As many of you know, an LLC’s assets are generally not subject to claims by creditors of LLC members for their personal debts. The LLC and its owner are generally considered separate legal entities with their own assets and liabilities. In our previous blog series on LLC statutes (available here), however, we mentioned that creditors of LLC members can get to the assets of the LLC by applying for a charging order, if the state law so provides. A charging order gives the creditor the right to receive distributions from the LLC to which the debtor/member would otherwise be entitled, if any, but does not confer any right to order distributions or participate in the LLC’s management. The purpose of a charging order is to protect other members of an LLC from having involuntarily to share governance responsibilities with someone they did not choose or from having to accept a creditor of another member as a co-manager—that is, to protect the autonomy of the original members and their ability to manage their own enterprise.[1] (Of course, that assumes a carefully written LLC agreement was in place before the issue arose to prevent the creditor from having management rights.) But what if there are no other members to protect? And what if the sole member files bankruptcy?
Under federal bankruptcy law, the commencement of a bankruptcy case creates an estate, which is comprised of all legal or equitable interests of the debtor in property as of the commencement of the case,[2] i.e., nearly everything that a debtor owns. It follows that a debtor’s member interest in an LLC (also known as an LLC interest in some states) automatically becomes part of the bankruptcy estate. The more difficult question to answer, however, is whether a debtor’s non-economic interest (e.g., management, governance, and voting rights) also becomes part of the estate, making the bankruptcy trustee a substituted member of the LLC. This would give the bankruptcy trustee the right to run the LLC and possibly use the LLC assets in the bankruptcy administration. Although most state LLC statutes and LLC operating agreements require the consent of remaining member(s) for a transfer of a member’s LLC interest, admission of a new member, or appointment of a manger, such restrictions do not seem to make much sense when there are no other members. Several bankruptcy courts have dealt with these issues, leading to a growing trend that makes a distinction between the remedies available to creditors of single-member LLCs and multi-member LLCs.
This will be a multi-part blog series on single-member LLCs and creditors’ rights. In our next post, we will look at In re Albright,[3] one of the first cases where a bankruptcy court held that a single member LLC has no charging order protection.
This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
Steps have been taken to verify the contents of this article prior to publication. However, readers should not, and may not, rely on this article. Please consult with counsel to verify all contents and do not rely solely on this article in planning your legal transactions.
About the Author
R. Shawn McBride – R. Shawn McBride is the Managing Member of The R. Shawn McBride Law Office, P.L.L.C., which helps clients in legal issues related to starting companies, joint ventures, raising capital from and negotiating with investors and outside General Counsel functions. Shawn can be contacted at: 407-517-0064; [email protected], or <a ” ” target=”_blank” href=”http://www.rshawnmcbridelaw.com”>www.mcbrideattorneys.com.
[1] In re Albright, 01-11367 ABC (Bankr. D. Col. 2003), at 3.
[2] 11 U.S.C. § 541(a).
[3] In re Albright, 01-11367 ABC (Bankr. D. Col. 2003).