Could You Please Clarify Business Versus Personal Assets/Debts With Regard To Liability, Protection And Bankruptcy?

A couple questions:

1. An LLC protects your personal assets from business debts/lawsuits, etc; does it also protect your business assets from personal debts/lawsuits, etc? (Could a creditor from a personal account seek compensation from your business?)

2. The same questions w/regard to bankruptcy: If you personally file bankruptcy, can you leave your LLC in tact & untouched (including assets)? And, how does that work in the event of business debts or loans that have been personally guaranteed? (Are these discharged as personal debt within the personal bankruptcy – still leaving the business in tact – or do they expose your entire business to risk by connecting the two?

Answer

These are fairly complicated questions, but here’s the overview:

1. Your ownership in the LLC is a personal asset of yours. Think of it like a stock. If you own GM stock, GM’s creditors can’t come after your house simply due to your ownership.

On the other hand, a personal creditor of yours can seize your assets, including your GM stock.

However, your membership interest in an LLC is somewhat different from owning stock in that your LLC’s operating agreement can have provisions in it which prevent a creditor who seized your interest from exercising any control over the LLC.

In other words, the personal creditor would “own” the LLC interest in the sense that the creditor would receive any profit distributions (this right of the creditor is called a “charging order”), but could not control the operations of the LLC.

This has an interesting application. Remember how LLCs are pass-through entities? That means that the owner owes taxes on the LLC’s profits, regardless of whether the LLC pays out any money to the members.

Normally, of course, the members will pay themselves out all the profits, or at least enough to cover taxes.

However, if a creditor has taken over your LLC interest, the remaining members could do something very sneaky to the creditor.

They could cause the LLC to recognize profits (say, by selling an appreciated asset), but NOT distribute any money to the members.

Thus, the creditor would owe taxes on his share of the profits, but would receive no money to pay them with.

2. Bankruptcy would be similar to the above, but with the extra complications of bankruptcy law. You’d really need to talk to an attorney about this one.

There is some case law that says that a single member LLC owner who goes bankrupt might be in a worse position than if a member of a multi-member LLC declares bankruptcy with regards to control of the LLC, but again, you’d need to speak with an attorney.

Back To LLC Questions & Answers