If your business has a merchant cash advance pulling money out of its account every day and you are weighing Subchapter V of Chapter 11, one question comes before all the others. What’s going to happen to that MCA? You’re not alone. If you’re ready for the short version of the answer, here it is: It depends! This is one of those situations where you will not get a pat answer of yes or no, because what happens depends on what the court decides. And what the court decides is whether your MCA was a loan or a true sale of your future receivables. Subchapter V doesn’t change the status of your MCAs one way or the other. Loans aren’t true sales. They behave completely differently in bankruptcy.
A Borrower or as a Seller
This is how the MCA lender wants you to think of it: in exchange for $50,000, you sold $80,000 worth of receivables to the MCA provider. It collects by taking a cut out of each day’s or week’s receipts, either through a card processor it approves or by debiting your bank account directly. MCA companies claim they are not lenders and that they are not giving out loans. They usually avoid using the word ‘loan’ in their materials. But it doesn’t matter how fancy your letterhead is, cash advances are still cash advances. The line that an MCA is not a loan is a slogan, not a reality. However, many courts have looked beyond their label to hold MCAs to be loans. So the question for you is this: Will the court see me as a borrower or as a seller?
If the answer is seller, your MCAs are not loans. The receivables you sold are not property of your bankruptcy estate. (1) The MCA provider owns the receivables it purchased from the bankrupt merchant, and (2) The merchant can’t stop them from collecting on them because it filed bankruptcy. When the transaction is structured as a purchase of receivables, the automatic stay does not apply. In other words, your MCA payments continue unabated in bankruptcy. Not fun for anyone.
If the answer is borrower, however, the picture changes. The MCA is treated as a loan. The provider is a creditor. The receivables continue to be property of your estate, so the automatic stay applies, and the provider must cease collection efforts after you file. Plus the provider’s rights of recovery in such a situation are nothing more than a junior lien. If a merchant cash advance is treated as a loan, it’s covered by state usury laws. The provider could be looking at interest refunds to the borrower, hefty civil fines, and perhaps even criminal charges.
Here is how that played out in one case. In In re Shoot the Moon, LLC, decided in 2021, a Montana bankruptcy court decided that what the MCA provider said was a sale of anticipated sales receipts was, in fact, a loan. It then had to choose between New York and Montana usury law, and it picked Montana, which caps interest rates at the greater of 15% or six points above prime, with a penalty of double the interest. That didn’t bode well for the MCA lender. The trustee won a judgment of $1,216,685 on the usury claim. In addition, the court held that payments made to the buyer during the three months before the bankruptcy filing were preference transfers that could be clawed back, and it barred the buyer’s proof of claim until it actually paid the preference judgment. That’s a nightmare scenario that could become reality for many MCA providers.
Courts Mostly Ask Three Questions
So how’s a judge to tell whether your MCA provider is a disguised lender or a good faith purchaser of your receivables? Courts mostly ask three questions: what do the documents say, what rights and remedies does the provider have, and how did the two of you actually deal with each other? Courts start by reading the actual transaction documents. The fact that the transaction documents label the agreement a sale is not conclusive. When your company sells receivables, courts look at whether the price paid was a fair amount for the future sales it received and whether you gave a wide security interest in other assets to back it up, which looks more like a loan.
Then come the provider’s remedies. For instance, do the lender’s options if the borrower stops paying extend way beyond the rights it would have in the actual debt being sold? That’s a big hint the deal might actually be a loan. This also counts if the lender gets full personal guarantees, a power of attorney, the right to take money straight from the borrower’s checking account, or the right of the borrower to “buy back” the receivables. Finally, the borrower’s right to change the amounts it is paying may look like it is real, but if it is subject to the lender’s approval, it’s really no option at all.
What you two actually did also counts. Even if your paperwork says “purchase,” the judge will look at the real relationship. Read the emails and letters back and forth. If you see words like “loan,” “terms,” or “balance,” it looks more like a loan than a sale. Also, if you roll an old loan into a new one using the same collateral, it’s probably a loan. The same goes for stacking a new advance on top of one that is not yet paid off. A seller of the receivables doesn’t go back and sell the same ones over and over again.
Your Current Lender
The bank. Always the bank. Most MCA borrowers already owe a bank or asset-based lender with a first lien on substantially everything they own. Your bank has a contract saying you can’t do a merchant cash advance (MCA) unless they say you can. Almost nobody asks. Not asking means you don’t tell the bank. You just do it. Your existing lender finds out you got an MCA, and you’re in trouble. Selling receivables the bank has a lien on may be conversion. If they held a claim on your accounts receivable (i.e., invoices owed to you), they could seek to recover any money you received from an MCA provider. And your current lender is likely stronger than the MCA. When picking friends and enemies, you want the stronger party as the friend.
Then there is you, personally. MCA providers often ask the business owner to sign a guarantee of the MCA and a confession of judgment, which can be filed against the business owner in case of default. In enforcement proceedings, the FTC alleged that MCA providers withdrew money without authorization and illegally used confessions of judgment to target guarantors’ personal property and get judgments against them.
None of this means Subchapter V is the wrong move, only that it is not the only one. When you find yourself in financial trouble, you have a number of choices, including bankruptcy, an assignment for the benefit of creditors, a friendly foreclosure, or an out-of-court workout. It is possible to negotiate an agreement with an MCA creditor. The problem is that many businesses wait too long to do any of these things. And the longer they wait, the fewer options they have. I urge you to ignore those voices telling you to sell your way out of this situation. No matter what, this is not going to fix itself. The sinking feeling you have is telling you to call someone.
