LLCs and personal bankruptcy

August 6, 2008: 10:53 AM ET

When a majority owner goes bust, what happens next depends on the terms of the company's operating agreement.

David, CPM LLC, Baton Rouge, La.
If the managing member/majority owner of an LLC files for personal bankruptcy, does that managing member default his ownership shares in the LLC to the other two members?

By Shara Rutberg, Fortune Small Business contributor
Dear David: Two issues determine the answer: the terms of your operating agreement and the Louisiana state statutes.

"Look at the terms of your operating agreement that talk about what happens if there is a bankruptcy filing by a member," says Suzanne Saxman a partner in the Chicago office of Seyfarth Shaw and vice chair of the middle market and small business committee of the business section of the American Bar Association. "It could be termination of the LLC, dissolution of the company, or an option for other members to buy back that member's interest. But it's unlikely there will be a true forfeiture."

David Sokolow, a professor at the University of Texas School of Law who teaches business organizations agrees: "A member's interests [his financial stake] in the LLC is like any other financial asset, so it would be available to satisfy the claims of the members creditors," he says. Your operating agreement might also contain a right of first refusal, holding that if a member moves to sell their shares, they must offer it to the other members first.

"In Louisiana, when somebody files a personal bankruptcy claim, those shares become property of the bankruptcy estate, just as if they were shares of Exxon (XOM) or any other company," says Rudy Cerone, an attorney who specializes in business bankruptcy law at McGlinchey Stafford in New Orleans.

Those shares can then be sold for cash to satisfy creditors.

"There are some exemptions for personal, and in some states, real property for things like the clothes on the person's back, or other items to help give them a fresh start," Cerone says.

Give us your advice: Check out recent "Ask & Answer" questions.

Related links:

Business structures 101: LLC vs. S-corp

When bankruptcy looms

Getting a loan after bankruptcy

What an LLC does - and doesn't - protect

Join the Conversation
Search This Column
View all entries from this: Week, Month
Powered by VIP.