Single-Member LLC Bankruptcy: 5 Questions About the Membership Interest as an Asset

When the owner of a single-member LLC files a personal bankruptcy, the company does not enter the case; the owner's membership interest does, and the whole difficulty lies in deciding what that interest is. It is not the delivery van. It is not the receivables. It is a bundle of rights under a state statute and an operating agreement, some economic and some managerial, and the five questions below concern which of those rights the trustee receives and what they are worth.

A different case, the LLC's own filing, leaves the membership interest in the owner's hands and usually empties it: in a chapter 7 liquidation the company receives no discharge, and whatever survives the creditors goes last "to the debtor." The rest of this page concerns the owner's case, where the interest itself becomes an asset.

1. The Interest Enters the Estate Whatever the Operating Agreement Says

Section 541(a)(1) places in the estate every legal or equitable interest the debtor held in property when the case began, and section 541(c)(1) brings the interest in "notwithstanding any provision in an agreement, transfer instrument, or applicable nonbankruptcy law" that restricts its transfer, or that is "conditioned on ... the commencement of a case under this title" and works a forfeiture or termination. An operating agreement clause stating that a bankrupt member forfeits the interest does not keep the interest out.

What arrives, under Delaware's statute as one example, is personal property of a particular kind. Section 18-701 declares that "A limited liability company interest is personal property. A member has no interest in specific limited liability company property." The trustee receives the interest, not the company's equipment, accounts or lease. Those remain the company's.

2. State Law May Say the Owner Stopped Being a Member the Day the Petition Was Filed

Delaware's default rule, in 6 Del. C. 18-304, is that a person "ceases to be a member" when the member "Files a voluntary petition in bankruptcy," or has an order for relief entered against the member, "Unless otherwise provided in a limited liability company agreement, or with the consent of all members." In a company with one member, the consequence cascades. Section 18-801(a)(4) dissolves an LLC "At any time there are no members," unless within 90 days (or the period the agreement sets) the last member's personal representative agrees to continue the company, or a member is admitted under a provision of the agreement written for exactly that purpose.

Two federal provisions push against this. Section 541(c)(1) overrides provisions conditioned on the filing that forfeit or terminate the debtor's interest, and section 365(e)(1) bars terminating an executory contract after the case begins "solely because of" such a provision, subject to exceptions in 365(e)(2) for contracts that applicable law excuses the other party from performing with anyone but the debtor. Whether an operating agreement is an executory contract at all, whether a state statute's default rule counts as a "provision" in the relevant sense, and which rule prevails in a one-member company are questions the Code does not answer on its face; they turn on the particular agreement and the state statute behind it.

Whether a statute that dissolves a company because its only owner sought relief should survive a Code written to prevent exactly that forfeiture is a question worth holding.

The practical point is smaller and more useful. Delaware lets the operating agreement "otherwise provide." A single-member agreement that states the member does not cease to be a member on filing, and that names a successor who may continue the company, answers most of this in advance. An agreement drafted from a form and unread since the filing fee cleared is unlikely to say any of it.

3. The Trustee May Step Into the Member's Shoes, Not Merely Collect Distributions

An assignee of an LLC interest ordinarily receives economic rights only. Delaware's section 18-702 gives an assignee the right to share in profits and losses and "to receive such distribution or distributions" the assignor would have received, but "no right to participate in the management" unless the agreement provides otherwise or all members consent. In a company with other members, that limit protects the partners who did not file.

In a company with one member, there is no one left to protect. A Colorado bankruptcy court reached that conclusion in In re Albright, 291 B.R. 538 (Bankr. D. Colo. 2003). The debtor, the sole member, argued that "at best, the Trustee is entitled to a charging order and cannot assume management of the LLC." The court disagreed: "Because there are no other members in the LLC, the entire membership interest passed to the bankruptcy estate, and the Trustee has become a 'substituted member.'" It added that "In a single-member entity, there are no non-debtor members to protect. The charging order limitation serves no purpose in a single member limited liability company." The trustee was authorized to liquidate property the LLC owned.

A single-member LLC shields the company's assets from the owner's creditors. In the owner's own bankruptcy, the trustee may arrive as something closer to the owner.

Albright applied Colorado's statute and binds no other court. It is, all the same, a decision a trustee in a single-member case can be expected to cite, and an owner whose company holds real value should assume the argument will be made.

Chapter changes the picture. In chapter 13 the debtor "shall remain in possession of all property of the estate" under section 1306(b) unless the plan or confirmation order provides otherwise, so the member usually keeps running the company while plan payments reflect its value. In chapter 7 a trustee's duty is to collect and liquidate, and control of the company is what the trustee will want.

4. The Charging Order Limits the Owner's Creditors, and the Trustee Is Something Else

Outside bankruptcy, Delaware gives a member's judgment creditor a narrow remedy. Under section 18-703, a charged creditor "has only the right to receive any distribution or distributions," and the charging order "is the exclusive remedy," "whether the limited liability company has 1 member or more than 1 member." No creditor of a member may reach the company's property. Other states have written their statutes differently, and the governing state's text controls.

A funder holding a judgment on the owner's guaranty, outside bankruptcy, meets that wall. The trustee, inside bankruptcy, holds the interest itself under section 541 rather than a lien upon it, which is why Albright could treat the charging-order limit as beside the point.

5. The Interest Is Worth What the Company's Creditors Leave Behind

An interest in a company is worth the company's value after the company's debts. A restaurant LLC whose receivables are subject to a merchant cash advance funder's filed security interest, whose ovens secure an equipment loan, and whose lease is in default may carry an interest worth little, or, more precisely, worth whatever a buyer would pay for the privilege of waiting behind those creditors, and the trustee will weigh the cost of selling it. The owner's exemptions under section 522(b) may protect some value, and Delaware's section 18-703(c) preserves exemption rights in the interest, though the amounts depend on the exemption scheme that applies.

Where the Settlement Question Fits

For many single-member owners, the personal filing is driven by guaranties of the company's merchant cash advances. Delancey Street works on that debt by negotiation, and because the company is not a law firm, it does not advise on bankruptcy or on membership interests; it coordinates with independently licensed counsel where legal work is needed. A free, confidential initial review can show whether the guaranties might be resolved without the owner's case ever placing the interest before a trustee. An owner with substantial company value, a funder that will not negotiate, or guaranties beyond any realistic settlement needs bankruptcy counsel first, and the operating agreement should be on counsel's desk at the first meeting.

The single-member LLC is a wall with one door, and the owner holds the key. Bankruptcy is the one proceeding in which the owner has to hand it over.