Most owners who end up in bankruptcy court with merchant cash advance debt took the first advance because a bank would not move fast enough. The ease with which a merchant cash advance could be obtained led them to a second advance and then a third. Now the company is suffocating. So what happens to those advances once the business files Chapter 11? Many small businesses with an MCA debt will file for Subchapter V of Chapter 11 bankruptcy. Once this is done, the constant pulling of money from bank accounts will cease and the company will get operating capital to get the business back on its feet. That is the short answer. The longer one depends on how the funder behaves, what the contract really was, and whether you are on the hook personally.
If you are in this position, you are far from alone. Kathleen DiSanto, a Florida bankruptcy trustee with Bush Ross PA, put it bluntly: “I can’t think of a case in a long time where I haven’t seen them. And nobody has just one. They all have multiple.” The number of bankruptcy cases that listed debts to MCA companies grew significantly in 2023 and reached a record last year, with more than 230 filings, according to Bloomberg Law data. Many of these cases were filed in Florida and Texas, but more than half of the federal districts had MCA cases in the last year. It is not only small shops, either. Cosmetics entrepreneur Pat McGrath’s company filed for Chapter 11 bankruptcy, owing more than $3 million in payments to MCA companies as well as $43 million in debt on a secured loan. A Subway franchise with 43 stores also filed for bankruptcy, owing $1.4 million in debt on an MCA loan and revenue purchase agreement with an annual return rate of 94 percent.
None of this came out of nowhere. When the banks tightened their lending rules after the 2008 financial crisis, MCAs took off in the US. They grew in popularity more recently, fueled by the pandemic and a reduction in government-backed relief. Suddenly, every social media platform was a place you would see ads with quick access to funds without extensive credit checks. The MCA market in the United States is currently estimated to be worth approximately $20 billion and is expected to exceed $30 billion.
A Merchant Cash Advance Is Not a Loan
It helps to remember what a merchant cash advance actually is, because the whole bankruptcy fight turns on it. On paper, a merchant cash advance is not a loan and there is no interest rate. You essentially sell a portion of your future receivables for immediate cash flow. You will not pay an interest rate, but a “factor rate” of 1.1 to 1.5 is typical. The factor rate times the advance creates the “fixed” repayment. You will pay the advance provider daily or weekly. So if you get advanced $100,000 and have a factor rate of 1.3 that will mean you must pay them back $130,000, total. The problem is, the factor rate can, in some cases, have the effect of a 100% or even 200% annual interest rate, said Leslie Tayne, of Tayne Law Group, a New York firm specializing in debt relief. “It comes with heavy repercussions,” she said.
A related peril is “stacking,” when a business can’t make its payments and must take more advances to get out of the hole. This is increasingly common as a precursor to collapse. Rogers Landworks LLC, a land-clearing and trucking business in Florida, is one case in point. It filed for Chapter 11 bankruptcy in December after receiving 21 MCAs for more than $3.6 million. The company told the court its bankruptcy “was necessitated by accumulated MCA debt and aggressive MCA collection activity.” Tampa bankruptcy attorney Daniel Etlinger said it plainly: “Debtors are using these MCAs as sort of their last Hail Mary to stay out of bankruptcy.”
What immediately happens when a business makes the hard call to file a bankruptcy petition? MCAs stop pulling money from your bank account. Filing also buys the company breathing room and the cash needed to get back on track. Chapter 11 allows the business owner to keep operating their business and use their cash flow to pay their costs. As DiSanto said, “The MCAs are very ruthless until a bankruptcy petition is filed.” Bankruptcy is particularly necessary if the funders are attempting to enforce a default with a very high price tag or if the funders won’t settle.
MCA Funders Are Losing
What comes next often surprises owners. MCA funders often do not appear in court to contest a discharge, and when they do, it’s difficult for them to prevail on maintaining a revenue purchase arrangement or persuading the judge that they should be repaid. Those funders who contest being deemed lenders don’t always prevail, and risk producing undesirable precedent. Patricia Fugee, an Ohio bankruptcy attorney with FisherBroyles, said “There’s a lot of caselaw that recategorizes them as loans, but it’s not universal or automatic. I think MCA funders are losing on the sale versus loan argument more often than they’re winning.”
That sale-versus-loan question is the real fight. If the funder truly bought your future revenue, it argues that money was never yours. If it made a loan, it holds a debt, and debts can be dealt with in a plan. A Houston bankruptcy judge allowed the trustee liquidating an oil and gas contractor named Anadrill Directional Services Inc. to advance a suit claiming an MCA funder violated usury laws and dressed up a loan as a purchase of future sales. In October, a judge in U.S. Bankruptcy Court, Middle District of Florida, Tiffany Geyer, approved an Orlando-area fertility clinic’s restructuring plan that wiped out MCA debts. She determined that they had more loan-like qualities and that the clinic lacked property interests to transfer in future revenues.
Recharacterization is not guaranteed, though. The outcome depends on the contract, the court and the funder, and you should not assume your case will go the way the fertility clinic’s did. Etlinger says bankruptcy is a “quick litmus test” of how a funder is posturing. This can be useful for business owners, who are in many cases personally responsible for the debt when the business can’t pay. Tayne says trying to restructure these deals with aggressive funders can be “like negotiating with the mob.”
DiSanto, for her part, is “loath to think of an instance when bankruptcy isn’t the best solution for a debtor who has multiple merchant cash advance loans.” Still, bankruptcy tends to become necessary when funders refuse to settle, so it is worth finding out early whether yours will negotiate. All of this is to say that when a business owner has to rely on bankruptcy court to navigate the merchant cash advance process, something has gone wrong long before the filing. Fugee wants the problem caught earlier: “It begs for regulation. It begs for education. I wish there was a way to educate small businesses before they seek this sort of assistance,” she said.
