LLCs and Bankruptcy

Sun, Sep 16, 2012

Bankruptcy

LLCs (Limited Liability Companies) are a popular business entity in the United States. Individuals form them in order to gain protection for their assets—both personal and business. (Sometimes companies own LLCS too.) Florida’s rules for LLCs are in Florida State Statutes Title XXXVI, Chapter 608.

There are single-member LLCs and multi-member LLCs, each offering different circumstances:

Single-member LLCs

Single-member LLCs are those owned by one individual. They provide some protection of assets; yet help simplify the tax process. All profits and losses are posted on the individual’s tax return. Unless the owner elects to be taxed differently, the company is not filing it is own tax returns as a corporation would… it is considered, for tax purposes, as a “disregarded entity.”

Multi-member LLCs

Multi-member LLCs are those owned by more than one individual. (Note: There is some debate about whether an LLC owned by a married couple is still considered a single-member LLC.) All profits and losses are posted on each individual’s tax return. Just like the single-member LLC, the company is not filing it is own tax returns as a corporation would (unless otherwise elected). The profits and losses are distributed as discussed in the member documents that each LLC should draft to decide this type of thing.

 

The U.S. Small Business Administration has more information about the advantages of LLCs here on their website. While LLCs are popular for many, some issues that come up make the LLC choice the undoing of the company and/or the individual. Bankruptcy can be one of these situations, especially for a single-member LLC. (A 2010 Florida court case provided much help with deciding about how single-member LLCs would be treated in bankruptcy.)

Each situation is different, but here are some typical concerns that might come up:

  •  If an individual, who is part of an LLC, files personal bankruptcy, will their interest in the LLC be affected?

Probably. Florida’s State Statute 608.431 states the following: “An interest of a member in a limited liability company is personal property.” Personal property is usually part of a bankruptcy proceeding.

  • If an individual that is part of a multi-member LLC files personal bankruptcy, will the other members and the LLC itself be impacted?

Yes—they will be impacted in some way. Each state differs in its laws, but Florida law provides some protection to other members of an LLC when one member files bankruptcy. This is not to say that the bankruptcy will not cause headaches for the LLC, but it should not cause the entire LLC to be seized in a bankruptcy. (This depends on each individual case and is certainly something to discuss with an attorney.) Good operating agreements are essential to help protect members in this situation. Attorney Christopher D. Smith has seen how poor initial document creation can cause many a headache for an LLC.

  • If the owner of a single-member LLC files personal bankruptcy, will that also affect the LLC?

Yes. Florida law discusses this in Florida State Statute 608.433. The LLC status does not protect single-member LLCs very much in this type of proceeding, since there is only one member. That one member’s interest is personal property, and Florida State Statute 608.431 therefore applies.

  • If a multi-member LLC is filing bankruptcy for the LLC, will each individual’s personal assets be protected?

Typically, yes–since an LLC is formed to protect each person’s individual assets. Good operating agreements help protect members in this situation.

  • If a single-member LLC is filing bankruptcy for the LLC only, will the individual’s personal assets be protected?

Not necessarily. Some protection is provided, but keep in mind that many single-member LLCS mingle funds and perhaps sign personal guarantees for business transactions. This is another situation in which good attorney advisement from the get-go is ideal.

SmithLaw works closely with many bankruptcy clients and knows how complicated bankruptcies involving LLCs can get. Make sure that you understand the ins and outs of LLCs before relying on them to protect your assets.

Image: Some rights reserved by taberandrew

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