This K&L Gates Legal Insight highlights certain potential bankruptcy and insolvency issues that clients and legal practitioners should take into account when forming a limited liability company (“LLC”) under state law. These issues affect the drafting of key provisions in an LLC operating agreement to set forth management and ownership rights and remedies and to identify what the parties intend if insolvency arises or a bankruptcy is filed for the LLC or one or more of its members.

Despite statutory certainty with respect to the formation and operation of LLCs in the fifty states and the District of Columbia and notwithstanding the contractual flexibility available and permitted in operating agreements that govern the membership interests of LLCs, the risks of insolvency, bankruptcy and dissolution of LLCs remain undefined in the United States Bankruptcy Code, 11 U.S.C. §§ 101 - 1532 (the “Bankruptcy Code”). Indeed, the Bankruptcy Code neither defines LLCs nor adequately addresses critical issues that affect the rights, liabilities and remedies of LLCs, their members, creditors or third parties-in-interest in critical Chapter 11 reorganization cases or Chapter 7 liquidations.

This lack of clarity in federal bankruptcy law increases business risks for owners, investors and managers of LLCs when business adversity threatens. The extent to which future ambiguities are not addressed in the operating agreement affects the ultimate resolution of matters relating to insolvency, bankruptcy and dissolution. It leaves far too much to expensive litigation, trials and judicial decision.