Will Filing Bankruptcy Stop Merchant Cash Advance Withdrawals in 2026?

If you are an entrepreneur and have been in business long enough, chances are that you have been approached by a merchant cash advance (MCA) company offering financial assistance. You may have even taken one. While it may have seemed like a good idea at the time, like most things it may have had some drawbacks. One of the differences between a merchant cash advance and a loan is that the payments are usually daily. What happens if you file bankruptcy?

A merchant cash advance (MCA) is a form of financing in which a business sells its future accounts receivable in exchange for a lump sum upfront. The business can use the lump sum as if it were a short-term loan. Depending on how the contract is written, an MCA may be considered either a loan or not a loan. As for whether an MCA is dischargeable in Chapter 11, the answer is maybe. If the deal counts as a sale of your future receivables rather than a loan, it may not be discharged at all, so a bankruptcy court will need to determine whether the MCA is a loan or not.

A typical feature of MCAs is that the business makes payments daily. Typically, these payments are automatic. They are deducted from the business account when they are due. Contractors, for instance, often receive payments when work is completed. Of course, the MCA still has to be repaid every day. It can take 30 to 60 days for a client to pay, and without daily income, it’s pretty easy for a business to get in trouble. In most cases, if you don’t have enough cash in the account to pay the lender, you are automatically in default and the entire balance becomes immediately due.

Dodd-Frank Act

So why do so many small businesses take these advances at all? Part of the answer is the Dodd-Frank Act. The Act also hurts small business lending because it raises the compliance costs of banks dealing with them. The portion of commercial and industrial loans made up by small loans shrunk 9 percentage points after the Dodd-Frank Act passed in 2010, according to NBER. At small banks the drop was twice as big. Nearly all of the drop can be attributed to regulation, researchers say. That made small loans less attractive to banks. But the demand for short-term money didn’t go away, so a lot of owners, understandably, turned to these alternative funding companies. You’ll find that many of them are merchant cash advance companies. They were able to fund small businesses because they were not subject to the rules that the banks were subject to. According to the contracts, technically, they’re not a loan. They’re actually a sale of your future receivables.

Whether CapCall’s MCA Deals Were Loans or Sales

That sale label is currently under scrutiny. In September 2021, the U.S. Bankruptcy Court for the District of Montana issued an opinion in CapCall, LLC v. Foster (In re Shoot the Moon, LLC) that questioned how merchant cash advances should be handled. A New York-based merchant cash advance company called CapCall asked the court to rule that it owned $228,449.93 of segregated funds from the bankruptcy estate of Shoot the Moon, LLC. Virtually all of the business’s assets were liquidated and the proceeds were far less than what was owed to secured creditors with priority over CapCall. Had CapCall been successful, it would have received all that money before anyone else. Thus, the bankruptcy court needed to decide whether CapCall’s MCA deals were loans or sales. What if the deals were sales? In that case, CapCall owned the receivables outright. But what if they were loans? As a creditor CapCall only had a security interest, which was subordinated to the other parties who had secured claims against the receivables. Since the collateral was not worth as much as all the senior liens combined, section 506(d) of the Bankruptcy Code means that CapCall ends up with an unsecured claim and no enforceable lien, which in turn means that CapCall gets nothing.

To answer that, the court used what amounts to the duck test: if it looks like a duck, swims like a duck, and quacks like a duck, it probably is a duck. In other words, whether a MCA transaction is a loan or a sale depends on what it looks like in the real world, not just on paper. That means the court has to review the contract and consider the circumstances surrounding it. In a classic case of giving it a name and saying it is so, an MCA is usually structured as a sale of future receivables. But, the court said, when you look at the paperwork behind the actual deal, it’s a loan. CapCall lost. Judge Whitman L. Holt determined that the agreement was simply too much like a loan to qualify as a true sale. He also ruled that CapCall violated Montana’s usury law and that it had no ownership interest in the bankruptcy estate.

Bankruptcy Relief for Small Businesses with These Deals

So does bankruptcy stop merchant cash advance withdrawals? The honest answer is that it depends. Each advance will be different. MCA lenders write their contracts so that, technically, or arguably, they’re not a loan, they’re a sale of your future receivables. And under the contract, they have purchased them. If the bankruptcy court goes along with the lender’s argument that the advance was a sale, the debt may not be dischargeable in Chapter 11. If the court sees beyond the label and determines that it was really a loan, as it did in CapCall, the lender holds a security interest instead of title, and it can end up behind other creditors.

One opinion from one court will not transform the MCA industry, but it is the first legal win for businesses ensnared by such deals. The CapCall decision does not mean that bankruptcy courts will automatically treat all MCA deals as loans. So there is still a way to go for bankruptcy relief for small businesses with these deals. It is an area of law worth keeping an eye on as more small businesses are steered toward MCAs.