Picture a typical case. The owner of a small company has taken several merchant cash advances and can no longer keep up with the debits. She had two options. She could negotiate a settlement on the advances, or she could file for Chapter 11. Neither is easy, and each comes with its own set of problems and pitfalls. The MCA market was estimated to be $19.65 billion in 2025 and projected to grow to $26.87 billion by 2030. But MCAs are under increasing scrutiny. And when the merchant goes bankrupt, a huge question becomes: Is the MCA really a ‘sale of future receivables’ (as the contract claims) or a disguised loan? How this question is resolved will determine the right path forward.
What is a merchant cash advance anyway? It’s when a funder buys your future credit card receipts or receivables at a discount to give you cash up front. You repay the money by daily or weekly ACH withdrawals from your bank account, usually as a percentage of your estimated monthly sales. So if you get a $90,000 advance to buy $140,000 of receipts and a $4,000 daily debit, the $50,000 difference is the funder’s “profit.” And that profit adds up: effective annual rates can exceed 300% in some cases. It’s a popular financing option for small businesses that don’t qualify for a bank loan.
Form Doesn’t Trump Substance
It may say in your contract that an MCA is not a loan. But for courts, form doesn’t trump substance. When you buy receivables in a true sale, the buyer takes the risk that the receivables are never actually collected. If the funder is ‘absolutely entitled to repayment under all circumstances’, the risk is not transferred from you and it is a loan. Courts use three main factors in deciding if there has been a true sale:
- (1) whether there is a reconciliation provision in the agreement,
- (2) whether the agreement has a finite term, and
- (3) whether the funder has recourse if the merchant goes bankrupt.
Other evidence might include default clauses in which the funder has the right to demand immediate repayment, a personal guaranty which is collectible on default or bankruptcy, and a security interest in the merchant’s assets.
The first sign of a disguised loan: reconciliation that sounds so one-sided that you should really call it an illusion. What I mean is the funder is under no obligation to repay any money it collects above the percentage of revenue it’s agreed to take, and there is no provision for reconciliation once the merchant is “in default” (defined as missing a daily or weekly payment, or violating a covenant such as a solvency covenant). The second characteristic is that it’s a de facto fixed term even though there is no stated maturity date. How do you figure out when the MCA will be repaid? You take the amount the merchant owes, divide it by the amount the merchant has to pay each day, and presto! You have a fixed maturity. Your eyes may be glazed over by now, but I promise to be gentle.
There are other clues this isn’t really a receivables sale. If the merchant personally promised to pay, or gave a security interest in the business’s property, courts have treated that as a mark of a disguised loan. Also watch out when the contract does not identify the specific receivables purchased, and the merchant is free to use the money however it chooses so long as the periodic payment is made. The courts view that last one as ‘a significant indicator of a loan.’
Chapter 11
What has this got to do with Chapter 11? If a merchant cash advance is recharacterized as a usurious loan, the payments to the funder may be subject to claw-back as constructively fraudulent transfers under section 548(a)(1)(B) of the Bankruptcy Code. In In re Anadrill Directional Services, the bankruptcy court in Texas allowed a lawsuit by the trustee to go forward. The court’s reasoning: if the MCA was, as alleged, a criminally usurious loan, then it was void under New York law. (MCA contracts typically choose New York law, which is why its usury rules keep coming up.) A void contract has no legal effect; it cannot create rights, duties, or obligations. Accordingly, the debtor received nothing of reasonably equivalent value in exchange for what it paid. The court also pointed out that the merchant there was on the hook for $1,016,000 after receiving only $650,000.
Which brings us to Section 547. In In re J.P.R. Mechanical, the court issued a summary judgment for the trustee, avoiding the MCA payments as preferences. Because the agreements and conduct had made the MCA into a debt, the payments made in the 90 days before bankruptcy while the debtor was insolvent could be clawed back. The funder, which had filed proofs of claim identifying itself as a ‘creditor’ with a ‘claim’ for money owed, admitted there was a debt. And the ‘ordinary course of business’ defense failed because the payments were far above the regular daily amounts and were not ordinary.
How does a Chapter 11 plan stay confirmed when it treats merchant cash advance funders as unsecured? In Butler Trucking, the court did so because the senior lenders’ liens were larger than the value of all the collateral, and because no one objected to the Chapter 11 plan’s characterization of MCAs. That treatment depended on the debtor winning a separate fight to have the so-called sale recharacterized as debt. What happens to the receivables your business generates, after filing for bankruptcy protection? They’re not the funders property. You didn’t have them when you supposedly sold them, and you can’t sell something that hasn’t happened yet. In the IVF Orlando case, a bankruptcy judge wrote, ‘one cannot sell more than one owns, and when the MCAs were executed prepetition, the Debtor had no future receivables to convey, only a hope they may come to exist.’ Section 552(a) of the Bankruptcy Code reinforces this point. Even if you think of these funders as creditors with a security interest instead of as an owner, even then their lien would not attach to the receivables you get after your bankruptcy petition is filed.
Butler Trucking had one more wrinkle. The debtor’s plan rejected all executory contracts - a move that arguably includes merchant cash advances - leaving the funder with only a prebankruptcy unsecured claim (see sections 365(g)(1) and 502(g)).
Settle or File
So, settle or file? Settlement is whatever you worked out with your funders on your own. The clawbacks, preference recoveries and unsecured status all happen only if you go to a bankruptcy court; you don’t get those results automatically. In either scenario, the key is the same: pull out your contract, see what it says, and understand how you both acted. All the things that make an MCA look like a loan are the same factors considered in bankruptcy. If it functions like a loan, particularly one with an interest rate above the state’s usury cap, it may be dischargeable or restructureable in Chapter 11, and you may even be able to recover payments you have already made. Here is my advice: choose a reputable attorney, and do it early.
