enough evidence to require further proceedings. What happened on remand is not in the appellate record.
Whether the owner’s distributions from the old LLC were unlawful. The court did not reach the question because it had not been raised in the trial court.
Whether the equipment sale was for fair value. The court held only that the landlord offered no evidence that the sale was fraudulent.

The decision is unpublished, so it is not binding precedent under the Michigan Court Rules (MCR 7.215(C)(1)), although courts may consider it. The Court of Appeals docket shows no motion for reconsideration and no application to the Michigan Supreme Court; the appellate file closed in March 2016.

What this means for Michigan business owners closing an LLC

Dissolving does not erase the company’s debts. The claims process in the LLC Act organizes how creditors are paid and can cut off some claims if the company follows the notice procedures. It does not reduce what a creditor is owed. A creditor that files a claim can still sue the dissolved LLC and win a judgment for the full amount, even if the company has little left to pay it.

Starting over in the same business is allowed, but the details matter. The LLC Act does not prohibit an owner from closing one company and opening another. But a court may treat the new company as the old one continued, and let the old company’s creditors pursue it, based on factors such as overlapping ownership, the same kind of business in the same area, the transfer of the old company’s equipment and website, and telling customers the business is simply “moving.” An owner planning a fresh start should deal with the old company’s debts openly, whether by paying them, negotiating a settlement and release, or making sure the new venture is genuinely separate.

Paying yourself before creditors carries risk. When an LLC winds up, creditors are paid before members (MCL 450.4808), and distributions that leave the company unable to pay its debts are prohibited (MCL 450.4307). In this case, the court did not decide whether the owner’s alleged distributions of more than $7,000 were improper, because the argument had not been raised in the trial court. Liability under MCL 450.4308 runs to the company itself, and a proceeding under that section generally must be started within two years. For most distributions, the clock runs from the date the distribution was authorized, or from the payment date if payment came more than 120 days later (MCL 450.4307(3), 450.4308(5)).

Records help. The landlord’s fraud theory failed because the defendants offered the accountant’s valuation of the equipment, made after consulting an unrelated dealer, and the landlord produced no evidence to the contrary. When assets move from a closing company to a company owned by the same people, documentation of how the price was set matters.

A personal guaranty changes the analysis. The owner here had not signed one, so the landlord had no contractual guaranty claim against him and had to rely on theories such as veil piercing, fraud, and improper distributions. An owner who did sign a guaranty is ordinarily not released from it by dissolving the company, although the guaranty’s terms and any later release still matter.

Frequently asked questions

Can I close my LLC and start a new one in the same business?

Yes. The LLC Act does not prohibit it. But if the new company is, in substance, the old one continued, a court may hold it responsible for the old company’s debts under the successor-liability doctrine. In Phillips-Johnson, the Court of Appeals found enough evidence for the successor-liability claim to survive summary disposition where the same person held a majority ownership interest in both companies, both companies ran the same kind of business in the same area, the new company bought the old one’s equipment and website, and customers were told the gym was moving.

Does dissolving an LLC wipe out its debts?

No. Dissolution itself does not eliminate the debt, and a dissolved Michigan LLC can still be sued (MCL 450.4805(3)). The LLC Act provides written- and published-notice procedures that can bar certain untimely claims (MCL 450.4806 and 450.4807). When the company winds up, creditors are paid before members (MCL 450.4808).

What is successor liability in Michigan?

It is a set of exceptions to the general rule that a company buying another company’s assets for cash does not take on the seller’s debts. The exceptions apply when the buyer agreed to assume the debts, the deal was effectively a merger, the transaction was fraudulent, some elements of a good-faith purchase were missing or the transfer was made without consideration and the seller’s creditors were not provided for, or the buyer is a “mere continuation” of the seller.

Can I take money out of my LLC while I am closing it?

Only with care. When an LLC winds up, its assets go first to creditors (MCL 450.4808). A distribution that leaves the company unable to pay its debts as they come due, or with assets less than its liabilities, is prohibited (MCL 450.4307), and members or managers who approve or knowingly receive an improper distribution can be liable to the company (MCL 450.4308).

Closing one business and starting another?

The Law Offices of Maynard F. Newman, P.L.L.C. helps Michigan business owners wind up an LLC the right way and set up a new venture so it starts on a clean footing.

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Please note: This article is provided for general educational and informational purposes only and does not constitute legal advice. Reading it does not create an attorney-client relationship between you and the Law Offices of Maynard F. Newman, P.L.L.C. The law may change, and the outcome of any case depends on its specific facts; confirm the current law and consult a qualified attorney before acting. This content may also be considered attorney advertising.