LLC Membership Interest in Bankruptcy
Limited liability companies provide asset protection benefits, not because the membership interest in an LLC is exempt from levy and collection, but because the Florida statutes limit a creditor’s collection remedies to that of a charging lien on LLC distributions, if any, to the debtor.
This past week a client with a valuable membership interest in a multi-member LLC asked whether his LLC interest would be protected from a trustee in the event the debtor filed Chapter 7 bankruptcy. The issue is whether collection restrictions imposed by Florida statutes, or other restrictions imposed on creditors by the LLC operating agreement, are binding upon a bankruptcy trustee. It seems that the answer depends on terms and conditions of the LLC operating agreement, and upon interpretation of an uncertain issue by the particular bankruptcy judge.
There is very little case law on the status of LLC membership interests in bankruptcy. The consensus is that where the LLC operating agreement is an “executory contract” the bankruptcy trustee cannot sell the debtor’s membership interest, but where the operating agreement is not executory the LLC interest is deemed to be a non-exempt property interest which is subject to the trustee’s powers over the debtor’s bankruptcy estate.
Whether the LLC agreement is an executory contract depends upon whether the court finds that the agreement imposes affirmative obligations on the debtor as a consideration for receiving his rights as a member. For example, an LLC that excuses the debtor from ongoing obligations to contribute additional money, to vote in LLC affairs, or to assist with LLC business is probably not an executory contract. An operating agreement is more likely to be an executory contract protected in bankruptcy if the debtor’s rights to distributions are contingent on the debtor/member’s continuing performance or duties.
There is a good overview of this legal issue in an article published in the January, 2007, Florida Bar Journal written by Thomas Wells and Jordi Guso.
Last updated on May 22, 2020