Can an LLC File Chapter 7 Bankruptcy? Process and Options Explained

LLC owners have several options beyond Chapter 7, including simply dissolving the LLC, filing personal bankruptcy instead, reorganizing under Chapter 11, or negotiating with creditors outside of bankruptcy. The right choice depends on the LLC’s assets, your personal liability, and your business goals.

If your limited liability company (LLC) is facing financial challenges, understanding your bankruptcy options is critical. Read on for more information regarding Chapter 7 bankruptcy for an LLC and your alternatives. If you’re still not sure, consider speaking with a bankruptcy attorney.

Can an LLC File for Bankruptcy?

The short answer is yes, an LLC can file for bankruptcy. Any LLC may file, including small-business LLCs and single- and multi-member LLCs.

When an LLC files a business Chapter 7 bankruptcy, it differs from a personal filing. An LLC that files a Chapter 7 is liquidated without other negotiations. All assets are sold to pay secured debts. There is no discharge of unsecured debt because the LLC no longer exists.

LLCs that wish to continue operation as functional entities should consider reorganization or other alternatives. The Chapter 7 liquidation completely terminates the LLC as an operating business.

An LLC cannot file a Chapter 13 bankruptcy. These repayment plans are designed for individuals who need to pay off their debts over time. Small business owners who want to keep their businesses and repay their debts need a Chapter 11 reorganization instead.

A partnership is not a separate legal entity. Business owners in a partnership, like a sole proprietorship, are personally liable for the company’s debts. A partnership would not file for a Chapter 7 business bankruptcy, even if the partners file for personal Chapter 7 bankruptcies.

How Does Bankruptcy Work for LLCs?

When an LLC files for bankruptcy, the company stops operating, and an automatic stay takes effect. This prevents creditors from coming after the company’s assets. A bankruptcy trustee will liquidate all the company’s assets and distribute them to secured creditors. This will be done in accordance with the priority provisions of the U.S. Bankruptcy Code.

Filing for a Chapter 7 bankruptcy ensures several things, including:

• The LLC assets are fairly distributed among creditors
• Collection efforts by creditors will be stopped
• There’s a minimized chance of any lawsuits being brought by creditors

There are other advantages that may apply in certain situations.

How LLC Chapter 7 Differs From Personal Bankruptcy

A personal bankruptcy provides the debtor with a “fresh start” upon the completion of the bankruptcy process. In an LLC bankruptcy, those protections do not exist. LLC owners should realize that when they prepare to file a Chapter 7, this is not debt relief and a new start. The bankruptcy process will instead end the business’s operating interest.

Any existing unsecured creditors cannot collect on remaining debts, as the company will no longer exist. They may be able to file lawsuits against the company’s individual owners. A discharge is not issued because the filing entity (the LLC) no longer exists.

Since the LLC has no living expenses or personal property, there are no exemptions. Business assets and property are not exempt in an LLC Chapter 7. All assets and property will be taken and liquidated. The bottom line is that when an LLC files a Chapter 7, the owners will have nothing left when the trustee is done.

When Chapter 7 Makes Sense for an LLC

When would a limited liability corporation want to file a Chapter 7 bankruptcy? It’s a good question. Let’s examine the pros and cons.

When LLC Chapter 7 IS the Right Choice

You may want to consider a Chapter 7 and complete liquidation when:

• Your LLC has many creditors and complex debts
• The creditors have become aggressive with debt collection, have begun or won lawsuits, received judgments, or are threatening asset seizure
• You have significant assets to liquidate and are unlikely to sell or reuse them yourself
• There is a risk of fraudulent transfer claims because of the nature of the business

Suppose you and your partners have a startup pizza restaurant. You purchased a good deal of specialized equipment, including brick pizza ovens, kitchen fixtures, furniture, a point-of-sale receipt system, and high-definition TVs for the sports bar.

Alas, your pizza bar was not as profitable the first two years as you needed to pay off your loans. Selling pizza ovens and niche restaurant furniture is not something you know how to do. Some of your creditors have suggested the reason you can’t make a profit is that one of your former partners siphoned off all the money when they left to open a pro surfing shop in Hawaii.

Under these circumstances, a Chapter 7 is probably a good option. Your debts are more than you can unravel yourself and have reached a point where you can’t pay them off. Your assets will require special handling to pay off your secured creditors, and you’re going to need legal assistance to disprove any alleged fraud.

When LLC Chapter 7 Is NOT the Right Choice

You do not want to file a Chapter 7 if any of the following apply:

• Your LLC has almost no assets
• You are the only debtor (in a single-person LLC)
• All debts have personal guarantees
• You want to keep the business operating after the bankruptcy

It’s common for solo practitioners to create an LLC to protect their personal liability. For example, let’s say you are a financial consultant and run your business out of a separate room in your house. Your business assets consist of a laptop and a briefcase. With clients paying you many months after you render services, you’ve fallen behind on your business and personal debts. Your business debts mainly include travel expenses, computer subscriptions to keep your software up to date, and occasional seminars for your continuing education.

In this case, a Chapter 7 would be a very bad idea. Selling your assets would get your creditors nothing, and shuttering your office would wipe out your ability to pay. You need a repayment plan, not a liquidation.

When You May Still Be Personally Liable for LLC Debts

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:

Personal Guarantees

If you give a personal guarantee for the business debt, you will be held liable. Even after the business receives debt relief, creditors can still come after your assets. It’s very important to review any debt agreements you sign on behalf of the LLC.

Some common personal guarantees include:

• Commercial leases (landlords almost always require a personal guarantee)
• Bank loans and lines of credit
• Business credit cards
• Equipment financing
• Major supplier accounts

Taking on a personal guarantee increases your responsibility. If you personally guaranteed your LLC’s $5,000/month commercial lease for 3 years but filed Chapter 7 and closed after 12 months, you’re still personally liable for the remaining lease payments.

Personal Credit Cards or Loans Used for Business

If you took out loans or used your credit card to pay for the business, you will be personally liable for those debts. These debts are in your name, and you provided personal assurance that you would repay them.

Even if you spent money on behalf of the business and noted it as a business expense for tax purposes, the debt remains your personal debt. This means you should use a business credit card for business expenses and have the company reimburse you for those expenses on a personal credit card.

Certain Debts You’re Liable for by Law

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

Businesses collect point-of-sale taxes and withhold FICA, Medicare, and employee withholding taxes, reimbursing the government on a quarterly basis. This is known as a “trust fund” since employers and business owners hold the money “in trust” for the government and their workers. If your business does not pay the taxes because of bankruptcy, you are personally liable to repay them to the government. If your LLC collected $15,000 in sales tax from customers but didn’t pay it to the state, you’re personally liable for that money even if the LLC dissolves.

Commingling Personal and Business Finances

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.

Red flags that lead to personal liability include:

• Using an LLC bank account to pay personal expenses (mortgage, groceries, etc.)
• Using a personal bank account to pay LLC expenses
• Never maintaining separate bank accounts
• No LLC operating agreement
• No corporate records, minutes, or documentation
• No annual meetings or formalities
• Treating LLC assets as your personal property

Courts may find the LLC is just your alter ego and disregard the corporate form, holding you personally liable for all LLC debts.

Fraud or “Piercing the Corporate Veil“

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.

Courts may pierce the corporate veil if:

• LLC was severely undercapitalized from the start (formed with almost no money)
• Completely ignored corporate formalities (no records, agreements, meetings)
• Used LLC to evade existing personal obligations or debts
• Made fraudulent transfers or misrepresentations to creditors
• Treated LLC as your personal piggy bank

If you formed an LLC and immediately transferred personal assets into it to avoid paying a personal creditor before filing for LLC bankruptcy, a court may find it fraudulent. If so, it will hold you personally liable.

If You’re Personally Liable for LLC Debts

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. Filing bankruptcy for the LLC won’t protect you from personal liability. You may need to file:

• Personal Chapter 7 (if your income qualifies under the means test)
• Personal Chapter 13 (if income too high for Chapter 7)
• Both LLC and personal bankruptcy (if LLC has assets worth liquidating AND you have personal liability)

An attorney can help you determine the best strategy based on your specific situation.

LLC Options for Bankruptcy

Nobody wants their LLC to fail and be forced to file for bankruptcy. It’s important to know when you should file under the company or personally.

File LLC Chapter 7 Bankruptcy If:

• You have many creditors and complex debts
• You have significant assets
• You are facing litigation and aggressive collection action

An LLC Chapter 7 filing might be best if you have many creditors, complicated debts, and substantial assets with limited use outside your business. Liquidation may offer the wisest option if this situation.

File Personal Chapter 7 Bankruptcy If:

• You meet the means test, and your income is below the state median
• You have significant personal liability and personal guarantees on your debt
• You have few assets and want to keep your business open

Having significant debt, with most or all of it carrying your personal guarantee of repayment, means that a business bankruptcy won’t help you much. A personal bankruptcy won’t affect your business operations, but it will clear some of your personal debt. This can free up income to pay off your other business debt.

File BOTH LLC and Personal Bankruptcy If:

• You meet the criteria for a personal bankruptcy
• You have significant personal assets or property tied up in the business
• A reorganization is not possible

If you have a personal stake in the business and are a creditor as well as a debtor, you may need to file both types of bankruptcy to protect your personal assets. A bankruptcy attorney can explain what you should do in situations where the business may owe you money that has not been repaid.

Alternatives to LLC Chapter 7 Bankruptcy

Because a Chapter 7 ends the business, leaves the owners with nothing, and may allow creditors to reach into their personal finances despite the LLC’s protections, owners may want to consider other alternatives to filing a Chapter 7. Let’s examine other possibilities.

Chapter 11 Reorganization

If the LLC members want the business to continue operating despite the debts, filing for 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.

Dissolution

LLCs can’t just pack up and close the doors. They must go through a process called dissolution. Dissolution is a legal process of closing down the LLC, notifying employees, settling with any vendors and outstanding clients, and paying any final debts or negotiating last bills.

Out-of-Court Negotiation with Creditors

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

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

The court fee to file for bankruptcy is $338, the same as when you file for personal bankruptcy. Attorneys’ fees will be an added cost. It’s difficult to file for a business bankruptcy without a bankruptcy lawyer’s help.

A Chapter 7 filing costs $338 if you only file the documents. Attorneys typically charge $2,000 for a personal bankruptcy. For an LLC filing, costs may range from $2,000 for a simple business such as a private consulting firm to more than $10,000 for a complex LLC with multiple creditors.

Factors that can increase your attorney fees include the number of creditors and what you owe. If your financial records are in poor condition, the fees will increase, since it will take more time to assemble the documents.

If any of the creditors file adversary proceedings to challenge a debt discharge, the costs increase. Adversary proceedings and other court appearances increase the attorneys’ fees.

When You Need a Bankruptcy Attorney for LLC Bankruptcy

If you are considering a Chapter 7 LLC bankruptcy, consider hiring an attorney. Bankruptcy is filed in federal court, but each state has its own rules (called “local rules”) about exemptions and how debts and assets must be presented.

For complex asset and debt situations, you should at least consult a bankruptcy attorney before filing:

• There is real property owned in the LLC’s name
• You have intellectual property or patents
• You have outstanding accounts receivable
• There are concerns about commingled finances or piercing the corporate veil
• You have questions about filing an LLC bankruptcy, personal bankruptcy, or other options
• There are disputes between LLC partners

If you made any recent money transfers or sold any property, getting legal advice is a good idea. Income and transactions like these can suggest that you were concealing assets, even if you weren’t. An attorney can explain how you need to account for these transfers during your bankruptcy.

Your attorney will also represent you in any adversary proceeding and during the meeting of creditors. Since bankruptcy will have long-term legal and financial outcomes that will affect you and your business, consider reaching out to a business bankruptcy attorney to manage your LLC bankruptcy case.