Chapter 7 Bankruptcy for LLCs: Everything You Need To Know
By Maddy Teka, Esq. | Legally reviewed by Bridget Molitor, J.D. | Last reviewed November 08, 2023
This article has been written and reviewed for legal accuracy, clarity, and style by FindLaw’s team of legal writers and attorneys and in accordance with our editorial standards.
The last updated date refers to the last time this article was reviewed by FindLaw or one of our contributing authors. We make every effort to keep our articles updated. For information regarding a specific legal issue affecting you, please contact an attorney in your area.
If your limited liability company (LLC) is going out of business due to financial challenges or has many business debts, filing for a Chapter 7 bankruptcy may be a good option for you.
Upon an LLC bankruptcy filing, a trustee will step in to liquidate the remaining business assets, which will then be used to pay creditors.
Read on for more information regarding your Chapter 7 bankruptcy options for an LLC.
How Does Bankruptcy Work for LLCs?
As soon as a bankruptcy petition is filed, a corporation or LLC 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 ensures several things, including:
- That LLC assets are fairly distributed among creditors
- That collection efforts by creditors are stopped
- A minimized chance of any lawsuits being brought by creditors
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, unlike a sole proprietorship, the company's debts will not be passed 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. So, it's 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 separate your personal and business finances, 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. But attorney's fees will be an added cost. It's difficult to file for a business bankruptcy without a bankruptcy lawyer's help.
The cost of attorney's fees depends on several factors:
- The company's sources of income
- The number of creditors
- Whether the creditors bring a lawsuit 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 liable for the company's debts. So, it's 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 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 your proposed plan will offer them something better than what they would receive had the LLC declared bankruptcy.
Filing for Another Type of 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 give business owners a longer period to pay the company's debts.
The court and the creditors must review and approve your plan of how and when you expect to pay your debts.
An LLC cannot file for Chapter 13 bankruptcy.
Speak to a Bankruptcy Attorney for Legal Advice Regarding Your Chapter 7 Bankruptcy Case
You'll need a lot of knowledge of bankruptcy laws and procedures if you plan 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.