When an LLC collides with the bankruptcy court, is it
possible that an ironclad entity may look more like an egg shell? Is there a
bankruptcy chink in the LLC armor?
Surely, this cannot be. If a member files a personal chapter
7 bankruptcy petition, conventional wisdom dictates that the member's chapter 7
trustee will, at most, be a "transferee" of the member's economic interest with
only to distributions (if and when they occur). Nothing else happens.
Nothing more to the story and nothing for LLCs to worry about, right? Those from
the "show me" state would demand to see the case.
In In re Ehmann, 319 B.R. 200 (Bankr. D. Ariz. 2005), the
bankruptcy court held, with respect to an interest in a multi-member Arizona LLC
formed by the debtor's parents:
The LLC interest is a "property" right giving the chapter
7 trustee broad powers.
Because the LLC interest is "property" of the estate, state law and contract law
restrictions and limitations are unenforceable against the
The trustee has all of the rights and powers the debtor
had as a member.
Appropriate remedies available to the trustee
include, among others, an appointment of a receiver to take over and operate the
LLC and even the dissolution and liquidation of the entity.
While the dispute was eventually settled (and subsequent
order withdrawn, 337 B.R. 228 ), this bankruptcy court had little
difficulty bulldozing conventional wisdom and granting extraordinary rights and
powers to an unknown chapter 7 trustee.
Don't be blindsided by a member's bankruptcy. Is a solution
possible? For an answer, see the next LLC Alert.
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.