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Consider an LLC that owns a rental home worth $700,000 and has bank debt of $500,000. A renter slips, falls, sues, and wins a $300,000 settlement. Is the bank debt senior to the lawsuit, leaving the lawsuit $100,000 short? LLC members are wiped out, but with the limited liability of an LLC the story ends there?
What if the $500,000 loan is owed to one of the LLC members? Does that change anything, assuming the member has a fully documented and separate loan agreement with the LLC?
Lenders can lend money secured or unsecured. If they lend it secured then what is the security? That is, what property secured the loan?
For your example that could be a mortgage over the land or a charge over the assets of the LLC or both. In this particular example, it doesn’t make a difference but if the sale of the property only realised $400,000 and the security was a mortgage only then only $400,000 is secured and the rest is unsecured.
Further, in some jurisdictions it is a requirement that security interests be “perfected” by complying with administrative provisions to register the security interest on some sort of public record. If this doesn’t happen, the debt is unsecured.
Secured creditors rank ahead of unsecured creditors and in the order spelled out in the contracts or equally if the contracts are silent. Unsecured creditors rank in the order spelled out in 11 USC 507.
The members of the LLC are not necessarily protected from the bankruptcy if it is possible to pierce the corporate veil.
