Chapter 7 for an LLC With MCA Debt: 5 Consequences of a Business Liquidation

Business entities like LLCs can file bankruptcy, but when they do, they get no discharge, only liquidation. That means your Chapter 7 trustee will sell off your LLC’s nonexempt assets and distribute the proceeds to your creditors, including the merchant cash advance companies. Only natural persons (individuals) can get discharges.

But there’s a problem. The business and the business owner are different parties, because business structure and human being are different things. Filing on behalf of the business means nobody filed on the owner’s behalf. The liquidation of an LLC or corporation doesn’t get rid of a personal guarantee the owner made, and many merchant cash advance companies demand them. That lender will be out of luck as to the business, but the business owner with the guarantee will have given the lender an alternate route to recovery.

In a sole proprietorship, by contrast, the owner is the business and the business is the owner. No separate entity. Filing bankruptcy as a sole proprietor means filing as an individual. If you file Chapter 7 as an individual, most of your debts get discharged, though there are exceptions for certain taxes. Chapter 13 is another option. It involves a payment plan up to five years instead of a clean sweep, but it’s an option.

Big Consequence

First, the business entity ends. Chapter 7 bankruptcy trustees are in the business of ending things, not running them. The trustee uses the business assets to pay creditors under federal bankruptcy law’s rules. That doesn’t mean the trustee can’t keep the shop open for a while if it helps with the selling, but only briefly.

The second important thing a bankruptcy filing creates is what lawyers call an automatic stay. They mean it stops most (but not all) collection actions - lawsuits, garnishments, the demand phone calls - with no court order needed. Once it’s on the clerk’s docket, the filing itself is enough to pause the process. The merchant cash advance lenders will still exist, and have the right to file claims. They’ll just have to take a number and wait in line. In lots of no-asset cases, there’s nothing to distribute to anybody. When that’s true, the unsecured creditors who get nothing at the end don’t need to file claims. A secured creditor keeps its lien without a claim, but the trustee can undo a security interest that wasn’t properly perfected.

The third gotcha of bankruptcy is this: the person who files is the only person protected by the filing. It doesn’t shield anyone else from collection, like owners. If you signed a personal guarantee, the lender isn’t going to forget it. What happens next depends on what you signed, what the rules for your state are, and what else the funder has filed. Whether you’ll need a personal bankruptcy as well as a business one, you’d need a bankruptcy lawyer to tell you. If it comes to that, the CFPB guidelines say a bankruptcy can legally stay on a personal credit report up to ten years. A judgment or a lawsuit can stay seven years or until the statute of limitations runs out, if that’s later.

The fourth big consequence: bankruptcy trustees look backward. The trustee has the power to undo payments to ordinary creditors in the 90 days before filing, to insiders within one year, and fraudulent transfers can be undone within two years of filing.

In a bankruptcy, how a court treats the MCA depends on the contract and where the court is. MCAs can be seen as either the sale of receivables or as a loan disguised as a purchase. In New York, an important question in whether to recharacterize an MCA as a loan or not is how sure the repayment is. Do you absolutely have to pay a set amount, no matter how much you sell, or does the amount you repay change with your sales? Another clause New York looks at is the “reconciliation” clause.

The last big consequence of bankruptcy is the owner still has things to do. There’s a “creditor’s meeting” scheduled about 21-40 days after filing, and someone authorized for the LLC has to attend and answer questions under oath.

Unpaid payroll taxes come with an extra sting: if you were responsible for handling the company’s payroll tax withholdings, and you willfully didn’t pay them over, the IRS can “assess” the “Trust Fund Recovery Penalty” (TFRP) against you directly. That can happen even if the business is still in business. After the IRS sends you the notice, you have 60 days to appeal it. Once the IRS makes an assessment it gets aggressive with collection, with liens, levies, and more.

Closing a business that had employees means finishing up the payroll paperwork. The final Form 941 (or 944 if you’re on the annual system) is due for the quarter final wages were paid, and W-2s have to get to employees by the return’s due date.

Facing Lawsuits from MCA Companies

If the business is still generating revenue, Chapter 11 bankruptcy (under Subchapter V for businesses with no more than $3,424,000 in debt) can protect the business while it keeps operating under a repayment plan. With Subchapter V, only the business files a repayment plan, within 90 days. The plan’s payments come from disposable income for three to five years, and there’s ongoing reporting to the court. It’s still a court case.

The alternative to bankruptcy, which covers only MCAs and nothing else, is restructuring - working with a company that’ll consolidate your payments into one reduced weekly sum. They’ll also negotiate your balances with the MCA lenders, but all this happens without going to court. Unlike bankruptcy, with the non-court restructures there’s no automatic stay to stop collection. Results aren’t guaranteed either. The goal is to settle the debt for less than it says on the contract. There’s also the fact that nothing in the law obligates the companies you owe to negotiate.

If you’re talking bankruptcy, talk to a bankruptcy lawyer. Don’t try it yourself. Get a pro, talk about both your business and your own obligations, and don’t file anything until you have an expert’s opinion. A business bankruptcy can close a business with no cash flow left, but it doesn’t always take care of the rest.