What Happens to Debt When You Dissolve an LLC?

By Cindy DeRuyter, J.D.

What Happens to Debt When You Dissolve an LLC?

By Cindy DeRuyter, J.D.

When the owners, also referred to as members, in a limited liability company (LLC) decide to close the business, they must formally dissolve the company. Voluntary dissolution—a closure that is initiated by members—requires members to adhere to state law and follow its procedures exactly. If the business had outstanding financial obligations, members must pay those debts from business assets before taking distributions for themselves.

Four people in suits at table discussing documents

Notice and Payments to Creditors

If the LLC owes money to vendors, service providers, or anyone else, the members cannot simply notify the state to dissolve their business and split what's left. Instead, they must first reasonably identify creditors. In some states, the business must send formal notices to all known creditors of the business before taking additional actions, which might include liquidating assets, paying creditors, and distributing remaining assets to members.

Generally, members must mail or otherwise provide to each creditor the official notice. The notice must include claims-submission procedures and a deadline for submitting such claims, as provided by state law.

Some state laws also require LLCs to publish notices of dissolution in legal newspapers, with information about when and how to present claims for payment. These provisions give unknown creditors the opportunity and information necessary to file claims.

Priority of Payment

Creditors have priority for payment before the members are paid. Owners who are also creditors can submit claims for repayment. The business may legally pay such creditors' claims before they make any distributions to members based on their membership interests.

An LLC that chooses to make distributions to members without paying known creditors in full could unintentionally put the members at risk of personal liability for the business's debts. However, such liability would be limited to the amount distributed to each member during dissolution. Additionally, owners cannot intentionally dissolve the business and immediately open a new one simply to evade liability for financial obligations.

Insolvent LLCs

If the LLC does not have enough assets to repay its outstanding debts, it is financially insolvent. In that situation, the members are not personally liable beyond their ownership stake in the business.

Members of an insolvent business could benefit from working with a bankruptcy attorney. If the company goes through a bankruptcy proceeding, the court can determine which creditors have priority for repayment.

Involuntary Dissolution

Rather than members voluntarily deciding to dissolve the business, a court order could also trigger involuntary dissolution. This can occur when one or more creditors files a lawsuit for payment or when a customer, vendor, or other party sues the company for damages. Instead of members paying creditors from the LLC's remaining assets, an involuntary dissolution involves a court-appointed trustee who is responsible for liquidating and distributing company assets.

State laws, which vary, define the expectations and processes for dissolving LLCs. The information provided in this article is general in nature and does not represent any specific state's laws. An LLC facing voluntary or involuntary dissolution might benefit from consulting a licensed business law attorney in its jurisdiction.

This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.