LLC and Partnership Bankruptcy: Chapter 7, 11, and Subchapter V

When an LLC or partnership can no longer pay its debts, federal bankruptcy gives it two doors: liquidate under Chapter 7 and shut down, or reorganize under Chapter 11 (including a cheaper small-business track called Subchapter V) and keep operating. LLC and partnership bankruptcy differs from personal bankruptcy in one decisive way — the business itself never gets a discharge of unpaid debts — and it does not, on its own, protect the owners from personal guarantees, general partner liability, or a surprise tax bill on forgiven debt.

Chapter 7 for a Business Is a Wind-Down, Not a Fresh Start

Chapter 7 is a straight liquidation. A court-appointed trustee takes control of the entity, sells its assets, and distributes the proceeds to creditors under a statutory priority list. It is faster than reorganization, and at the end the business ceases to exist.

The catch is what the statute does not do. Only an individual qualifies for a Chapter 7 discharge.¹ An LLC or partnership walks out of Chapter 7 with its unpaid debts still on the books. In practice, that rarely matters because the entity has stopped operating and has nothing left to collect against. But those debts follow the entity if it ever tries to resume business.

The Chapter 7 filing fee is $338.²

Chapter 11 Lets the Business Keep Operating

Chapter 11 lets a business restructure its debts under court supervision instead of shutting down. Existing management typically stays in place as the “debtor in possession” and runs day-to-day operations rather than surrendering the company to a trustee.³

The core work is the reorganization plan. Creditors are divided into classes based on the type of debt they hold — secured creditors with collateral in one class, general unsecured creditors in another — and each class votes on the plan. To confirm it, the court must find the plan feasible, proposed in good faith, and compliant with the bankruptcy code.³ If a class rejects the plan, the court can still force confirmation through a “cramdown” that requires additional fairness findings, but creditor buy-in makes the process much smoother.

Traditional Chapter 11 is expensive. The filing fee alone is $1,738,² attorney retainers for mid-sized businesses commonly run $50,000 to $150,000 with hourly billing on top, and the debtor owes quarterly fees to the U.S. Trustee for every quarter the case remains open.⁴ For a business with enough revenue to justify the cost, reorganization can preserve jobs, customer relationships, and going-concern value that would disappear in a liquidation.

Subchapter V: The Small-Business Track

Subchapter V of Chapter 11, created by the Small Business Reorganization Act of 2019, is a faster and cheaper reorganization path for qualifying entities. It removes the U.S. Trustee quarterly fee obligation and cuts out some of the most expensive procedural layers of traditional Chapter 11.⁵ Attorney retainers typically run $15,000 to $30,000.

Who Qualifies

The business’s total noncontingent, liquidated debts cannot exceed $3,024,725. A temporary increase to $7.5 million expired in June 2024 and has not been reinstated.⁵ At least half of that debt must have come from commercial operations, and the entity must be actively operating when it files. Passive investment vehicles and single-asset real estate entities are excluded. The debtor must elect Subchapter V on the petition form at the time of filing.

How the Plan Gets Confirmed

Instead of a creditor committee, the U.S. Trustee Program appoints a Subchapter V trustee who works with the debtor and creditors to build a consensual plan.⁵ If creditors will not agree, the court can confirm the plan over their objection as long as the debtor commits all projected disposable income for three to five years to plan payments.⁶ That cramdown option gives small businesses real leverage when a few creditors dig in.

What Happens to the Owners

Filing bankruptcy for the entity protects the entity’s assets. It does not automatically protect the people behind it.

General Partners Stay Personally on the Hook

Under state law, general partners are personally liable for the partnership’s debts, and that liability survives the partnership’s bankruptcy. The automatic stay protects only the debtor entity, not nondebtor partners, so creditors can pursue general partners individually while the partnership case is pending.⁷ If liquidation of partnership assets does not fully pay creditors, they can reach a general partner’s personal savings, home equity, and other assets.

LLC Members and Personal Guarantees

LLC members normally have limited liability: the business’s debts are not automatically theirs. That protection has two significant holes.

First, lenders and landlords routinely require LLC owners to sign personal guarantees on business loans and leases. A guarantee is a separate contract between the lender and the individual. When the LLC files bankruptcy, the guarantee remains fully enforceable against the person who signed it. To eliminate that obligation, the individual would need to file a personal bankruptcy case.

Second, courts can “pierce the veil” of limited liability when the LLC has not been treated as a genuinely separate entity. The typical test requires a showing that the owners so dominated the LLC that it had no independent existence, and that this domination was used to commit fraud or injustice. Commingling personal and business funds, failing to keep separate books, and treating LLC property as personal property all invite veil-piercing claims.

The Automatic Stay Does Not Cover Guarantors

When the entity files, the automatic stay bars creditors from collecting against the business or seizing its property.⁷ The stay applies only to actions against “the debtor.” Individual owners and guarantors are not the debtor in a business case. A creditor holding a personal guarantee can send a demand letter, file suit, and garnish the guarantor’s wages the same day the business files. Anyone weighing whether a business filing alone will solve their financial problems needs to understand that gap.

Cancellation-of-Debt Income Can Reach the Owners

When a bankruptcy reorganization reduces what the business owes, the IRS treats the forgiven amount as cancellation-of-debt income. For pass-through entities like partnerships and most LLCs, that income flows through to the individual partners or members on their personal returns. The tax bill can be substantial, and it surprises owners regularly.

Federal law provides two exclusions, but each has a limit that catches business owners off guard. Debt canceled in a Title 11 bankruptcy case is not included in income, but the exclusion applies only to the entity that is actually the debtor. An LLC member or partner does not qualify simply because the business filed; the individual would have to be personally bankrupt to use this exclusion on their own return.⁸

The second exclusion applies if you were insolvent immediately before the debt was canceled — total liabilities exceeding the fair market value of total assets. You can exclude cancellation-of-debt income up to the amount by which you were insolvent, reported on IRS Form 982.⁹ The insolvency test is measured at the individual level, so an owner who is personally solvent cannot use the exclusion just because the LLC or partnership was insolvent. Tax planning before filing is essential if you want to avoid a bill from the IRS the following spring.

Commercial Leases: Assume or Reject

For many LLCs and partnerships, commercial leases are among the largest continuing obligations. Bankruptcy gives the debtor the right to either assume a lease (keep it) or reject it (walk away). Rejection treats the lease as breached and converts the landlord’s remaining claim into an unsecured debt rather than an ongoing obligation the business must keep paying in full.¹⁰

The window is short. For nonresidential real property leases, the debtor must assume or reject the lease within 120 days of filing, or by the date the court confirms a reorganization plan, whichever comes first. The court can extend that deadline by 90 days for good cause, and any further extension requires the landlord’s written consent.¹⁰ If the debtor does nothing, the lease is deemed rejected and the business must surrender the property immediately. Missing this deadline is one of the more common avoidable mistakes in business bankruptcy.

Who Gets Paid, and In What Order

Not all creditors are treated equally. Secured creditors with liens on specific property are generally paid first from the value of their collateral. After that, unsecured claims are paid according to statutory priority categories:¹¹

Administrative expenses of the case itself, including trustee fees and professional fees for attorneys and accountants.
Employee wages, salaries, and commissions earned within 180 days before filing, up to a statutory per-employee cap, with employee benefit plan contributions in the next tier.
Unpaid federal, state, and local taxes owed by the business.
General unsecured creditors — trade vendors, suppliers, and anyone else without collateral or priority status. This group is last in line and often receives pennies on the dollar, if anything.

The order explains why employees and tax authorities tend to recover more than trade creditors in business bankruptcies, and why administrative costs of the case itself eat into what is left for everyone else.

How the Case Starts

The case begins when the entity files a voluntary petition with the bankruptcy court. Attorneys typically submit the documents electronically through the court’s Case Management/Electronic Case Files system, which opens the case immediately and assigns a case number. The court may allow installment payments of the filing fee in some circumstances.

The moment the petition is filed, the automatic stay takes effect. It stops creditors from collecting debts, foreclosing on business property, repossessing equipment, or continuing lawsuits against the entity.⁷ The court clerk notifies every creditor on the debtor’s matrix. The stay remains in place unless a creditor successfully petitions the court for relief, which typically requires showing that collateral is not adequately protected or that the debtor has no equity in the property.

Between 21 and 40 days after filing, the U.S. Trustee schedules a Section 341 meeting of creditors.¹² A representative of the LLC or partnership must attend and testify under oath about the accuracy of the financial schedules and the location of business assets. Creditors may attend and ask questions. If the debtor’s representative fails to appear, the trustee can move to dismiss the entire case.

Who Has to Authorize the Filing

Someone has to decide the business should file, and that decision must be properly authorized under the entity’s governing documents. For an LLC, the operating agreement controls; many agreements require a majority or unanimous vote of the members before the entity can file bankruptcy. Courts have consistently held those provisions enforceable, and a petition filed without the required authorization can be dismissed. For a partnership, a resolution signed by the partners is required.

This can produce deadlock when owners disagree — one faction wanting to reorganize, another wanting to dissolve. The operating agreement or partnership agreement decides who wins; where the documents are silent, state law fills the gap and the rules vary. Resolving the internal dispute before filing is essential. An unauthorized petition wastes time and money and may expose the person who filed it to personal liability for the costs of the case.

When Creditors Force the Filing

Bankruptcy is not always the debtor’s choice. Creditors can force an LLC or partnership into bankruptcy through an involuntary petition under Chapter 7 or Chapter 11.¹³ If the business has 12 or more creditors, at least three must join the petition, and their combined undisputed claims must total at least $21,050. With fewer than 12 creditors, a single creditor meeting that threshold can file alone.

Partnerships face an extra wrinkle. Fewer than all of the general partners can file an involuntary petition against their own partnership, effectively forcing the entity into bankruptcy without unanimous agreement.¹³ If all general partners have already filed personal bankruptcy, a single general partner, a partner’s trustee, or a creditor of the partnership can start the case. A partnership cannot avoid bankruptcy just because one partner refuses to cooperate.

Alternatives Worth Considering First

A federal filing is not the only option, and in some situations it is not the best one.

Out-of-Court Debt Workouts

A private workout is a direct negotiation between the business and its lenders to restructure loan terms without court involvement. Common outcomes include extended maturity dates, reduced interest rates, debt-for-equity swaps, or refinancing on more favorable terms. Workouts fit best when the business has a manageable number of financial creditors who can agree. They typically do not address obligations to trade vendors, landlords, or employees. The main advantages are speed and confidentiality; the main weakness is that every creditor must agree voluntarily, and a single holdout can kill the deal.

Assignment for the Benefit of Creditors

An assignment for the benefit of creditors is a state-law alternative to Chapter 7. The business transfers its assets to an assignee, who sells them and distributes the proceeds to creditors. It is generally faster and cheaper than a federal filing, and the business can choose the assignee rather than waiting for a random trustee. But an assignment lacks the automatic stay, so secured creditors can still foreclose on their collateral. The assignee cannot sell assets free and clear of liens without creditor consent or full payment, and executory contracts cannot be assumed without the counterparty’s agreement. For a straightforward asset pool with cooperative secured lenders, an assignment can be an efficient wind-down tool. For anything more complicated, the protections of federal bankruptcy are usually necessary.

1
Office of the Law Revision Counsel. 11 USC 727 – Discharge
2
United States Courts. Bankruptcy Court Miscellaneous Fee Schedule
3
United States Courts. Chapter 11 – Bankruptcy Basics
4
U.S. Department of Justice. Chapter 11 Quarterly Fees
5
U.S. Department of Justice. Subchapter V Small Business Reorganizations
6
Office of the Law Revision Counsel. 11 USC 1191 – Confirmation of Plan
7
Office of the Law Revision Counsel. 11 USC 362 – Automatic Stay
8
Internal Revenue Service. Publication 4681 – Canceled Debts, Foreclosures, Repossessions, and Abandonments
9
Internal Revenue Service. Instructions for Form 982
10
Office of the Law Revision Counsel. 11 USC 365 – Executory Contracts and Unexpired Leases
11
Office of the Law Revision Counsel. 11 USC 507 – Priorities
12
Legal Information Institute. Federal Rules of Bankruptcy Procedure – Rule 2003
13
Office of the Law Revision Counsel. 11 USC 303 – Involuntary Cases