New changes to laws for dissolving corporations in Colorado in 2020

Like a marriage, no one starts a new business venture expecting it to fail. However, if problems arise later, many partners end up wishing they had planned more carefully and taken the time to draft quality corporate documents.
Shutterstock 1067767622

When new business partners form their new companies, they are often so excited they do not spend much time or money drafting the documents that will govern the company’s operations.

New partners often forget to consider fundamental issues like deciding what will happen if one or more partners elects to leave the business. What rights, if any, will the other partners have to acquire the outgoing partner’s business interest?

Like a marriage, no one starts a new business venture expecting it to fail. However, if problems arise later, many partners end up wishing they had planned more carefully and taken the time to draft quality corporate documents.

When business partners have no mechanism for buying each other out or transferring their interest or dissolving their business, Colorado law steps in and various statutes and rules provide an answer. However, you may not like what the laws state, which is why it is always preferable to draft an agreement that suits your needs.

In addition, the law changes from time to time, and in July 2020 the law related to the dissolution of corporate entities had a significant change.

New this year is the ability to purchase other stakeholders’ shares if there is a dissolution. This change applies to corporations only, and not limited liability companies or general partnerships.

Corporate Dissolution Generally

Under Colorado law, corporations, partnerships, and limited liability companies conduct business based on fundamental operating documents that govern how the company operates. It is very similar to a constitution that is designed to survive the test of time and allow the company to operate and grow.

Like a constitution, the company’s governing rules are often designed to be flexible so that the company can grow without constant revision to the operating documents. For example, instead of defining exactly how the company will conduct business, the operating documents will provide for the election of directors and officers (if it is a corporation) or managers and members (if it is a limited liability company).

The officers and directors would then be responsible for conducting business on behalf of the company. However, while many templates for bylaws and operating agreements contain the basic rules, many business partners fail to account for the possibility of conflict. For example, consider some of the following disputes:

  1. In a 50/50 partnership, how do the partners resolve the inevitable situation where one partner no longer wishes to be in business with the other?
  2. Can the partner force a buyout?
  3. Can the partner sell his or her interest to a third party and are there any limitations?
  4. What is the price for the buyout?

The short answer is it entirely depends on whether the corporate documents provide a resolution. If not, the only choice may be a judicial dissolution through the court system. Well-drafted corporate documents typically contain numerous mechanisms to address the situation where one or more business owners wish to exit.

A common tool could be a right of first refusal permitting the other owners to acquire the exiting owners’ shares in the company at fair market value (or some predetermined formula prescribed in the corporate documents). Another mechanism might be tag-along or drag-along rights allowing the existing owners to attempt to sell the entire business to a third party before the exiting partner is bought out.

There are also alternative dispute resolution techniques where the owners agree to appoint an arbitrator to determine the value of the exiting owners’ interest. If no tie-breaker provisions or mechanisms for an exit exist, the only option is to ask the court to dissolve the company.

Going through a judicial dissolution is not an easy or efficient process. Many people incorrectly assume that the courts have the power to resolve the problem by ordering one owner to buy the other owner out. However, corporations, limited liability companies, and partnerships are governed by contract law principles. This means that the courts are generally bound by the same rules that govern the company. The court cannot force an owner to do something that they did not agree to in the corporate documents.

In many circumstances, the court’s only option is to dissolve the company by appointing a receiver to wind everything down. The Court also has the option to refuse to dissolve the company, which can be even more problematic if the business partners are in significant conflict with one another.

If the business is ordered to be dissolved, the receivership process can be expensive, time-consuming, and often results in the dissolution of a profitable company to the detriment of all partners involved. Many business owners are shocked to learn how little flexibility exists in the judicial process to resolve a partnership dispute

July 2020 Changes to Dissolution Process for Corporations

On July 1, 2020, a new amendment to the Colorado Business Corporations Act went into effect that allows corporations and shareholders to elect to purchase the shares of a shareholder petitioning for judicial dissolution for fair market value. See C.R.S. § 7–114–305.

The new amendment appears to be an attempt by the legislature to give courts some flexibility to avoid dissolving the company. However, the election only applies to corporations and not to partnerships or limited liability companies.

Further, the election can only be made by the corporation itself or any of the other shareholders who did not petition for dissolution. This means that if you are the owner wishing to exit the business, you cannot force the corporation or the other shareholders to buy your shares at fair market value. The outgoing owner can petition for judicial dissolution and wait to see whether the corporation or shareholders elect to purchase the shares.

There are significant questions raised by the new amendment. If the election to purchase is claimed, the court has broad discretion to dictate the terms of the sale, including determining the fair market value of the shares and payment terms. The court can permit payment to be made in installments and may require collateral to secure the payment obligation. From a business perspective, the new election remedy for a corporation is far from ideal. An outgoing owner could be forced to sell their shares based on the determination of a judge who knows nothing about their business.

Even with the new amendment, judicial dissolution is not a great solution for business owners. You would be much better off negotiating these issues with partners when you form the company. You could also amend existing agreements if you did not think about these issues before.

At the very least, if you have an existing business, you should review your corporate documents and make sure that your documents address any potential problems. If your documents do not resolve major disputes, it might be time to discuss the issues with your business partner(s) and consider amending the corporate documents to address these problems.

Duncan Griffiths is a shareholder at Griffiths Law PC. Duncan has over 10 years of experience practicing civil litigation in numerous areas that include construction, insurance, real estate, breach of contract, partnership disputes and domestic torts. Since joining Griffiths Law, Duncan also represents family law clients in complex matters involving business interests, trusts and other areas requiring specialized expert witnesses. Duncan has tried multiple jury trials through verdict as well as numerous arbitrations and bench trials. He represents clients in state and federal court, both at the trial court level and on appeal where he has obtained favorable rulings for his clients. This includes a published opinion involving the recording of magistrate orders and whether it complies with Colorado’s spurious lien statute. Duncan has been identified on the Colorado Super Lawyer’s Rising Stars list for seven consecutive years as well as the National Trial Lawyers Top 40 Under 40. He has published numerous articles on a variety of topics relating to construction, insurance coverage, partnership disputes, and domestic relations.

(This sponsored content was provided by Griffiths Law PC)

Categories: Business Insights, Legal, Sponsored Content