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

Property of the Estate

When a person files a bankruptcy petition, all of their property of every kind becomes property of the estate, which is then managed by a trustee. Since a debtor’s interest in a company is an asset, the trustee may take it over or sell the debtor’s interest in the company. If it’s a single-member LLC, the trustee can step into the shoes of the owner as the only member and control the LLC, including making it sell its property.

The 2003 Colorado bankruptcy case, In re Albright, illustrates this point. There, the LLC was owned by a single member. When the owner filed Chapter 7 bankruptcy, the Chapter 7 trustee managed the bankruptcy estate. The trustee became the successor-in-interest to the LLC member’s interest in the LLC. The court then held that the trustee as sole member of the LLC had the rights to operate the LLC and, in effect, could have the LLC sell its property and pay the net proceeds to the bankruptcy estate.

Outside bankruptcy, a judgment creditor’s collection efforts are usually limited to a ”charging order” that assigns distributions to them (a lien that routes distributions to the creditor). But the state charging order rules do not bind a bankruptcy trustee the way they do a judgment creditor. The idea behind the charging order limit is to protect other members. But if your LLC has only one member, there’s nobody to protect. In re Albright, cited above, is frequently cited, but that holding is not binding on other courts.

In LLCs with more than one member, the law gets a little tricky, and the courts are split. Though some courts have granted the trustee all the member rights, including management, others give only distributions. In Albright, the court said that if the LLC has more than one member, and if there is at least one non-consenting co-member, the trustee is entitled only to the economic benefits of that membership (i.e., distributions) and nothing else. But adding a second member may not serve any purpose if it’s merely a nominal one. A revocable trust is not a good idea, since the true beneficial owner would be the person who filed, and that’s not much of a step away from owning it themselves.

There is some question as to whether it’s possible to draft an operating agreement to prevent the kind of transfer that occurred in Albright. Generally speaking, no, your operating agreement cannot prevent your interest from becoming property of the estate when you file bankruptcy. Section 541(c)(1) of the Bankruptcy Code provides that an interest becomes property of the estate even if the agreement contains a provision or restriction on the transfer of the interest and even if applicable non-bankruptcy law voids the interest or terminates it on bankruptcy or insolvency. A provision or practice which states that a membership interest is terminated upon the member’s filing for bankruptcy or which terminates a member’s right to control the LLC or otherwise act on behalf of the business if the member files for bankruptcy, is generally unenforceable. As long as a buyout is triggered by an ordinary event unrelated to the member’s filing for bankruptcy, a provision that gives the LLC the option of buying out a member’s interest is usually valid, provided it pays fair value to the estate.

Bankruptcy Exemptions

Your bankruptcy exemptions determine what property is yours to keep, and what must be turned over. Since April 1, 2025, the federal exemptions list has a wildcard exemption up to $1,675 which can be used to protect any property including a membership interest. You can add up to $15,800 of any unused federal homestead exemption. Your state of domicile for the 730 days immediately before filing will determine which state’s exemptions, if any, you can use. Some states do not allow you to use the federal list.

If your exemptions fall short, you might hope a Chapter 13 repayment plan will let you keep your interest in the LLC instead of giving it to a Chapter 7 trustee, but a business interest also puts pressure on the repayment plan. There are important limitations to look out for. Chapter 13 is only for individuals, and only those with unsecured debts under $526,700. Besides those limits, the Chapter 13 plan must pay each unsecured creditor at least what a Chapter 7 liquidation would, counting your non-exempt interest in the company.

As long as your member interest was already on the line, maybe the LLC itself should file bankruptcy instead? The important thing to know about Chapter 7 is that only individuals get a discharge. An LLC which files a Chapter 7 will not get its debts discharged.

Moving Assets into an LLC Shortly Before Filing

Nobody wants their property liquidated in a bankruptcy, so the temptation to move money around to protect it can seem irresistible. Moving assets into an LLC shortly before filing is no guarantee that you can shelter it. Bankruptcy code section 548 provides that if the intent of the transfer was to hinder, delay or defraud creditors, the trustee can have the transfer undone. Getting an LLC interest of equal value in return is no defense. Funding the LLC well before the first hint of a claim, keeping a separate bank account, and paying the company’s bills out of its own account is a better course.

If a creditor attacks an LLC in court, they are looking to find out if the company had a life of its own, or whether it was only a facade or alter ego of an individual owner. That’s where the extra scrutiny on one-member LLCs comes in. The judge may well assume a “my LLC” attitude because the same individual is both sole manager and owner. That’s why it’s especially important to keep the company separate. At the very least, keep records of decisions as both member and manager, and avoid treating your company’s money as your own.