Directors and/or officers who take responsibility for dissolving a company can be tempted to use company funds to repay debts to themselves as opposed to other creditors. This can expose those responsible to serious potential personal liability if the company is insolvent or on the verge of insolvency. The recent Minnesota Court of Appeals decision in Drewitz v. Motorwerks, Inc., Court File No. 27-CV-04-008927 (Minn. Ct. App. June 22, 2015) (“Drewitz”) punctuates the seriousness of the potential liability.
The factual summary in Drewitz is long and convoluted representing the culmination of three district court proceedings and appeals. The over ten year proceeding in some ways stands for the proposition that district court litigation is too costly and time-consuming. In any event, while the litigation was pending, the defendants sold the assets of the subject business and distributed proceeds to the sole remaining shareholder.
The sole shareholder received $21 million in distributions from the company effectively leaving the company unable to pay the eventual and long delayed award received by plaintiff in the litigation. The plaintiff successfully argued that in those circumstances, the sole shareholder breached his fiduciary duty to the plaintiff/creditor.
The court in Drewitz observed that corporate directors are required to “pay or make provision for the payment of all known debts, obligations, and liabilities of the corporation” before distributing remaining assets to shareholders. Drewitz at p. 15; citing Minn. Stat. §302A.725, subs. 1(b), 3 (2014).
The court concluded that the plaintiff was entitled to pursue the sole shareholder directly as a result of the distribution. This decision should stand as a reminder and warning to officers and directors handling the dissolution of companies to exercise extreme caution about making distributions while any claims remain pending against the company.