Limited liability companies, like other businesses, can file for bankruptcy if they have more debts than they can handle. Bankruptcy can wipe out business debts and let the owners walk away clean. It may also require closing the LLC for good.
LLCs in Bankruptcy
In a Chapter 7 liquidation, the LLC goes out of business and the bankruptcy court sells off the assets. In Chapter 11, the business "reorganizes," wiping out some debts and paying others. This keeps the company alive, but it's usually more expensive than Chapter 7. While the LLC structure should block creditors from going after your personal assets for unpaid debts, there are exceptions. For example, if you've personally guaranteed the debts, the LLC's creditors may be able to sue you.
Members in Bankruptcy
If an LLC member files for personal bankruptcy, state laws differ on what happens to the company. The K&L Gates law firm says that in Pennsylvania, for example, one member's bankruptcy will dissolve the LLC. Other states, such as Delaware, protect the LLC in those instances. The terms of the operating agreement can override state law. If the agreement says, for example, that a member's bankruptcy dissolves the LLC, that's what's going to happen.
Management and Membership
If you're in personal bankruptcy, your creditors may be able to claim your financial stake in the LLC. That diverts your share of the company's profits to your creditors. State laws usually prevent creditors from obtaining your management rights in the company. That protects your partners from having to do business with someone they didn't ask to join the LLC. Many operating agreements also prohibit someone new entering the company without the other owners' consent.
The rules are different if the company is a one-member LLC and the owner files bankruptcy. Unlike a partnership, there are no other members who will suffer if you give up your ownership. The bankruptcy court can take control of the entire business and sell off your ownership or just the assets. If you dissolve the LLC before you file personal bankruptcy, you'll have to settle with the LLC's creditors as part of the dissolution process. You probably won't be able to avoid paying some or all of the debts.
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.