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When an LLC Fails, What Happens to Its Debts?

Martin Eckler | April 12, 2024

Where do the debts of an LLC go when it fails? Keep reading to find out.

Summary: If your LLC fails, there are seven steps you can take to dissolve it: vote to dissolve the LLC, notify your creditors, settle financial obligations, notify tax authorities, cancel licenses and permits, distribute remaining assets, and formally dissolve the LLC with the state. In this article, we’ll break down these steps in detail. And remember this: SoloSuit can help you resolve your debts for good.

When you start a business and form a limited liability company (LLC), you hope that the business will succeed, but the harsh truth is that most startups fail. If you’re in the unfortunate situation of closing your business because things didn’t work out, you’ll have to deal with the debts of the LLC. 

But how do you handle those debts? Below you’ll find an explanation of your options for how to handle debts when your LLC fails.

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LLCs can limit personal liability

The main reason that you chose to form an LLC was probably the personal liability protection that it offered. It’s a good thing you made that decision because now you’re not personally liable for the debts of the business. That means that creditors cannot pursue you personally or go after your personal assets to settle the debt.

They can, however, go after the remaining assets of the LLC.

That being said, there is an exception to your personal liability protection. If you personally guaranteed any of the debts of the business, which is common, you are personally liable for those debts. Depending on the terms of the loans, you may have to either continue to make payments on the debt or pay it in full. If you don’t, creditors can sue you personally, which means your personal assets are at risk, including your home.

Bankruptcy can help resolve debts of an LLC 

You have the option to file bankruptcy for the LLC, which can resolve the debts of the LLC. In bankruptcy, the assets of the LLC are sold to pay creditors, and the LLC is no longer responsible for any debt that remains. However, any personal guarantees still leave you responsible for those personally guaranteed debts. In such cases, if you are not able to settle those debts with your personal funds, filing for bankruptcy personally may be your only option unless you can negotiate a deal with those creditors. 

Follow these steps to dissolve your LLC

Whether you file for bankruptcy or not, you’ll need to go through the process of dissolving your LLC. If you don’t formally dissolve the LLC, you’ll still be responsible for any state filing and fee requirements. Dissolving an LLC and formally wrapping up the business has multiple steps.

Keep reading to learn about seven simple steps you can take to dissolve your LLC.

1. Vote to Dissolve the LLC

Your operating agreement should specifically define the voting procedure for dissolution of your LLC. Generally, a majority of members must vote to dissolve. If you don’t have an operating agreement, you’ll need to refer to the default rules of your state, and follow those procedures. Once the vote has occurred and been recorded, you’ll need to draft a resolution to dissolve the LLC. 

You can find more information on state specific LLC processes on howtostartmyllc.com. 

2. Notify Your Creditors

You’ll need to notify your creditors in writing of the LLC’s dissolution, and give them specific instructions about how to file claims. State laws generally dictate how long you have to give creditors to file a claim, which can usually be no less than 180 days from the written notice. 

Creditors include any party that the LLC owes money to, including vendors and leaseholders. Claims filed by creditors after the specified due date will not be valid.

3. Settle Financial Obligations

You’ll need to settle any claims filed before your LLC can be officially dissolved. This will require settling the debts with the remaining assets of the LLC or filing for bankruptcy. You’ll also need to settle any tax obligations of the company at the federal, state, and local levels. 

Additionally, you’ll need to cancel any business contracts and leases and settle those obligations.

4. Notify Tax Authorities

When you settle your tax obligations, you should also provide written notice of the pending dissolution of the LLC. Be sure to notify all tax authorities that you’ve had obligations to.

5. Cancel Licenses and Permits

You’ll need to cancel any business licenses and permits that were required for your business. This will prevent any renewal fees that might occur automatically. 

6. Distribute Remaining Assets

If any assets of the LLC remain after you’ve settled all the LLC’s financial obligations, they need to be liquidated and distributed to members based on their ownership percentages. 

7. Formally Dissolve the LLC with Your State

Every state has different procedures and requirements for LLC dissolution. It will involve filing dissolution documents with the state, and you may be required to attach proof that your tax obligations have been settled. If your LLC was registered as a foreign LLC in any other states, you’ll need to follow the dissolution procedures for those states as well.

Be sure to follow the entire dissolution process according to your operating agreement terms and the laws of your state. Doing so can prevent any future legal issues.

Try again

The failure of a business can be very disheartening, but you don’t have to give up your entrepreneurial dreams. Failure is just an opportunity to try something new, and you may come up with a new business idea that you want to pursue. You should examine the reasons that your LLC failed and learn from what happened. You can use that knowledge to build a new strategy and business plan for your next business.

While most startups fail, clearly many also succeed. You’d be surprised at how many successful entrepreneurs experienced business failures, sometimes multiple times, before they finally found a winning idea and formula. As entrepreneur and author Steve Blank said, “Failure is an integral part of the search.” Failure is a learning process, and those with an entrepreneurial spirit persist until they find success.

The bottom line

Settling the debts of an LLC that fails is no easy task, but you can get through it. You just need to determine the best route for you, follow applicable laws, and go through the entire process to wrap up the affairs of your LLC. You should engage your attorney to help you to ensure that everything is done by the letter of the law.

And again, don’t give up! You can start over, learn from your mistakes, and build the kind of business you envision. 

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