A LLC is a for-profit company that is owned by its shareholders. It enjoys limited liability, which means that the maximum liability of each of its owners is limited to their investment in the shares of the company. In case the LLC declares bankruptcy, the personal assets of its owners cannot be sold to pay the debts. The LLC status makes the company separate from its owners.
However, there can be a few cases where the owners’ personal assets can be used to pay off company debt. Such exceptions occur when:
1. The company owners personally guarantee the business debts. Also, if the company has accumulated heavy credit card debt, then the owners may be personally liable because the fine print in most credit cards specifically covers such a situation.
2. Some state laws may hold the owners personally liable for company debts. For example, laws in some states hold company owners personally liable for unpaid employment taxes.
3. If the LLC owners have mixed up their personal finances with the company’s then there can be a case for making the company liable. For example, receiving money in personal name on behalf of the company, paying creditors from a personal account instead of issuing a company check.
All company owners must treat the company as a separate entity, and this can help protect their personal assets in case their LLC goes bankrupt. When a LLC goes bankrupt, its owners have two choices – file for bankruptcy under Chapter 7 or under Chapter 11.
Chapter 7 is intended for companies that have absolutely no future. The business should have reached such a state that no matter how hard the company tries, it can never get back to its profit days. This can be because their cash flow is insufficient to meet their operating expenses and the company is buried under debt; it may be because the competition has wiped the company’s product off the shelves. Whatever the reason may be, a LLC that sees no future may file for bankruptcy under Chapter 7. The petition is filed in a bankruptcy court that has jurisdiction, and the court appoints a case trustee who determines the company’s assets that can be sold. Such assets are sold and the money realized is distributed among creditors. After the bankruptcy case is closed, the LLC ceases to exist.
A LLC that is under a mountain of debt, but has a profitable product line, can file for bankruptcy under Chapter 11. Chapter 11 enables the company to reorganize its business and pay off its debts over a long period. The LLC can keep going at its business and generating profits while paying off creditors over the stipulated period. The LLC has to file a reorganization plan with the relevant bankruptcy court, get it approved from a majority of its creditors, and then execute the plan as per its terms. Any default of any of the terms means that the bankruptcy has failed. If the company sticks to the plan, it becomes debt-free after the plan is completely executed.
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