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Is My Limited Liability Company Safe in Bankruptcy?

By Kent Anderson, Oregon Bankruptcy Attorney

Limited liability companies, called LLCs for short, have become a popular method of organizing business relationships. Nearly unknown until the early 1980s, all 50 states have now adopted statutes that permit this business format. While LLCs can file bankruptcy, it is much more common for members who own LLC interests to seek relief from creditors in the bankruptcy court. When an LLC interest has value, trustees have had some success in reaching the assets of the LLC to fund the bankruptcy estate. A recent case from Florida has made LLCs owned by a single member even more vulnerable to creditors and bankruptcy trustees.

Limited Liability Companies are generally quite difficult to penetrate for creditors of a member. Because an LLC is like a partnership in the relationship between the member/owners of the business, state laws have provided protection when a creditor tries to collect from the business for the debts of a member. In most cases, a member’s interest in an LLC can not be transferred, either voluntarily or involuntarily, without the permission of all the other members of the LLC. This prevents an outsider from becoming an LLC member and participating in management of the business unless everyone agrees. Outside creditors are not permitted to force their way in and become a member.

Under most state laws, judgment creditors of an LLC member can only ask the court for a charging order that gives the creditor all of the member’s distributions from the LLC operations. If the other members decide not to distribute profits from the company, the creditor has very limited options. In Olmsted v. Federal Trade Commission, the Florida Supreme Court authorized the FTC, a judgment creditor, to force the sale of assets ownned by an LLC to satisfy the debt of it single member. This opens the door for creditors in states with laws similar to Florida, to forget charging orders and seek liquidation of single member LLCs to satisfy judgment debts.

Because a bankruptcy trustee has all the rights of a judgment creditor as well as additional powers granted by the bankruptcy code under section 541, a single member LLC will likely offer very little protection to a bankrupt member. This could result in an unpleasant surprise to bankrupt debtors with small business LLCs and no other members.

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Full post as published by Bankruptcy Law Network on December 18, 2010 (boomark / email).