Asset Protection from Bankruptcy

As part of an asset protection plan, people may place certain assets into a single member limited liability company (LLC) with the belief that these assets are protected from individual creditors. However, in the bankruptcy context, a single member LLC will not provide any asset protection for a person from their individual creditors.  In multiple jurisdictions, bankruptcy courts held that, where the debtor was the sole member and manager of the subject LLC, the Chapter 7 Trustee could seize control of the LLC and may cause the LLC to sell the assets of the LLC.

Nevertheless, in each of these cases, the bankruptcy court treated the single member LLC differently than an LLC with multiple members.  In cases where a single member files for bankruptcy while other members of a multi-member LLC do not, and where the non-debtor members do not consent to a substitute member status for a member interest transferee, the bankruptcy estate is only entitled to receive the share of profits or other compensation by way of income and the return of contributions to which that member would otherwise be entitled.

However, before adding a second member to an LLC, be aware of the “peppercorn” membership interest.  A “peppercorn” membership interest is when the LLC owner gives a third party a small interest in the LLC for the sole purpose of avoiding or hindering a creditor from collecting.  In this context, a bankruptcy court will avoid the transfer of any ownership interest in the LLC to the third party, which would create a single member LLC again, and then subsequently allow the Chapter 7 Trustee to seize control of the LLC and liquidate its assets.

In closing, before transferring all personal assets to an LLC, make sure the LLC has more than one member and that all members acquired their membership interests for equitable consideration. If these steps are followed, then even in bankruptcy, an LLC can shield personal assets from individual creditors.

Randy M. Creighton, Esq.