What Happens to My LLC If I Declare Personal Bankruptcy?

By Laura Payet

What Happens to My LLC If I Declare Personal Bankruptcy?

By Laura Payet

If you own a limited liability company (LLC) and declare bankruptcy, what happens next depends on whether you're the company's sole owner or you share ownership with other members. Before declaring, you should have a clear idea of the consequences personal bankruptcy may have for your business.

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What Happens During Bankruptcy

Bankruptcy is a legal process in which you petition the U.S. Bankruptcy Court to discharge or reorganize your debts so that you can start over with your debt load eliminated or significantly reduced. Individuals can file for bankruptcy under Chapter 7 or Chapter 13 of the U.S. Bankruptcy Code.

Chapter 7

Chapter 7 is the most common bankruptcy procedure for individuals. The court appoints a trustee to liquidate your assets and distribute the proceeds among your creditors. Bankruptcy law permits you to designate certain assets as exempt from liquidation. Generally, the property you can claim as exempt depends on your state. Business assets are usually not exempt, unless they are tools of the trade that you need to work. For example, if you're a contractor, your tools, which are literally the tools of your trade, may be exempt. All of your nonexempt assets become part of the bankruptcy estate used to pay off your debts.

Chapter 13

Chapter 13, also known as reorganization, is for debtors who do not qualify for Chapter 7. You may be able to file for Chapter 13 bankruptcy if you have continuing income that will allow you to pay back at least some of your debts. Instead of liquidating your assets, you keep them and propose a repayment plan for the court's approval.

When You Are the Sole LLC Owner

When you declare Chapter 7 bankruptcy, your ownership interest in your LLC is an asset that becomes part of your bankruptcy estate subject to liquidation for paying your creditors. If you are your LLC's sole owner, the bankruptcy trustee may require you to shut your business down, at least temporarily, to assess the value of the company and its assets and to prevent you from incurring further debt. The trustee may choose to collect any accounts receivable or to sell the business entirely and use the proceeds to compensate your creditors. If, however, the trustee determines that selling the business would not raise enough money to be worthwhile, they may leave it for you to continue running instead of liquidating it.

When You Share LLC Ownership

If you are one of multiple LLC members, your share of the company becomes part of your bankruptcy estate, but the trustee likely will not interfere with the business unless you are the majority owner. Although you have both an economic and a management interest in the LLC, only the economic interest becomes part of the estate. If the trustee decides to sell your interest, the purchaser could not participate in company management. The trustee could also ask the court to issue a charging order against the LLC, which entitles them to collect your share of distributions to pay down your debts.

Check the LLC's operating agreement before you file for bankruptcy. It may contain provisions addressing this situation. For example, you may be required you to sell your interest back to the company or the other members beforehand or to grant the company a right of first refusal before selling your interest.

It can be challenging to know whether bankruptcy is the right move for you. Before you make the decision, consider consulting an attorney that can help you determine the best course of action and guide you through the process.

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.