Is it possible that something as remote as a bankruptcy
petition filed by one member can wreak havoc with your LLC?
Generally, an LLC is a hybrid entity that has some
characteristics of a corporation, yet is treated as a partnership for federal,
state and local tax purposes and for determining the existence of federal
district court jurisdiction (see related article),
among others. Treatment as a partnership adds enormous complexity that can be
ignored at the LLC's peril.
Overlay the possible implications of the LLC or a member
filing a bankruptcy petition, and the problems and risks multiply exponentially.
If an individual member files a chapter 7 bankruptcy
petition, I can think of two misconceptions when LLCs and the bankruptcy courts
collide over the LLC member's bundle of economic/voting/management rights:
The clauses/restrictions/limitations in an LLC operating
agreement that become effective on, or triggered by, the filing of a
bankruptcy petition are valid, binding and enforceable in bankruptcy court.
When an individual member files a personal bankruptcy
petition, (a) a member's LLC interest will not become property of the
bankruptcy estate, subject to the powers of a chapter 7 trustee; (b) even if
a member's interest is property, a chapter 7 trustee will be prevented from
taking any action as a member because of the limitations/restrictions found
in the LLC's operating agreement; and (c) no bankruptcy court in Arizona has
allowed a trustee to step in and exercise member powers.
The answers — and the powers of the bankruptcy
court — may surprise. My next LLC Alert will explain.
Don't be blindsided by an individual member's bankruptcy.
Article © Fred Witt 2014. All Rights Reserved.
Disclaimer: This alert is
provided for general information only and is not intended to constitute legal
advice. Please consult with your own legal advisor before making any decisions.