Multi Level Marketing and Bankruptcy: a Unique and Challenging Combination Skip to main content

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Multi Level Marketing and Bankruptcy: a Unique and Challenging Combination

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Multi level marketing, also called "direct selling- "affiliate marketing" or "home-based business franchising", has become popular in the past few years as a way for those with an entrepreneurial streak to build their own businesses with minimum investment. It has been especially appealing to, and vigorously directed towards parents (usually mothers) who wish to stay at home with their children but want or need to earn income at the same time.

The structure is designed to create a marketing and sales force by recruiting promoters of company products, or "distributers-, and compensating them not only for their own personal sales, but also for the sales generated by others they introduced to the company, creating a "downline- of distributors and a hierarchy of multiple levels of compensation.

The companies and products are generally marketed and promoted via word of mouth, often in a 'club-like' atmosphere. There are hundreds of companies that operate under this structure, selling everything from vitamins to long distance service. A motivated distributor with an active down line can earn a nice living with long term residuals. On the downside, it does take a lot of time and work to make an MLM business successful. Some distributors can end up spending a lot of time and money, incurring thousands of dollars of credit card debt for travel, advertising and conventions, while earning little or no money.

Balancing large credit cards debts to fund their operation can put them in a very precarious position. Additional problems can arise for previously successful Multi Level Marketers when the sponsoring company suddenly changes the terms of the distribution commission structure, or there is a switch from one MLM program to another, or because sales have dropped off due to the economy or an unexpected increase in competition in the marketplace. Once the problem gets large enough and the owner finally realizes he is on a sinking ship, grabbing onto the bankruptcy lifesaver will require unique strategy and a great amount of skilled counsel from a qualified attorney.

Because of the nature of the MLM business, the process for filing bankruptcy isn't as clear-cut as it might be for other debtors. It could give rise to additional objections by the Trustee or an increased risk of lengthy and expensive litigation.

For example, the first hurdle in the process of filing bankruptcy under Bankruptcy Code is that all consumer debtors must submit to a median income, or means test, to determine their eligibility for Chapter 7 and/or their unsecured creditor payment obligations for Chapter 13. The means test looks at the six month period immediately prior to the month of filing. It is a formula designed to keep filers with higher incomes from filing for Chapter 7 bankruptcy. Only bankruptcy filers with primarily consumer debts, not business debts, need to take the means test. Filers with higher incomes who fail the means test may use Chapter 13 bankruptcy to repay a portion of their debts, but may not use Chapter 7 bankruptcy to wipe out their debts altogether.

MLM distributors contemplating bankruptcy may or may not be subject to the means test, because, arguably, their debt may be considered primarily business debt as opposed to consumer debt. Depending on the state of residence and filing, the question of whether personal credit card debt used to finance a home based business yields "consumer debt- or "business debt- is likely a threshold question.

There may also be questions of what actually constitutes "income- in the MLM scenario. Trustees could argue that payments submitted by downline distributors for advertising or marketing constitutes income that should be included in the means test calculation.

Assuming that the means test is required, the MLM debtor may encounter a problem with the presumption of abuse arising from recent prior months of high income. This is especially true if the distributor's income was suddenly reduced due to a change in the compensation schedule or a termination of a particular program. Or, in the case of MLM debtors with a history of starting and growing multiple successful organizations, the Trustee may presume a high income will be generated in the near future.

These are just a few of the issues that could crop up when Multi Level Marketing is a factor in a personal bankruptcy. Others include issues of income suppression and asset diminution.

If you are involved with an MLM organization and are beginning to experience financial problems and pressure, consulting with an experienced attorney before the problems escalate can help you avoid the pitfalls discussed here.

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