Bankruptcy Questions Answered

What Happens To LLC Membership Interest In Chapter 7 Bankruptcy?

I received an email from a bankruptcy attorney with an interesting question about debtors’ interests in limited liability companies. The debtor and his non-filing spouse started a new business using a limited liability company. The debtor and his spouse do not have any joint debt. Here’s the question:

LLC membership interest provide asset protection outside of bankruptcy court. Most new small businesses are formed as limited liability companies rather than S-corporations to take advantage of the asset protection features as well as certain cost efficiencies. A creditor cannot levy upon a LLC membership interest. Florida statutes limit the creditor’s collection remedies to a lien on LLC distributions, if any. When a debtor files bankruptcy, however, the LLC provides much less protection. The bankruptcy trustee is not limited to a charging lien, and the trustee may seize as part of the bankruptcy estate a debtor’s LLC interest which is not otherwise exempt. (There may be some bankruptcy protection when the LLC is an executory contract). What will happen to the LLC interest owned by this debtor?

Nothing. The debtor will list his LLC interest at its current fair market value. The value of the debtor’s membership interest is not what he hopes the LLC will be worth in the future after years of his own hard work and a little luck, but the amount its worth today to an arms length buyer. Although the question does not reveal the nature of the LLC business I assume that without the debtor and his spouse investing their sweat equity the value of the LLC today is 0. The trustee is very unlikely to pursue an LLC interest with no present value to anyone but the debtor.

In addition, the debtor’s LLC interest may be exempt. The question as asked stated that the married couple owns the LLC together. I will assume that the two spouses own 100% of the LLC interest jointly. Florida law provides that all property, including intangible personal property such as an LLC interest, owned jointly by husband and wife is tenants by entireties property. T by E property is exempt in bankruptcy filed by one spouse where the two spouses have no joint unsecured debt. Because this debtor and his spouse have no joint debt the debtor’s interest in the jointly owned LLC interest is exempt as tenants by entireties. If each of these spouses owed a separate 50% of the membership interest the entireties exemption would not apply.