Can I Be Involved in an LLC and File Bankruptcy?

by Joe Stone, studioD

No law prohibits you from filing personal bankruptcy if you are an owner of an LLC. Filing for personal bankruptcy generally gives the court control of your personal assets through a court-appointed trustee. Whether the bankruptcy court will control the LLC depends on several factors including the number of owners in the LLC and the type of bankruptcy you file.

Debt Protection for Multi-Member LLCs

State LLC laws generally protect an LLC from the personal debts of its individual members by limiting the type of remedies that can be pursued against the members' LLC-ownership interests. For example, Iowa and Illinois LLC laws limit a creditor's remedies to enforce a debt against a member's LLC interest to a charging order – that is, a court order with a similar effect to a wage garnishment. The creditor only receives a payment on the debt when and if the LLC makes a distribution to the member. The creditor cannot disrupt the LLC's business operations by forcing a sale of the member's interest or placing a lien against it. A bankruptcy trustee can likewise be limited in his control of the member's ownership interest to just receiving LLC distributions and is precluded from interfering with the other members’ operation of the business.

Single-Member LLCs and Chapter 7

Although a multi-member LLC can be protected from one member filing bankruptcy, the situation is entirely different for a single-member LLC when the member has filed for personal bankruptcy under Chapter 7. Because the member is seeking discharge for all his debts, the bankruptcy court will treat his LLC ownership interest as an asset of the estate. This gives the trustee broad authority to take over the management and control of the LLC, including selling the business to make funds available to pay the member's creditors.

Single-Member LLCs and Chapter 13

If the owner of a single-member LLC files for Chapter 13 debt adjustment rather than Chapter 7 debt liquidation, he may be able to avoid having the trustee seize control of the LLC. Because the purpose of Chapter 13 is to adjust debts based on a regular income, it is most likely in the creditors’ best interests to have the member continue operating the LLC so an income is available to pay the adjusted debts. However, if the bankruptcy case is converted from Chapter 13 to Chapter 7, the trustee will most likely be empowered to seize control of the LLC.

Prohibiting an LLC Bankruptcy Filing

The only court precedent that supports a prohibition on filing bankruptcy involved an LLC itself filing a bankruptcy petition. The bankruptcy court upheld the validity of an LLC operating agreement that included a provision prohibiting any member from filing a bankruptcy petition on behalf of the LLC. The bankruptcy court dismissed the LLC's bankruptcy petition based on the provision in the agreement. Nothing in the case opinion suggests that such an agreement could be enforced against an individual debtor.

About the Author

Joe Stone is a freelance writer in California who has been writing professionally since 2005. His articles have been published on LIVESTRONG.COM, and He also has experience in background investigations and spent almost two decades in legal practice. Stone received his law degree from Southwestern University School of Law and a Bachelor of Arts in philosophy from California State University, Los Angeles.

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