By Cara O'Neill
A LLC is like a corporation in that it is considered a separate entity under state law. In other words, a LLC has its own individual status much like that of a person, and it is because of this status that a trustee cannot simply sell the entire LLC and distribute the proceeds to creditors. That’s the theory, at least. What happens in reality, however, may be a different story depending on who holds interest in the LLC.
While the bankruptcy trustee can’t sell the LLC, your interest in the LLC is an entirely different matter. Just as your vehicle, household furnishings, timeshare and stocks are assets that become a part of the bankruptcy estate, so does your interest in the LLC. This is especially important to keep in mind if you are the sole member of a single member LLC since in that case, all of your interest becomes a part of the bankruptcy estate, which is in effect, the entire LLC.
When to File Bankruptcy
The decision to file bankruptcy is no different in this case than any other case. First, evaluate the value of your interest along with all of your other assets. Next, determine the amount of assets that your jurisdiction allows you to “exempt” from the bankruptcy estate. If the value of your interest is within the exemption limits, then filing bankruptcy may make sense. If the value of your interest exceeds your exemptions, determine whether it is worth paying the trustee to retain the interest and proceed accordingly.
The Effect of Bankruptcy on the LLC
There are two easy solutions to the three basic scenarios that arise when a LLC member files bankruptcy. First, since the trustee is interested in quick cash, you or the LLC can purchase the interest from the trustee. The second involves dissolving the LLC, selling its assets and dispersing the proceeds to the interest holders. If the trustee and LLC members cannot come to an agreement, however, the trustee may initiate litigation and put the ultimate fate of the LLC in the hands of a judge.
CNN Money: LLCs and Personal Bankruptcy