Dissolving an LLC With Debt: 9 Decisions Before Closing the File

LLCs (limited liability companies) are simple to form and run - but not so simple to dissolve. Articles of dissolution, once filed, finalize the process. And before they’re filed, dissolving an LLC with debt raises some challenging legal decisions. An LLC’s dissolution doesn’t negate its debt. Once the LLC is dissolved, all money remaining in the business must go toward repaying its creditors. The LLC won’t have any new money coming in, so its creditors know they’ll have to fight over whatever remains.

So dissolving isn’t just a bunch of paperwork and an event. The decision to dissolve starts a chain of other decisions. You have to make sure creditors are paid first - even if it eats up all the money you’ve contributed. You have to be careful when taking or returning money to the business after you’ve decided to dissolve. And debts from taxes, loans, or distributions could follow you beyond the life of the company. Dissolving an LLC with debt involves nine decisions.

Whether the Business Is Viable

The first, most fundamental decision is whether the business is viable - whether it can survive and thrive once the debt is managed or resolved. If yes, bankruptcy can keep it operating under Chapter 11 or Subchapter V. If not, the only option is liquidation. Traditional Chapter 11 reorganization is often unrealistic for smaller businesses, with its fees, red tape, bureaucracy, and publicity. Subchapter V helps some of them.

Only filing for bankruptcy can instantly stop a lawsuit or foreclosure. Weigh carefully if you need it now, or can get your house in order before closing shop.

How nasty are your creditors? Is this likely to be a dust-up, or World War III? Creditors sometimes escalate the litigation, fight over your assets, and chase debt collection. If that’s likely, filing for Chapter 7 bankruptcy can be a wise move. The cost and complexity of the Chapter 7 process can mean it’s not worth it for an orderly, cooperative wind-down. If creditors can agree to work together, an assignment for the benefit of creditors gives you the most control over the process.

Who’s Going to Manage the End of the Show

The next thing to decide is who’s going to run the show, or, to be clear, who’s going to manage the end of the show. If you file an assignment for the benefit of creditors, you decide who it gets assigned to, and they take over and settle accounts. Some assignees are better at selling a going business and getting as much for it as possible, but you need to pick the right one. The Chapter 7 trustee is bound to fulfill the legal duties of the role. Depending on the business, they may break it down and liquidate it, instead of selling it as an ongoing enterprise. It might feel like a tough call, but an assignment for the benefit of creditors is generally quicker and cheaper, with more privacy.

Control has its price: any assignment for the benefit of creditors means fees for the assignee. This money can come out of any proceeds of the LLC’s assets, or if they don’t go far enough, the LLC has to get cash for the costs some other way. An assignee can be paid up front by the owners or managers.

In Chapter 7, an LLC doesn’t get a discharge, unlike an individual filer. And if you personally guaranteed any debts, you can still get stuck with them.

Where do secured lenders stand? A lien can follow collateral even after it leaves the business. Although an assignment for the benefit of creditors doesn’t involve an automatic stay of secured lenders, they’ll sometimes be satisfied with quicker payments. An underwater lender may still want a fast sale. Some secured debts can stop an assignment for the benefit of creditors in its tracks. If the lender who owns the collateral won’t go along with the plan, an ABC is the wrong tool.

An assignment for the benefit of creditors is a serious move, transferring almost all the company’s assets. Usually, the board needs to approve it, and the members need to sign off on it. Written consent might be needed for leases and contracts. The other parties might go along with the plan, or they might not. A creditor could file an involuntary bankruptcy petition. But with an orderly, transparent ABC, dismissal arguments can be strong. This scenario is usually less likely than many owners fear.

A personal guarantee makes sure you’ll repay a debt, even if the business doesn’t. If you sign a personal guarantee, your promise to repay will outlive your LLC. An assignment for the benefit of creditors doesn’t protect the guarantor of the loan. Same with Chapter 7. Same with Chapter 11. Personal guarantees can be negotiable, but don’t try it as an afterthought. And beware: SBA loans generally require guarantees from owners of 20 percent or more. Map out your guarantees early and decide how to handle them. Some lenders might be happy enough with a reasonable payoff without a lot of publicity and drama.

Employment Taxes

Unpaid employment taxes are a special class of liability. If the business can’t pay, the IRS may assess a trust fund recovery penalty against responsible people who willfully fail to pay. If you pay creditors before you pay employment taxes, that’s a red flag for willfulness. If the IRS comes after you, you’ll have 60 days to appeal from the date of its letter.

More broadly, pay creditors first - that’s Delaware law. Most states say essentially the same thing: Don’t take money out of the business before creditors are paid. You’re legally required to maintain a reserve for claims likely within the next 10 years. And members who take money knowing it’s improper have to repay it, for up to three years.

And last, formally dissolve the LLC in every state where it’s registered to do business. It may still owe taxes or have filings required until it’s formally dissolved. The IRS won’t close an EIN until it’s certain all tax returns have been filed and taxes paid. Keep employment tax records for at least four years. One more tax trap: If a lender forgives a debt, that canceled debt counts as taxable income unless an exclusion applies. Insolvency exclusions apply only to the amount by which debts were more than assets, just before the debt was settled.

Waiting won’t give you more options; it’ll keep taking them away. The sooner you look at the hard questions, the more room you’ll have to maneuver and decide.