Recharacterization of Merchant Cash Advance Agreements in Bankruptcy

Merchant Cash Advance (MCA) agreements are increasingly popular as alternative financing tools for small businesses, especially those in need of quick cash. Unlike conventional bank loans, MCAs often carry extremely high effective interest rates. They also require daily or weekly payments — much more frequent than typical bank-financed loans.

Scrutiny and potential recharacterization in bankruptcy court. While MCA lenders market these agreements as non-loan cash infusions in exchange for a percentage of future receivables (i.e., a sale), bankruptcy courts routinely scrutinize MCA loans more closely, frequently recharacterizing them as disguised loans. This recharacterization can have devastating effects for the MCA lender and, potentially, represent a large windfall for a debtor. The consequences of recharacterization include the voiding of the agreement under certain state usury laws, the disallowance of claims, and the recovery of previous payments made by the debtor to the lender as preferences or fraudulent transfers. Three recent bankruptcy decisions, In re JPR Mechanical,¹ In re Williams Land,¹ and In re Global Energy Services,² demonstrate how courts determine whether an MCA agreement is a true sale or a disguised loan.

The three‑factor test to determine whether an MCA agreement is a true sale or a disguised loan. Despite only one of the cases being filed in New York, all three MCA agreements in these cases were governed by New York law. Each case therefore analyzed the three‑factor test articulated in LG Funding, LLC v. United Senior Properties of Olathe, LLC ³ and adopted by the Second Circuit in Fleetwood Services, LLC v. Ram Capital Funding, LLC.⁴ Under the LG Funding test, courts evaluating whether an MCA agreement is a true sale or a disguised loan typically focus on three elements:

(a) whether the payment amount can be adjusted based on the business’s actual revenue (i.e. the presence of a reconciliation clause);

(b) whether there is a set repayment schedule; and

(c) whether the funder has recourse, either directly against the debtor in bankruptcy or against a guarantor.

Application of the Three-Factor Test.  A meaningful reconciliation clause — like the one in Global Energy, which required payment adjustments based on actual collections — shifts risk to the funder and supports a true sale finding, whereas clauses deemed “illusory” like those in JPR and Williams Land failed to do so and indicate a loan. A finite or de facto fixed term, as found in JPR and Williams Land, suggests the MCA agreement at issue is a loan by implying a repayment schedule independent of receivables, unlike Global Energy, where no time limit was imposed. Finally, recourse in bankruptcy, such as personal guaranties, security interests, or the ability to file proofs of claim in bankruptcy, indicates a loan, which was the case in JPR and Williams Land. On the other hand, Global Energy’s express assumption of insolvency risk and lack of default upon bankruptcy favored a true sale characterization.

The key question is, “Who bears the risk?” Beyond the three factors each court analyzed, most bankruptcy courts emphasize a single overarching question: Who bears the risk of non-payment? In a true sale, the funder’s recovery depends on the merchant’s actual receivables, while with respect to a loan transaction, the funder is entitled to repayment regardless of performance. In JPR and Williams Land, the courts found that the funders bore little to no risk of repayment in the event the debtor failed to pay its obligations. Payments were fixed, reconciliation was limited, and recourse against the debtor, its property, and/or guarantors was available. In Global Energy, the court found that the lender bore the risk, as payments were contingent on collected receivables, reconciliation was enforceable, and there was no recourse in bankruptcy. Thus, whether an MCA agreement is characterized as a loan or a sale often comes down to who bears the risk in the event the debtor is unable to pay its debts.

How recharacterization can affect lenders. These three cases underscore the potential risks to lenders and benefits to debtors in bankruptcy. If an agreement is recharacterized as a loan, the lender may face disallowance of its claim, exposure to preference or fraudulent transfer actions, and even voiding of the agreement under New York’s criminal usury law, which caps interest at 25% per annum (note that Illinois does not have similar usury laws for corporate borrowers). In Williams Land, the court found the effective interest rate to be 101.1% and declared the agreement void ab initio. This allowed the debtor to recover payments and object to the funder’s claim. In JPR, the court avoided over $3 million in transfers as preferences. In Global Energy, however, the court found the agreement to be a true sale and dismissed the usury-based claims.

Opportunities for trustees/debtors. In sum, bankruptcy can dramatically shift the balance of power with respect to MCA agreements. Despite being on the end of a potentially onerous deal, debtors and/or chapter 7 trustees should carefully scrutinize these agreements for opportunities to recharacterize them and pursue claim objections, avoidance actions, or usury defenses. The outcomes in JPR, Williams Land, and Global Energy therefore illustrate both the risks for lenders and opportunities for debtors, in MCA transactions.

Questions about how an MCA agreement may impact a bankruptcy proceeding? Contact Sean Williams, Elizabeth Vandesteeg, or another member of the Financial Services & Restructuring group.

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¹ Apex Funding Source LLC v. Williams Land Clearing, Grading, and Timber Logger, LLC (In re Williams Land Clearing, Grading, & Timber Logger, LLC), No. 22-02094-5-PWM, 2025 WL 1426503 (Bankr. E.D.N.C. May 16, 2025).

² Guttman v. EBF Holdings, LLC (In re Glob. Energy Servs., LLC), No. 21-17305-NVA, 2025 WL 1012721 (Bankr. D. Md. Mar. 31, 2025).

³ LG Funding, LLC v. United Senior Properties of Olathe, LLC, 122 N.Y.S.3d 309 (App. Div. 2d Dep’t 2020).

⁴ Fleetwood Services, LLC v. Ram Capital Funding, LLC, 2022 WL 1997207 (S.D.N.Y. June 6, 2022).