Single Member LLCs: Confusing and Messy in Bankruptcy

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Single member limited liability companies cause a lot of confusion in bankruptcy cases.   A small business owner operating through an LLC often considers the assets and liabilities of the company to be his, personally.  He acquired the company’s assets through his own toil and he likely guaranteed the company’s debt. He may know that “technically” the LLC is a separate entity, but he probably feels that he and his company are one and the same.  He is not alone.  The IRS ignores single member LLCs for most purposes. Many lawyers would also ignore the distinction and include the individual owner as a defendant in a lawsuit involving the business of the LLC.   Loosely speaking, rightly or wrongly, single member LLCs are widely ignored – except in bankruptcy court.

Consider the following: if the individual owner of a single member LLC files bankruptcy (any chapter) –

  • Are the assets of the LLC property of the debtor’s bankruptcy estate?
  • Can the individual debtor claim the assets of the LLC as exempt?  What if the assets are necessary for the debtor’s trade?
  • Does the bankruptcy filing of the individual debtor stay the collection efforts of the LLC’s creditors seeking to recover from the LLC’s assets?

The answer to these questions is, NO.  The individual and the LLC are separate legal entities, and the assets and liabilities of the individual are separate from the assets and liabilities of the LLC.   See Miss. Code Ann. §79-29-311; In re Chang, Bankr. S.D. Miss., Case No. 10-51012 NPO (Dk#123); In re Modanlo, 412 B.R. 715 (Bankr. D. Md. 2006), aff’d, 266 F. App’x 272 (4th Cir. 2008); In re Desmond, 316 B.R. 593 (Bankr. D.N.H. 2004).

If the primary cause of the debtor’s financial difficulty is business related, a Chapter 11 reorganization of the LLC may be the only option if saving the business is paramount.  In such a case, filing a bankruptcy for the debtor, individually, is likely the wrong course of action.   Filing a Chapter 13 case for the individual will not help because the LLC’s debts cannot be modified or adjusted.  In an individual Chapter 7 case, the debtor risks losing his business altogether.  Although the assets of the LLC are not property of the bankruptcy estate, the LLC membership interest is subject to the control of the trustee. LLC membership interests are intangible personal property under Mississippi law.  Miss. Code Ann. §79-29-701. Even if the LLC interest has no obvious value, the trustee may have an opportunity to sell the LLC interest. I know of one case in which a competitor of a debtor’s business offered the trustee $10,000.00 for the LLC interest just to close the debtor’s business and shut out the competition.  You should carefully consider the potential consequences before filing a bankruptcy case for an individual who operates his business through a single member LLC.

One last word of caution – don’t get too creative in attempting a “work around.”  An individual bankruptcy case filed as “John Q. Debtor” d/b/a “John Q. Debtor, LLC” will face tough scrutiny and may be dismissed as filed in bad faith.   Also, efforts to “dissolve” the LLC with the Secretary of State to transfer ownership of assets prior to filing an individual bankruptcy will not work.  Mississippi law prohibits most distributions from an LLC if the LLC is insolvent.  Proper procedures for winding-up the business must be followed before in-kind distributions can be made to the member(s) of an LLC.  See generally, the Revised Mississippi Limited Liability Company Act,  Miss. Code Ann §79-29-101, et. seq., and, specifically, Miss. Code Ann. §79-29-609 which limits distributions by insolvent LLCs.  The Bankruptcy Judges in the Southern District have made it clear that they follow the mandates of the Mississippi Code regarding dissolution and that they treat LLCs and their owners as separate legal entities.

If you ultimately determine that it is in the best interest of an individual debtor with an LLC to file bankruptcy (because of problems with personal indebtedness such as medical bills or credit card debt, e.g.), it is important that the schedules and statements properly reflect the membership interest in the LLC.

  • The debtor should not include the assets of the LLC in the schedules.
  • The debtor should include the membership interest in the LLC on Schedule B, Line 13 – “Stock and interests in incorporated and unincorporated businesses.”
  • The debtor should place a value on the membership interest in the LLC.
  • The debtor should not include debt secured by assets of the LLC on Schedule D – “Creditors Holding Secured Claims.”  If the debtor personally guaranteed the secured debts of the LLC, then the debtor should include the LLC’s creditors on Schedule F – “Creditors Holding Unsecured Nonpriority Claims.”
  • The debtor should not include the LLC’s secured debt on the Statement of Intent, and the debtor will not have the option to reaffirm the debt or surrender the property.

Personal Note: The debtor should be prepared to provide the trustee with the LLC’s tax returns, bank statements, a detailed list of assets and liabilities.  The easier you can make it for the trustee to assess the case, the faster the debtor will receive a discharge and get on with his fresh start.

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One thought on “Single Member LLCs: Confusing and Messy in Bankruptcy

  1. I enjoy your blog and concur with the foregoing comments. Most of the problems over here in Alabama Middle are a result of sloppy work by debtor counsel. The more problematic issue for me has always been “what options do I have as trustee for realizing value from a debtor’s interest in an LLC?” The case law isn’t very helpful.

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