The Florida Limited Liability Company Act, and similar statutes in other states, go a long way to ensure that the debts and liabilities of one member do not affect the the LLC and its other members.  For instance, a judgment creditor of an LLC member is generally only entitled to a charging order (that is, a right to receive authorized distributions) against the member’s interest in the LLC, under Florida law.  But state law and provisions of an LLC operating agreement that are designed to limit creditors’ claims against a member’s LLC interest are sometimes at odds with Federal bankruptcy law.  So, what happens when an LLC member goes bankrupt?

Federal bankruptcy law allows the bankruptcy court to ignore creditor protection state laws and contracts–meaning the bankruptcy trustee can exercise all of the rights and privileges of the bankrupt member–unless the LLC operating agreement is an “executory contract.”  Simply put, an executory contract is a real contract, where all of the parties have meaningful obligations.  In standard LLC operating agreements, non-management members might not have any real obligations.  This was the case in the bankruptcy case In re Ehmann, which in 2005 dealt with this issues head on. 

From Ehmann we learn that LLC operating agreements–especially for non-operating, “family” holding companies–should include the following:

• A stated purpose of the LLC that would be frustrated if a bankruptcy trustee is allowed to “take over” the bankrupt member’s interest.
• A duty for the members to make mandatory capital contributions to the LLC under defined circumstances.
• An obligation for each member to compaly with fiduciary duties owed to the LLC and the members.
• An obligation for each member to participate in the management of the LLC.