Chapter 7 Bankruptcy for LLCs: Everything You Need to Know

If your limited liability company (LLC) is going out of business due to financial challenges, or has a lot of business debts, filing for a Chapter 7 bankruptcy may be a good option for you.

When an LLC files for bankruptcy, a trustee will step in to liquidate the remaining business assets, which will then be used to pay creditors.

How Does Bankruptcy Work for LLCs?

As soon as a bankruptcy petition is filed, the business will stop operating and an automatic stay will take effect. An automatic stay prevents creditors from coming after the company's assets.

When an LLC files for bankruptcy, the bankruptcy trustee will liquidate all the company's assets and distribute them to creditors. This will be done according to the priority stipulated in the U.S. Bankruptcy Code.

Filing for a Chapter 7 bankruptcy will ensure a number of things, including:

  • Assets are fairly distributed among creditors
  • Collection efforts by creditors are stopped
  • The chances of any lawsuits being brought by creditors are minimized

Unlike in a personal bankruptcy, there are no property exemptions when a small business files for bankruptcy. You should also note that LLCs don't receive a debt discharge. A discharge will not be necessary because the company will cease to exist after liquidation, making it impossible for creditors to collect any remaining debts.

Personal Liabilities in Business Bankruptcy

Since an LLC is a separate business entity from its owners, the debts of the company will not pass on to the owners.

There are, however, some special circumstances where you may be personally liable for the debts incurred by the LLC. These include:

1. You Have Debts With Personal Guarantees

If you give a personal guarantee to the business debt, you will be personally liable. So, even after the business receives debt relief, creditors can still come after your assets. It is, therefore, very important that you carefully review any debt agreements you sign on behalf of the LLC.

2. You Incurred Personal Credit Card Debt

If you took out loans or used your credit card to pay for the business, you will be personally liable for those debts.

3. You Are Liable for the Debts by Law

The law requires owners to be liable for certain debts the LLC incurs. These include unpaid employment and payroll taxes. You may also be personally liable for unpaid sales tax.

4. You Failed To Keep Business and Personal Finances Separate

If you fail to keep your personal and business finances separate, creditors may come for your personal property. If creditors can show the bankruptcy court that you failed to comply with the formalities imposed on LLCs by state law, you can be held personally liable for the debts of the LLC.

5. You Face Fraud and Alter Ego Claims

If a creditor can prove that the LLC was a sham or that you have fraudulently attempted to hide money from creditors, they can come after your personal assets under the "piercing the corporate veil" theory.

If you find yourself personally liable for the debts of an LLC, you can also consider filing for personal bankruptcy to discharge any personal liability you may have.

How Much Does It Cost To File for Chapter 7 Business Bankruptcy?

The court fee to file bankruptcy is $335, the same as when you file for personal bankruptcy. However, attorney's fees will be an added cost to you as it is very difficult to file for a business bankruptcy without the assistance of a bankruptcy lawyer.

The cost of attorney's fees will depend on several factors like:

  • The company's sources of income
  • The number of creditors
  • Whether there is a lawsuit brought by the creditors to pierce the corporate veil

What About Partnerships?

Unlike LLCs, a partnership is not a separate legal entity. This means the business owners will be personally liable for the debts of the company. Therefore, it is highly unlikely that a partnership will file for Chapter 7 business bankruptcy.

Other Options for the LLC

There are also other options for small business owners of LLCs who are facing financial hardships. These include:

Out of Court Negotiations

If your creditors agree, you can try to negotiate a payment plan that would allow you to keep the LLC going. You should try to convince creditors that your proposed plan will offer them something better than what they would receive had the LLC declared bankruptcy.

Filing a Chapter 11 Bankruptcy

If the LLC members want the business to continue operating despite the debts, filing for a Chapter 11 can be an option. A Chapter 11 bankruptcy will allow the business to reorganize and will give the business owners a longer period of time to pay the company's debts.

The court and the creditors will need to review and approve your plan of how and when you expect to pay your debts.

Planning to File a Chapter 7 Business Bankruptcy? Speak to a Bankruptcy Attorney

You will need to have extensive knowledge of the laws and procedures of bankruptcy if you are planning on filing a Chapter 7 business bankruptcy. Since bankruptcy will have long-term legal and financial outcomes that will affect you and your business, you should consider speaking to an attorney to handle your business bankruptcy case.