By Austin Smith
Taroff & Taitz, LLP
Bohemia, NY
A
recent decision from the Bankruptcy Court for the District of Colorado
highlights the vulnerability of assets held by a debtor’s wholly owned LLC—and
the sometimes blurry line between property of the debtor and property of the
debtor’s company. In Wadsworth v. Sanders (In re Sanders), the debtor, a
former college football player, was the sole member of Big21, LLC, an entity
through which he managed his social-media and sponsorship business. On the
petition date, Big21’s business account contained approximately $20,292. But
between the petition date and the end of 2024, more than $535,000 was deposited
into the account, while approximately $527,000 was transferred out. Sanders,
2026 Bankr. LEXIS 555, at *8–9 (Bankr. D. Colo. Mar. 4, 2026).
The
Chapter 7 trustee commenced an adversary proceeding seeking to recover all or
some of those funds. The trustee alleged that, notwithstanding their deposit
into an account nominally owned by Big21, at least some of the funds
constituted property of the bankruptcy estate—either because they represented
compensation earned by the debtor before bankruptcy or because they constituted
distributions owed to him as Big21’s sole member.
The
debtor moved to dismiss. He argued that Big21 was a separate legal entity and
that property belonging to the LLC was therefore not property of his bankruptcy
estate. He further contended that, to the extent the funds represented his own
earnings, they were post-petition earnings excluded from the estate under 11
U.S.C. § 541(a)(6).
The
Bankruptcy Court concluded that the issue could not be resolved at the pleading
stage. Determining the character of the funds required a fact-intensive inquiry
into what services the debtor performed, when he performed them, the terms of
the underlying contracts, and the legal basis upon which Big21 received the
money:
“[W]hether
the funds are Sanders' pre-or post-petition earnings will depend on the type of
services Sanders performed, when he performed them, and the terms of the
contract(s) (if any) requiring those services. Whether the funds are instead
contract proceeds or LLC distributions will depend on the same evidence as well
as other issues . . . .” Sanders at *8–9
The LLC
Distinction—and Its Limits
The
decision is particularly interesting because the court recognized the familiar
rule that a debtor’s ownership of an LLC does not automatically make the LLC’s
property the property of the bankruptcy estate. As the court explained:
“A
debtor's membership interest in an LLC becomes property of his estate. The
assets owned by the LLC, however, do not. Instead, the debtor's right to
control management of the LLC and receive distributions from the LLC does.” Id.
at *5.
That
distinction is important. Section 541 does not ordinarily disregard state-law
entity separateness merely because an individual debtor owns 100% of an LLC. If
the LLC owns a bank account, a vehicle, or real property, the debtor’s
bankruptcy estate generally acquires the debtor’s membership interest, not
direct title to the underlying asset.
But
for a single-member LLC, that distinction may provide considerably less
protection than it first appears. The court cited decisions recognizing that
when a bankruptcy trustee succeeds to the debtor’s membership
interest—including the debtor’s management and control rights—the trustee may
be able to exercise those rights to cause the LLC to liquidate its assets and
distribute the proceeds. Thus, even though the LLC’s assets do not technically
become property of the estate on the petition date, the trustee may acquire the
power to reach their economic value through control of the LLC itself.
The
corporate form remains legally significant, but in the context of a wholly
owned LLC it may offer surprisingly little practical insulation from the
bankruptcy estate.
Whose
Money Is It?
Sanders presents a second—and analytically
distinct—problem.
The
trustee did not merely contend that he could exercise the debtor’s rights as
Big21’s sole member. He also alleged that some of the money passing through
Big21’s account may actually have been property of the debtor, and therefore
property of the estate, notwithstanding the name on the bank account.
That
question could not be answered simply by observing that the account belonged to
Big21.
If
the money represented payment for services performed by the debtor before the
petition date, it might constitute property of the estate. If it represented
compensation for services personally performed after the petition date, §
541(a)(6) might exclude it. If it constituted revenue belonging to Big21, it
might instead remain property of the LLC. And if the money represented
distributions payable to the debtor as Big21’s sole member, the debtor’s right
to receive those distributions could itself constitute estate property.
Sorting
among those possibilities required evidence. It could not be accomplished on a
motion to dismiss. Accordingly, the court held that the trustee had alleged
sufficient facts to proceed with his claims.
The
Practical Lesson
Sanders offers an important warning to
individual debtors who conduct business through wholly owned LLCs. The fact
that an asset is titled in the name of an LLC does not necessarily put its
economic value beyond the reach of a bankruptcy trustee. At least two separate
avenues of inquiry may remain open.
First,
the trustee may investigate whether property nominally held by the LLC is,
based upon the underlying transactions, actually attributable to the debtor or
otherwise represents property of the estate.
Second,
even where the property unquestionably belongs to the LLC, the trustee may
succeed to the debtor’s membership interest and, depending upon applicable
state law and the LLC’s governing documents, acquire sufficient management
rights to control the entity, liquidate its assets, and distribute its value to
the estate.
For
trustees and creditors, the lesson is straightforward: the LLC’s name on the
bank statement may be the beginning of the analysis, not the end of it.
For
debtors operating through single-member LLCs, the converse is equally
important. Entity separateness remains real, but bankruptcy law may give a
trustee both the incentive and the legal tools to look behind the account title
and determine precisely what the LLC owns, why it owns it, what rights the
debtor possesses, and ultimately what value can be brought into the estate.
The
Sanders court has now allowed that inquiry to proceed. The more
consequential question—how much of the roughly $535,000 that passed through
Big21’s account can actually be recovered for the estate—will have to await a
fuller factual record.