An operating agreement signed by all LLC members details their rights and responsibilities. The LLC is a hybrid business form, combining advantages of a corporate structure and a general partnership. A corporation insulates its shareholders from personal liability, just as the LLC protects its members from personal liability. However, a corporate shareholder may be subject to double taxation: the corporation is taxed and the shareholder is also taxed on dividends received. As in a general partnership, LLC members pay tax on income they receive. No income tax is assessed against the company itself.
Legal Requirements for an Individual Bankruptcy
Any person may file a Chapter 7 bankruptcy, seeking protection from creditors. The Chapter 7 bankruptcy trustee is appointed to administer the bankruptcy by collecting and liquidating the assets of the debtor. Among the assets that could be seized by the Chapter 7 trustee is any LLC ownership interest of the debtor. If the bankruptcy trustee takes over the disassociated member's interest, he then stands in the shoes of the expelled member, assuming the former member's LLC rights and responsibilities specified in the operating agreement.
State laws, following the model uniform LLC law, require that a LLC member be automatically disassociated from the LLC when he files bankruptcy. By automatic disassociation, the bankruptcy trustee will not be able to include the member's LLC ownership in the assets to be liquidated. A result of this disassociation, depending on the exact language of the operating agreement, is that other LLC members have the automatic right to purchase the interest of the bankrupt LLC member.
Preset Mandatory Buyout Provisions
The operating agreement may fix the process to be followed by the other members when purchasing the disassociated member's interest, such as finding its value by independent appraisal. An appraisal may not be necessary if the operating agreement includes a mandatory price at which the interest must be purchased. Depending on the success of the LLC, the mandatory price may cause a significant loss for the member declaring bankruptcy. No matter the price at which the member's interest is purchased, the disassociated member is still responsible for any debts owed to the LLC.