October 23, 2021

Volume XI, Number 296

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October 22, 2021

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October 21, 2021

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What Is A Known Liability And Why Does It Matter?

My last several posts have for the most part concerned the liability of shareholders when a corporation voluntarily or involuntarily dissolves.  Directors may also face liability under Section 316(a)(2) of the Corporations Code.   That statute makes directors jointly and severally liable for the distribution of assets to shareholders after the institution of dissolution proceedings, without paying or adequately providing for "all known liabilities of the corporation".   This liability is subject to Section 309 which prescribes a director's standard of care.  Directors are also not liable under the statute for claims not filed before a bar date when one has been set by the court under Chapters 18, 19 or 20 of the law.

Application of Section 316 begs the question of what constitutes a "known liability".   The phrase appears to embody two requirements. 

The first is that the liability be known.  In Assurance Co. of Am. v. Campbell Concrete of Nev., Inc., 835 F. Supp. 2d 995 (2011), an insurance company  expressly pled that its causes of action for unpaid deductibles arose after its insured's dissolution.   Accordingly, Judge Philip M. Pro found that the defendant director was not liable  because these obligations were not "known" when the dissolved corporation's assets were distributed under section 316(a)(2). 

The second requirement is that there be a "liability".  The General Corporation Law does not define the term "liability" and it is unclear whether contested, contingent or otherwise undetermined claims count as a "liability".   Matters are further muddied by the fact that Subdivision (c) of the statute uses different terminology in specifying who may bring suit under Section 316.  Subdivision (c)  provides that suit may be brought by any one or more creditors of the corporation whose "debts or claims" (rather than "liabilities") arose before the distribution of assets to shareholders.   Subdivision (c) provides that these "debts or claims" need not be reduced to judgment, but this does not clarify whether contested, contingent or otherwise undetermined claims are "known liabilities".   

Section 2008 provides an option for dealing with situations in which the existence or amount of a claim is contingent, contested or undetermined claim.   Under this statute, a corporation may, but is not required to, deposit the maximum amount of the claim with the Controller.  If, for example, a corporation is a guarantor of a promissory that is not yet due, it could deposit the entire indebtedness with the Controller who would then hold the amount in trust.   The existence of this option, however, does not answer the question of whether the guaranty  is itself a "liability" within the meaning of Section 316(a)(2).

Neither Sections 2009 nor 2011 provide any guidance because the terminology of each statute is inconsistent with the other and the terminology of each is inconsistent with Section 316.  Section 2009 refers to "debts and liabilities" while Section 2011 refers to "causes of action".  

All of this reminds me of Secretary of Defense Donald Rumsfeld's answer to a question at Department of Defense on February 12, 2002:

[B]ecause as we know, there are known knowns; there are things we know we know.  We also know there are known unknowns; that is to say we know there are some things we do not know.  But there are also unknown unknowns -- the ones we don't know we don't know.  

© 2010-2021 Allen Matkins Leck Gamble Mallory & Natsis LLP National Law Review, Volume XI, Number 229
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About this Author

Keith Paul Bishop, Corporate Transactions Lawyer, finance securities attorney, Allen Matkins Law Firm
Partner

Keith Bishop works with privately held and publicly traded companies on federal and state corporate and securities transactions, compliance, and governance matters. He is highly-regarded for his in-depth knowledge of the distinctive corporate and regulatory requirements faced by corporations in the state of California.

While many law firms have a great deal of expertise in federal or Delaware corporate law, Keith’s specific focus on California corporate and securities law is uncommon. A former California state regulator of securities and financial institutions, Keith has decades of...

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