What Is Involved in an LLC Bankruptcy?

Autumn Rivers

Declaring bankruptcy for a limited liability company (LLC) can be confusing because there are few solid laws governing the relatively new entity. Some judges may treat this type of company as a partnership, while others might treat it as a corporation. Additionally, many business owners may be surprised to find that obtaining business loans and an office often negates any protection for their personal property, meaning their personal assets can be taken during LLC bankruptcy. The result is that they usually have to file for both business and personal bankruptcy, but even doing so will not allow them to get out of paying payroll taxes.

Business owners should be aware that LLC bankruptcy can wipe out their unsecured debts.
Business owners should be aware that LLC bankruptcy can wipe out their unsecured debts.

One of the deciding factors of how an LLC bankruptcy will proceed is whether the company is treated as a corporation or a partnership. If the judge presiding over the business bankruptcy decides to treat the LLC as a partnership, he will likely dissolve it. In such a case, the company's assets would be distributed among creditors, and the owner would get to keep any leftover assets, which are usually few. If the judge treats the LLC like a corporation, he may suggest that the business owner offer ownership interest to another person. If the owner were to refuse this option, he would be treated like a corporate shareholder, because he would get to keep stockholdings despite bankruptcy.

Many business owners wonder if their personal assets are at stake during an LLC bankruptcy. The answer is that while one of the main points of limited liability companies is to protect the owner's personal credit, it can still be affected when the business is in financial trouble. This is because most lenders request that owners give up their limited liability protection to get a small business loan. In addition, many landlords ask business owners to sign a personal guarantee before they will rent out commercial property, which means the landlord can come after the business owner's personal property if he does not pay.

Owners who have never signed a personal guarantee and have not surrendered their limited liability protection will likely find that their personal assets are safe when they file for LLC bankruptcy. Most business owners, however, are not in this group, meaning their personal property is at-risk because of the bankrupt limited liability company. Therefore, they usually need to declare both business and personal bankruptcy, keeping in mind that the most popular routes, such as chapters 7 and 13, are available for personal bankruptcy only. In addition, business owners should be aware that LLC bankruptcy can wipe out their unsecured debts, such as business loans, but they will still owe payroll taxes.

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