If your business is behind on merchant cash advances, you are probably weighing two paths: working out a restructuring with the funders, or filing for Chapter 11. Small businesses turn to MCA funding because it closes fast, often without the due diligence a bank would do. With fewer requirements and fewer questions asked, more businesses than ever turn to MCAs to help them when they need it most. While the process may appear simple, the burden of repayment for the business owner can be significant. But many business owners do not have a deep understanding of the product and are simply trying to take care of their needs, and there is a tremendous difference between an MCA being a sale or a loan. It is important to determine whether an MCA is a sale or a loan because the answer will help us decide what the best course of action is for the business owner.
MCAs are essentially simple products with complex legal implications. The basic idea is that you exchange future business income for capital up front. The business accepts an advance of cash today from the MCA funder in return for a commitment to remit a portion of future sales to the funder until a fixed “purchased amount” is reached. The payments usually come out through daily or weekly ACH debits over a short window, and the purchased amount is substantially larger than the advance.
Our discussion about whether an MCA is a sale or a loan starts with the agreement itself. This is the operative document that governs the relationship between you and the funder, and most MCA agreements state expressly that the deal is a sale of future receivables and not a loan. In bankruptcy, the label matters: a “sale” can take the receivables out of the estate. A “loan” keeps the obligation inside. In other words, if the company goes bankrupt, the MCA funder could likely assert its right to collect the receivables, which could reduce the amount of cash available to the creditors. Conversely, if the advance is deemed a loan, the proceeds could likely remain in the estate. In court, the truth matters more than what a document says. In bankruptcy, the purchase-versus-loan question decides whether the funder walks away with estate assets or whether the debtor can claw value back.
This Is Where Chapter 11 Can Change the Picture
This is where Chapter 11 can change the picture. Once a business files, the debtor, or a trustee who steps into its shoes, can fight over recharacterization on two related fronts. The first is usury. The obvious question is whether an MCA constitutes a loan subject to usury law. Generally, New York law applies to MCA agreements. Under New York law, loans with interest rates above 25% per annum are criminally usurious and void. If an MCA is characterized as a loan, the interest rate may be well above 25%. So the label “sale” that most contracts try to use may not save the funder in bankruptcy if the economics cross the usury line.
The second front is an avoidance action. Section 548 of the Bankruptcy Code allows a bankruptcy trustee to seek to avoid certain transfers, including a payment to a lender that was made within two years of filing a bankruptcy petition, if the trustee can show that the transfer was made for less than reasonably equivalent value and the debtor was insolvent at the time of the transfer. You do not have to win the usury argument to use it. If the business paid the funder more than it ever received, a lack of reasonably equivalent value may be implicit.
A Recent Decision Out of the Eastern District of Louisiana
A recent decision out of the Eastern District of Louisiana, Crosby Tugs, L.L.C. v. Meged Funding Group (In re Crosby Marine Transportation, LLC), shows how this works in practice. The debtors filed Chapter 11 and brought an adversary proceeding against several MCA funders, seeking partial summary judgment against Aqua Capital LLC. The claim asked the court to treat Aqua’s “Revenue Purchase Agreement” as a disguised loan and to declare the purchased “Future Receipts” property of the estate. Aqua advanced $350,000 for $543,750 of the debtors’ “Future Receipts,” collected via daily ACH debits. Repayment was not linked to any particular customer or receivable, and Aqua obtained a security interest covering all of the debtors’ assets, a personal guaranty, a confession of judgment, and the right to debit the accounts on default.
There are several recharacterization tests, but each one asks basically the same question: who bears the risk that the “sold” receivables are never collected, the funder or the business? Courts look to substance over form, and calling the deal a “sale” is almost never enough. If you owe the money no matter what you collect, it’s usually treated as a loan. New York’s appellate court in LG Funding, LLC v. United Senior Properties of Olathe, LLC (2020) identified three primary factors: (1) a meaningful reconciliation clause, (2) a finite term, and (3) the funder’s recourse if the merchant goes bankrupt. Courts increasingly use those factors as a guide rather than a checklist and look at the totality of the circumstances.
Measured against that test, the Aqua agreement read exactly like a loan. For example, the agreement did not identify the “Future Receipts” that Aqua purchased as belonging to any specific customers of the debtors. Therefore, Aqua bore no risk of the receivables ever being collected. By contrast, the debtors bore all of the risk that the “purchased” receivables were never collected. The funder does not accept the risk that receipts might never come; the merchant does. That is the classic loan scenario. Aqua’s UCC collateral was not limited to the receivables it claimed to have purchased, but covered all of the debtors’ accounts, equipment, general intangibles and inventory, which the court saw as a hallmark of lending. The guaranty, the confession of judgment and Aqua’s power to accelerate and sweep the accounts gave it recourse far beyond any sale.
The reconciliation clause did not save the deal either. The debtors could ask to adjust the weekly remittance, but the total amount was not adjusted to reflect what was actually collected, and defaulting even once could terminate the reconciliation. Even if something called a reconciliation were present, reconciliation does not help if the figure never changes. The court called the provision arguably “illusory.” The parties did not set a term in the agreement, yet dividing the balance by the daily payment produced a de facto fixed schedule. Accordingly, the court held that the transaction was not a sale of future receivables but instead a loan and held that the future receivables were property of the bankruptcy estate.
Should You Pursue a Settlement with Your Funder
Given that most MCA agreements use the language of a sale, but with signs of a loan, should you pursue a settlement with your funder or file for Chapter 11? The answer, in short, is that a loan is a loan, even when it is called a sale. Once a debtor files for bankruptcy, as explained above, this allows the debtor or trustee to argue the transaction was not a sale, but a loan, and, therefore, all of the future receivables are property of the estate. If that argument wins, a usurious loan may be void, payments may be avoidable and recoverable under sections 544, 548 and 550 of the Bankruptcy Code, and the receivables the funder believed it had purchased may come back to the estate. For a distressed company, an MCA obligation can turn into a source of recovery. But it is not a free pass.
Crosby turned on its own facts. Your deal’s terms and the business’s circumstances matter. Businesses should weigh the specific terms and conditions of the transactions and the impact to the business as a whole. As such, it all depends on what your needs are at the time. Whether you restructure with your funders or file, do not assume the “sale” described in your agreement is a true sale. In other words, the label “sale” may not protect an MCA from recharacterization as a loan. By understanding these nuances, you can make the best decision for yourself and your business.
