LLC Bankruptcy: What Happens if a Company Goes Bankrupt?

Delina Chantel Yasmeh
Published by Delina Chantel Yasmeh | Author
Last updated: February 7, 2024
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If your limited liability company fails in its business endeavor, the company may have to file for bankruptcy. The process will allow you to minimize losses and have a fresh start.

As a Mergers and Acquisitions specialist and master’s degree holder in tax law, I’ve assisted business owners and entrepreneurs throughout the process of filing LLC bankruptcy.

After consulting our team of lawyers, we’ll provide a comprehensive guide on how to handle the bankruptcy without exposing your personal assets to liability.

Quick Summary:

  • If a company goes bankrupt, the LLC's remaining debts are settled by liquidating the business assets. 
  • In certain circumstances, liability may be extended to the members’ personal assets.
  • There has been a 17% increase in total bankruptcy filings in January 2024.
  • I strongly advise my clients to open a separate business bank account to protect their personal assets in cases of lawsuits and bankruptcy.

What Happens to the Debts and Liabilities of an LLC in Bankruptcy?

The debts and liabilities of an LLC in bankruptcy are typically handled within the bankruptcy proceedings.

It's important to note that an LLC is a separate legal entity, and in most cases, the personal assets of LLC owners are protected from the LLC's debts [1].

The treatment of debts and liabilities in an LLC's bankruptcy depends on the specific bankruptcy chapter filed and the relevant laws.

It's essential to consult with legal experts to fully grasp the implications of a specific LLC's bankruptcy situation.

Bankruptcy – the safety net that society provides us when we get in over our heads and the gift of a fresh start – the new beginning of the rest of our lives.

Personal Liability

The personal assets of LLC members are typically protected under state law, but there are circumstances in which they may be seized to settle the company's debts.

These include the following:

  • Signing personal guarantees to acquire loans or enter into contracts
  • Offering personal assets as collateral. In my experience, financial institutions require collateral especially for new businesses to serve as security on the loan.
  • Using your personal credit card to make business purchases
  • Debts resulting from fraud

If your LLC remained compliant during its operations and kept business funds separate, your personal assets will be protected from creditors.

To protect your personal assets, you have the option to file for personal bankruptcy.

To file a personal bankruptcy petition, you need to submit the following:

  • Proof of Identification: You should provide at least two forms of identification showing your correct name and address. Examples include a driver's license, passport, government-issued identification card, and Social Security Number.
  • Bank Statement for the Past 60 Days: This is to show that you have no money in the bank before the bankruptcy filing.
  • Recent Paystubs or Documentation of Unemployment: You should verify that you are not employed, working part-time, or have an income below the poverty thresholds set by the Federal Government for your household size.
  • Copy of Tax Return from the Past 3 Years: This is to show that you're not overpaying and making more than required.
  • Summary of Debts and Assets: You should attach a summary of business assets and debts, including the filed bankruptcy petition.

How Does Bankruptcy Affect Credit?

A woman managing files for bankruptcy

Bankruptcy can affect credit scores, as people who file for bankruptcy will have their accounts put up for collection by the credit bureau as part of the process.

This lowers your credit score because you will have a smaller line of available credit remaining, making it harder to get loans.

Declaring bankruptcy for debts may have a lesser impact on your credit score compared to personal bankruptcy.

Even though the procedure itself may not heavily affect your scores, the debts that led to the situation could remain on your credit report for seven to ten years.

This will harm your credit score, so I remind clients and business owners to be proactive about getting rid of debts before they get out of control [2].

Liquidation Bankruptcy

This type of bankruptcy is filed because the business has accumulated debt that exceeds the income of the company. Also referred to as Chapter 7 bankruptcy, the process involves liquidating the company’s assets to settle debts as well as cessation of the business.

It offers individuals a chance to eliminate various debts by selling non-exempt property.

A bankruptcy trustee will be appointed by the court to oversee the settlement proceedings by following the U.S. Bankruptcy Code.

One of the best things about filing for liquidation business bankruptcy is that it's fast, and you only have to disclose your name, address, and social security number.

You will include other information on the petition, but there are no legal documents or forms to fill out before submitting it.

In most cases, debtors do not need to attend court unless requested by the bankruptcy trustee.

Importance of Dissolving an LLC After Filing for Bankruptcy

Files scattered on the floor

After filing for bankruptcy, I inform business owners the importance of properly dissolving their LLCs.

Since the state still recognizes the existence of the company, the business will be required to continue paying annual reports, as well as franchise and income taxes.

Failure to voluntarily dissolve the LLC will result in tax implications, fines, and penalties.

Here are the steps for dissolution:

  • Consult your LLC’s operating agreement. The provision indicated in the document will specify the dissolution procedure and voting requirements.
  • The members should hold a meeting and vote on the dissolution.
  • File your final tax return to obtain clearance from the IRS.
  • Prepare and submit the Articles of Dissolution to the Secretary of State or its equivalent agency.
  • Cancel all licenses and permits, as well as business registrations from other states.

FAQs

What Happens to Debt When LLC Is Dissolved?

When an LLC is dissolved, the debts are settled by liquidating the company’s assets before it officially terminates operations.

Can a Company Come Back After Bankruptcies?

A company can come back after bankruptcies by filing Chapter 11, which enables the LLC to reorganize and have more time to settle its debts.

LLC Bankruptcy

LLC bankruptcy is a complex process that requires a thorough understanding of the legal implications and potential consequences for both the company and its owners.

When a company goes bankrupt, it is essential to comprehend what happens to its business assets and how they are distributed.

This is why it's important to provide valuable insights into what happens to the assets of a dissolved company, to make navigating LLC bankruptcy easier.

By leveraging expert knowledge and reliable information, business owners can make informed decisions and mitigate risks during this challenging period.

References:

  1. https://www.irs.gov/irm/part5/irm_05-001-021
  2. https://www.cnbc.com/select/what-is-a-credit-score-and-how-to-check-yours-for-free/

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