Client entering into LLC partnership but planning to file Chapter 7

[Ifonly]

I currently am working with a group of woman who want to form a LLC as equal partners (3 members).

One member plans on filing CH7 in the fall.

I don't think this will affect the partnership especially since it's service industry and will have no assets and there is no anticipation of a large capital donation being made by any member. I'm thinking that if she doesn't put capital in, the trustee can't ask her to liquidate a capital contribution.

Shouldn't the partnership simply be viewed as an income stream (provided they make any money of course)?

Thanks to anyone who can help - as a CPA this is slightly outside of my expertise.

[ScaredINMich]

I've been on both sides. Four years ago DH and I were in an LLC with another couple and they declared Ch. 7. The business was worth nothing, so the trustee didn't take anything/ BUT...it also made them exempt for the business loan we had.

Currently, I am in a service based LLC partnership. We had a couple thousand in the bank and no debts. Since half of that money in the bank is mine, I had to claim that as an asset, but it is safe due the wildcard.

Hope that helps.

[chrisdfw]

LLC can be structured such that the trustee would go nowhere near it.

For instance, often a provision can be in the LLC agreement that all new members must be approved by a unanimous vote of all existing members, and that new members can only receive distributions with the unanimous vote of existing members, etc. New members can also be required to contribute capital if requested by the existing members, for example any new LLC member must contribute 1,000,000.

These are extreme examples but what can be accomplished with a good attorney to set things up.

[justbroke]

But the Bankruptcy Trustee is not a "new" member under any reading of (bankruptcy) law. The Trustee steps into the shoes of the member as if they are the member themselves. The Trustee's powers are pretty unique.

I do agree that most Trustee's don't even like to deal with multi-member LLCs unless they could sell the debtor's share of the LLC or force a sale -- which the Trustee can or ask the court to do under the equitable powers of the court.

Just wanted to add that it's probably better to have a multi-member LLC agreement that grants a right-of-first-refusal if the member's creditors (or BK Trustee) gets a hold of the member's position, then trying to create a very bad agreement in an LLC! I would never ever sign a multi-member LLC agreement that provides that I can't be paid, unless all the other members agree. One fight, and it's over.

You may also want to look at 11 USC 541(c)(1) which makes such language void and unenforceable as to the Trustee in these cases.

11 USC 541(c)

(1) Except as provided in paragraph (2) of this subsection, an interest of the debtor in property becomes property of the estate under subsection (a)(1), (a)(2), or (a)(5) of this section notwithstanding any provision in an agreement, transfer instrument, or applicable nonbankruptcy law--

In the end, after all I posted, I'll say that this may all be for naught anyhow, and the Trustee probably isn't interested in this specific LLC anyhow.

[chrisdfw]

That is correct, the trustee would not be new, but these provisions are possibilities. The trustee CAN take an interest, but just as spendthrift provisions in trusts are still valid, LLC provisions would still be valid. I use have some of these provisions in family LLCs which hold certain assets. The assets are non-income producing anyway and there is no income to distribute, but the attorney set it up this way for creditor protection, inside and outside of bankruptcy. The trustee gets all the rights of the debtor, but no more rights than the debtor. I am not a lawyer and probably are not correctly conveying the actual reading of the provisions, and don't have any example LLC agreements in front of me.

Another way these things are dealt with is to make sure the members of the LLC have "responsibilities" in some states and districts this qualifies the LLC to be treated as an executory contract rather than an asset. The trustee would not be interested in assuming any responsibilities so this is something to consider.

Bottom line, I am just giving examples, you need an attorney that understands asset protection. You need such an attorney any time you go into a business partnership. Get an attorney. They can tell you what works in your state.

But, the trustee is probably not interested anyway. Everyone ought to consider a good asset protection attorney anytime they go into business. Complete protection is from creditors, trustees, AND your own business partners.

[justbroke]

Another way these things are dealt with is to make sure the members of the LLC have "responsibilities" in some states and districts this qualifies the LLC to be treated as an executory contract rather than an asset. The trustee would not be interested in assuming any responsibilities so this is something to consider.

That part I can agree with. I have just read cases where just having certain language in the LLC, doesn't necessarily make them impenetrable by the Trustee in a Bankruptcy proceeding.

But, the trustee is probably not interested anyway. Everyone ought to consider a good asset protection attorney anytime they go into business. Complete protection is from creditors, trustees, AND your own business partners.

I agree. An asset protection attorney is always a good thing when going into business, whether it be in a partnership or a sole proprietorship.

[Ifonly]

If it were my business, I would get a lawyer. I've advised my clients as such....and they will be signing a proposal agreement very clearly advising them I am NOT a lawyer ~ in fact, as a CPA I am not allowed to practice law ~ line is muddy when it comes to business contracts, however. I am setting their LLC in PA and PA does not require a lawyer to draft a membership agreement ~ hence, why I've been tapped for the whole job. They didn't even want to do a membership agreement (not required in PA) ~ I very strongly suggested they needed one for their protection. Considering they won't put together a capital contribution schedule or requirements, maybe there's nothing to protect? ;-)

I am considering suggesting that the two partners form the LLC and the third who is planning the CH7 work as an independent contractor until after discharge. Then modify the LLC to have her become an equal partner.

[justbroke]

I am considering suggesting that the two partners form the LLC and the third who is planning the CH7 work as an independent contractor until after discharge. Then modify the LLC to have her become an equal partner.

That's the best suggestion I read in this entire thread! Great thinking.