Since Limited Liability Corporations (LLC) are a relatively new type of business entity, LLC owners have some difficulty finding out how courts will treat their bankruptcy LLC cases. As an LLC declaring bankruptcy, the owner may get some liability protection since their business is a separate legal entity. However, this protection is not absolute. Why? B ecause as CEO of the legal entity, the owner has fiduciary duties that effectively give them the same liabilities as a sole proprietorship.

So some important questions remain. Will the judge treat them like an LLC, as a corporation or as a partnership? What will happen during a bankruptcy LLC when the company has only one owner? Currently, there is no code or law that directly addresses bankruptcy LLC proceedings.

Partnership Versus Corporation In Bankruptcy LLC

There are two different ways a bankruptcy court may handle the case of Limited Liability Corporation with a single owner. First, the judge may treat the bankruptcy LLC like a partnership. In this case the court would dissolve the LLC and deal out all remaining assets to creditors. Anything remaining goes to the owner. And as in most business bankruptcy cases, there isn’t usually much left.

But the judge may decide the LLC is a corporation. Here the judge would not dissolve the owner from the bankruptcy LLC. The former owner could give over ownership interest to another party. If the former owner decided not to do this, the bankruptcy judge would treat the former owner like a corporate shareholder. The owner would not have to give up stockholdings, just as a shareholder wouldn’t in a large corporation bankruptcy case. Usually under this scenrio, the owner ends up a little better off.

Legalities of a Bankruptcy LLC

One of the greatest drawbacks to filing bankruptcy as an LLC is that owner has no idea how the judge will treat them. Unfortunately, there are no specific rules for dealing with a Limited Liability Corporation in a business bankruptcy filing.

Because of this, there may be several different factors that a bankruptcy court considers when deciding what to do. The most important factor is the number of member owners in the corporation. That said bankruptcy laws do not define the number of individual owners a corporation must have, especially for an LLC.

Because the lines are so blurry here, it is hard to tell how the bankruptcy court will decide who needs to consent to the bankruptcy filing. All members of the LLC may have to consent to the bankruptcy LLC filing. On the contrary if the judge treats it like a corporation, then only one member must consent. Most often in LLC proceedings, the bankruptcy judge looks to state laws and codes to determine how to deal with the bankruptcy. Therefore these proceedings may vary from state to state.

Filing The Bankruptcy LLC

Before filing for bankruptcy as a corporation or partnership, schedule an appointment with a bankruptcy lawyer to discuss these issues. As an alternative, you can also talk to state or county bankruptcy officials who can clarify how they will determine the proper procedures for bankruptcy LLC. Make sure you interview several lawyers before you select one. They should specialize in bankruptcy and be well versed in the specific rules for your state. If possible, try to find an attorney who has experience filing bankruptcy cases for Limited Liability Corporations.



Thanks to Kevin Muir for contributing this article to our Bankruptcy blog:

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