The law governing California limited liability companies evolves in real time | Lessons from the courtroom battlefront

Conversion to an LLC from Another Entity — What Rights and Liabilities Change?

Not much, really.  While the entity’s form and structure morph to an LLC, the rights and liabilities of the entity are generally unaffected.

Under California’s statutes governing the conversion of an entity to an LLC (often from a corporation or partnership), all of the rights and liabilities of the old entity are shifted to the new entity.  See, e.g., Corporation Code sections 1150 et seq. and sections 17710.01 et seq.

Aggressive litigation attorneys with a claim against a recently converted LLC might be tempted to pursue BOTH the prior entity and the newly converted LLC.  But a recent opinion from a federal court in California’s Southern District — Brinkley v. Monterey Financial Services — rejects that tactic.

Facts:  Plaintiffs sue corporation.  Corporation converts to LLC.  Plaintiff continues to pursue corporation.

In the Brinkley case, plaintiff Tiffany Brinkley sued Monterey Financial Services, Inc. (“Old Monterey”).  While the lawsuit was still pending, Old Monterey underwent a voluntary statutory conversion from a corporation to a limited liability company (“New Monterey”).  To accomplish this, Old Monterey filed Form LLC-1A  (“Limited Liability Company Articles of Organization — Conversion”) with the California Secretary of State.

The Plaintiff amended her complaint to add New Monterey as a defendant.  But she also kept Old Monterey in the case as a defendant, and pursued discovery against it.

Discovery disputes erupted.  Plaintiff served identical written discovery on Old Monterey and New Monterey.  Old Monterey refused to respond on the grounds that it no longer existed — it had converted to New Monterey. 

Frustrated with the plaintiff’s discovery efforts against it, Old Monterey filed a motion to be substituted out of the case since its interests had been transferred to New Monterey.

Court’s Opinion:  New LLC has same rights and liabilities as the old corporation.  Old corporation dismissed from case.

The court granted the motion and dismissed Old Monterey from the case.

As a result of the conversion, the court held, “Old Monterey dissolved by operation of California law, ceased to exist as a legal entity, all of its assets and liabilities transferred to New Monterey, and New Monterey stepped into its shoes for all purposes.”

The court outlined all of the related impacts of filing a conversion with the Secretary of State:

  • “First, the corporation is immediately dissolved and the LLC springs forth in its place.”  As a result of this automatic dissolution, “the corporate powers, rights, and privileges of the [converting] corporation shall cease.”
  • “This statutory conversion also automatically causes the immediate transfer of all legal rights, assets, and liabilities to the newly-formed LLC.”  This specifically includes all real property and rights; all personal property and rights; all debts, liabilities, and obligations; and all rights and liens of creditors and lienholders.
  • Finally, an entity that converts into another entity “is for all purposes … the same entity that existed before the conversion.” Any action or proceeding pending against the prior entity may be continued against the converted entity.

Against that legal backdrop, the court found that there was no reason for the prior entity (Old Monterey) to remain in the case and be subjected to discovery. 

The court held: “California’s conversion statutes make clear not only that rights, property, debts and liabilities are automatically transferred to the new LLC, but also that the rights of creditors and all legal actions against the corporation continue unimpaired against the new LLC.  Thus, New Monterey and Old Monterey are not essentially the same entity—they are the same entity in the eyes of the law.” 

The court concluded: “Because New Monterey has stepped into the shoes of Old Monterey for all purposes, there is no reason for Old Monterey’s continued presence in this case. “

Lesson

Under California law, converting from a corporation or a partnership to an LLC generally won’t alter the legal rights and liabilities of the entity.  Those rights and liabilities simply shift from the prior entity to the converted entity.  As such, there is no reason for the prior entity to remain a party in ongoing litigation.

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