The merchant cash advance is a popular financing product for businesses that desperately need cash, and the deal is simple enough on its face: the funder hands over cash now in exchange for a share of what the business collects later. In other words, it is a percent of every dollar coming into the business. When those collections dry up and the debits keep coming, owners start asking about bankruptcy. Although Subchapter V is important, it is not an unlimited life raft for dealing with the exorbitant debt of Merchant Cash Advances. One important consideration for MCA-funded merchants looking to enter Subchapter V bankruptcy is a question few people think about when they sign: is the advance really a sale of future receivables, or is it a loan in disguise?
A True Sale or a Loan
The label decides who owns the money. In a true sale, the receivables are not part of the bankruptcy estate, so the automatic stay won’t prevent the funder from collecting on them after the filing. In a loan, the funder is only a secured creditor, which means it is subject to the stay and may also have to compete for the collateral with other secured creditors. Usury laws could apply to a loan, but not normally to a true sale. Can a merchant cash advance be a loan? Yes, and that is what the funder wants to avoid, as their collection rights could be barred or limited.
To decide if the deal is a true sale or a loan the court generally takes a holistic approach, and the words in the contract are only the start of it. No single factor decides the case.
Two bankruptcy cases show how this plays out, and they came out in opposite directions. In Shoot the Moon, a restaurant company signed eighteen separate merchant agreements with a funder called CapCall. Each time, CapCall funded the entire purchase price upfront, and took ACH debits from the restaurant until they got their money plus generous return. After the company filed, CapCall claimed the deals were true sales, which would have made money sitting in a segregated account its own. Then the trustee said they were disguised loans rather than true sales, and the court agreed - the agreements were secured loans which were also usurious under state law.
In R&J Pizza, the funder, Merchant Cash & Capital, won. The financing company purchased an undivided interest in R&J’s future credit card receivables, at a discount. Under the terms of their transaction, the credit card processor was to make payments directly to the funder. The funder could not charge any interest regardless of how long it took to get its receivables. After filing for bankruptcy, the company changed its processor, without notifying the funder. The court held this was a true sale; the company did not have any rights in the receivables after sale.
So what separated the two? The first thing the court will look at is what the papers actually say. Both agreements used language that pointed toward a true sale, which is not surprising - it is what the funder wants. CapCall’s agreements had long clauses saying the deals were purchases and not loans. That alone isn’t decisive; the court called those clauses “self-serving” and “conclusory,” because calling a deal a sale does not change what it is. In Shoot the Moon, despite what the contract said, the court found that the deals were loans, rather than true sales because of certain facts relating to the parties’ rights and obligations in the contracts.
Look at what CapCall’s contracts gave it. The contracts describe a security interest in all payment and general intangibles and all proceeds. They also had a security interest in inventory, equipment, and service marks. At first this does not sound like true sale language, and it is not. Those were broad-lien security interests, like an actual bank loan. The court held that a true buyer should get only a protective security interest in the accounts purchased. The financing statements named the company as “debtor” not “seller,” although there is a choice of “seller” or “buyer” on the forms. And the personal guarantee is broad, the power of attorney is broad, and there is a right to take money from the accounts anyway.
In R&J Pizza, though, the contract was just different. The agreements called the deal a “sale” and a “purchase” and the parties “seller” and “purchaser” all the way through. The financing statement was even set up the same way. No security interest is granted, no recourse if the receivables aren’t collected, and R&J has no right to repurchase. The personal guaranty was limited to misrepresentations and acts that were not credit-related.
The other thing the courts looked at was how the parties actually behaved. In Shoot the Moon, the parties repeatedly referred to “loans,” “terms,” “balances,” etc. But it also makes sense that courts don’t care what your funder calls it when they “talk the talk”. The money was stacked and rolled deal to deal. The company commingled funds. CapCall knew this. The court said rolling funds only works for a loan, since the buyer would have to be re-buying and re-selling receivables all the time. In fact, it is a fairly clear indication that the funding is a disguised loan. In R&J Pizza, by contrast, there was only one designated processor, and the company had no power to collect or commingle funds.
Not every factor pointed against CapCall; the contracts did not provide for a repurchase agreement and did not provide the company with the right to change the price terms. The court agreed that this was in favor of CapCall, but did not weigh it enough to outweigh the other factors. The court noted that it was rare to have all of the factors in this kind of transaction weigh in the same direction. One of the key questions that the courts would consider was which party was allocated the risk; if the credit risk was on the seller or the guarantors, it was more likely to be a loan.
Where do you go from here? For one, bankruptcy protections are not clear-cut. Indeed, whether or not your receivables will become property of your bankruptcy estate will depend on an analysis of the facts and circumstances and generally not on any dispositive factor. The language of the contract, coupled with the conduct of the parties will be what matters the most when a court looks at your advances. It is very important to get all the MCA agreements and UCC filings, as well as any e-mails and texts with the funders. Then look at whether the security interest extends beyond the receivables. Also find out what the personal guarantee says; see if they rolled advances into other advances, and note whether your company is named a “debtor” or a “seller.” Be sensitive to the language, and be on the look out if the funder is calling the obligation something other than a “sale”.
We are a debt settlement firm, not a law firm, and nothing here is legal advice. If you are considering bankruptcy for your Merchant Cash Advance funded business, working with the right Bankruptcy Attorney is key, and Subchapter V is only one path worth weighing. Don’t panic, although this certainly can be a scary experience. Take heart, and remember you are not alone in all this.
