Merchants who stack MCAs often want to know who gets paid first in case of bankruptcy or liquidation. If your business has several merchant cash advances with multiple funders, you’ll have several UCCs against your property. Creditors are in business to make money, and the last thing they want to do is get less than they are owed. Sometimes, though, they are forced to take a loss. When several funders have liens against the same struggling business, the question is which of them takes the loss and which walks away paid.
The answer turns on one thing. Every MCA funder claims its deal was a purchase of receivables, not a loan. If it’s a sale, the funder owns the receivables and can claim them over others. But if it’s a loan, the funder is just a secured creditor, ranked by seniority of its perfected security interest. Junior funders only get paid after the senior ones. If the senior liens exceed the value of the collateral, the junior funder may have an unsecured claim and no enforceable lien (see § 506(d) of the Bankruptcy Code). A junior funder is very worried about payment priority, but the judge cares even more about what the transaction really was. So before you can know where any funder stands, you have to know what you actually signed.
Merchant Cash Advance
Start with what a merchant cash advance is. You’re selling future receivables (future cash flow) in exchange for an immediate lump sum payment. That cash can then be used the same way as a short-term loan. In MCA-speak, an MCA isn’t a loan, it’s a sale. The funder doesn’t “lend” you the money, they buy it from you. Like a payday loan, MCAs are a small amount of money in exchange for future earnings. But where a payday loan comes out of the borrower’s next paycheck, an MCA is repaid every single day via an arrangement where funds are automatically transferred from the merchant’s checking account.
A daily repayment requirement can cause many clients to struggle. Contractors, who often wait 30 to 60 days after completing a job for payment, find themselves suddenly without much cash when the withdrawals begin. In most cases, the moment the merchant doesn’t have enough cash in the account to cover the payment, it is automatically in default, and the full balance comes due immediately. It makes no difference that the business may have earned enough to pay off the advance. Your MCA contract doesn’t care if your business does well or poorly. It cares that you can always make the daily payment.
A True Sale or Is Really a Secured Loan
Once a business is in that position and the funders start fighting over what is left, a court has to decide whether a transaction is a true sale or is really a secured loan. That means figuring out whether the owner of the receivables is really the business or the funder. If the transaction has the economic effect of a secured loan then the owner of the receivables is the business and all that the funder has is a security interest. Most MCA companies try to create something that looks like a non-loan. A 2021 bankruptcy case shows what happens when a court looks past the label.
CapCall, LLC v. Foster (In re Shoot the Moon, LLC) is a September 2021 decision from the U.S. Bankruptcy Court for the District of Montana. CapCall is a merchant cash advance funder located in New York. In this case, CapCall sought a declaratory judgment that it owned $228,449.93 in segregated funds as part of the debtor’s bankruptcy estate. That declaration would allow CapCall to skip the trustee’s distribution and claim the funds directly. The trustee, Foster, had sold almost all of Shoot the Moon’s business assets. The net proceeds were far less than the total claims held by several secured creditors who had perfected security interests senior to CapCall’s. As a result, if CapCall had prevailed, it would have been able to collect its funds before any other creditor.
Determining whether CapCall has a secured claim depends on whether the transactions between CapCall and Shoot the Moon are sales or loans. If the transactions are sales, CapCall is the owner of the receivables and should be treated as such in determining the creditor hierarchy in this case. If, however, the transactions are loans, CapCall has only a security interest in the receivables and would be subordinate to the interests of the other secured creditors. Furthermore, the fact that the value of the collateral is less than the claims of the senior secured creditors means that CapCall will be relegated to an unsecured creditor with no enforceable lien, pursuant to section 506(d) of the Bankruptcy Code. In other words, CapCall would not get a dime.
The court relied on the “duck test” to determine the nature of CapCall’s deals with the corporate debtor. The idea is simple: if something looks like a duck, swims like a duck and quacks like a duck, then it probably is a duck. This meant that the court would try to reconcile how CapCall described its deals on paper with how those deals worked in practice. The form of CapCall’s agreement with Shoot the Moon was not determinative of its legal status. Judge Whitman L. Holt determined that CapCall’s merchant agreements were too similar to loans to be true sales. He also found that CapCall had violated Montana’s usury laws, which protect borrowers from predatory rates in certain kinds of lending, and that it had no ownership of the funds in Shoot the Moon’s bankruptcy estate.
The Junior Funder May Not Get Paid at All
That is the lesson for anyone with several liens on file. If a new funder has a lien that is junior to existing ones, and the total liens are more than the collateral is worth, the junior funder may not get paid at all. The funder that insists it bought your receivables outright is betting that a court will accept the label. CapCall made that bet and lost everything it was claiming.
A single case won’t overturn the MCA industry, but it was the first legal win for the businesses on the other side. Keep an eye on these developments as small businesses continue to be pointed toward MCAs. For now, the honest answer to the title question is that the funder with the most senior perfected security interest gets paid first, the ones behind it wait, and a funder whose “sale” turns out to be a loan may find that its place in line is worth nothing. That changes how you talk to them, because a funder who knows they need more than a lien to collect in bankruptcy has a reason to come to the table.
