Merchant cash advances: Making good decisions in unprecedented times

Operating a successful business requires working capital and regular cash flow. When money is tight, business owners often consider alternative sources of funding. With the effects of the COVID-19 pandemic, many small businesses are encountering a slowdown, while attempting to do right by employees and hold out hope that things will return to business as usual quickly. These are unprecedented times, and it is important that business owners consider all of their options and the potential risk before committing to a funding path.

One type of alternative funding is a merchant cash advance. A merchant cash advance allows a business to obtain immediate sum against future receivables. Similar to a consumer “pay day loan,” the business is selling future revenue for cash today.  Most merchant cash advances are repaid within six to twelve months. The repayment of the advance, plus fees, is made by either: (1) a set percentage “holdback” from daily or weekly credit card receipts, or (2) an automated clearing house (ACH) withdraw from the business bank account in a fixed daily or weekly sum.

A merchant cash advance is significantly more costly than traditional financing, and the amount of the fees depends on the risk assessed by the merchant cash advance company. Usually, the factor rate is between 1.2 and 1.5, which means the fees can be equivalent to paying an annual percentage rate of up to 200% of the advance.

Given the exorbitant fees associated with merchant cash advances, many businesses have been trapped in cycles of debt – often taking out subsequent merchant cash advances to pay off the earlier advances. Some businesses have attempted to challenge attempts by the merchant cash advance provider to collect by arguing that the merchant cash advance is merely a disguised, usurious loan.

The question of whether a merchant cash advance constitutes a sale of future receivables or a loan that is secured by and paid from future receivables is an important distinction for determining (1) whether usury laws apply, (2) whether the merchant cash advance provider is a secured creditor, and (3) whether the payments made to the merchant cash advance provider are recoverable as preferential or fraudulent transfers in bankruptcy.

There has been a recent wave of case law concerning merchant cash advance agreements. The bulk of the case law addressing this issue has come out of New York state courts, and it appears that many merchant cash advance entities are including choice of law provisions in their merchant cash advance agreements calling for application of New York law, due to the favorable treatment they have received in that state.1

The courts that have addressed this issue have identified several factors that should be considered in determining whether a merchant cash advance agreement is a true sale or a disguised loan, including:

  1. Whether the merchant cash advance agreement includes a reconciliation provision that allows the merchant to adjust its stipulated daily payments to the amount of its actual daily receipts;2
  2. Whether there is an indefinite contract term, which is “consistent with the contingent nature of each and every collection of future sales;”3
  3. Whether the provider has recourse if the merchant goes out of business or declares bankruptcy;4
  4. Whether the provider requires the filing of a UCC-1 financing statement, to take a security interest in the receivables;5 and
  5. Whether the provider requires a personal guaranty to secure the debt.6

Ultimately, the question boils down to whether the repayment is absolute or contingent upon the merchant earning future income.7 If the repayment is contingent and the provider is taking the risk that it will not be paid, the courts will likely view the transaction as a true sale. This is the case even where the provider requires the filing of a UCC-1 financing statement or the execution of a personal guaranty (so long as the guaranty is not more broad than the obligations under the merchant cash advance agreement – i.e., it does not require payment in the event that the merchant fails to have future income).

Some courts in California have taken a more strict approach, finding that despite the form of the merchant cash advance transaction, where the purpose is to loan money at a usurious rate of interest, the subject transaction is a loan, not a sale.8

Although there are many state and federal courts that have not addressed this issue, those courts would likely consider similar factors in determining whether merchant cash advance agreements are true sales versus disguised loans. Accordingly, businesses must consider the high cost of merchant cash advances – the extreme fees, the drain on future receivables, and the likelihood that usury and predatory lending defenses will fail in any collection litigation initiated by the merchant cash advance provider.

The most commonly addressed issue in the bankruptcy courts regarding merchant cash advance agreements is whether payments of the receivables by the debtor to the merchant cash advance provider are preferential transfers, or whether those payments fall within the ordinary course of business exception under section 547(c)(2) of the Bankruptcy Code. The courts that have addressed this issue have generally determined that the relationship between the parties is determinative and payments to a merchant cash advance provider may fall within the ordinary course of business where the debtor has a history of using merchant cash advances and the payments are regular.9 Therefore, even in bankruptcy court, debtors and trustees have not had significant success recovering payments from merchant cash advance providers.

If your business is experiencing hardship due to the COVID-19 outbreak or otherwise, it will be imperative for you to consider all available funding and/or workout options. McDonald Hopkins’ business restructuring group attorneys are very experienced and well positioned to help you navigate your financing and/or workout needs, and we can help guide you through the myriad of financing options available in response to COVID-19.


1. New York trial courts have examined many merchant cash advance agreements and have largely determined that most of them are not loans, but purchases of receivables. See, K9 Bytes, Inc. v. Arch Capital Funding, 56 Misc. 3d 807, 57 N.Y.S.3d 625 (N.Y. Sup. Ct. 2017); Rapid Capital Finance, LLC v. Natures Market Corp., 57 Misc.3d 979, 982 (N.Y. Sup. Ct. 2017).
2. Id. at 816.
3' Id.
4. Id; Colonial Funding Network, Inc. v. Epazz, Inc., 252 F. Supp. 3d 274, 281(S.D. N.Y. 2017).

5. Rapid Capital Finance, LLC v. Natures Market Corp., 57 Misc 3d 979, 984-85 (N.Y. Sup. Ct. 2017) (explaining that execution of a security interest, though it may serve to protect the buyer’s ability to collect the underlying obligation, is insufficient alone to establish absolute repayment).
6. Platinum Rapid Funding Group Ltd. v VIP Limousine Servs., Inc., 2016 WL 6603853, at *4, 2016 N.Y. Misc. LEXIS 4131, at *9 (N.Y. Sup. Ct. Oct. 27, 2016) (finding contingent repayment where “[t]he guaranty is no broader than the obligations under the Agreement, and the requirement of payment by the Guarantor is no greater than that of the Merchant.”);
7. Lange v. Inova Capital Funding, LLC (In re Qualia Clinical Serv., Inc.), 441 B.R. 325 (B.A.P. 8th Cir.), aff’d, 652 F.3d 933 (8th Cir. 2011) (holding that the recourse provisions in the merchant cash advance invoice purchase agreement placed the risk of non-collection on the debtor, so the agreement was a disguised loan rather than a true sale). 
8. Essex Partners Ltd. v. Merch. Cash & Capital, No. CV1103366CASMRW, 2011 WL 13123326 (C.D. Cal. Aug. 1, 2011) (“It is apparent that the only purpose of the transactions was to loan money at a usurious rate of interest; therefore, the Court finds that the subject transactions are loans.”); Milana v. Credit Discount Co., 27 Cal.2d 335, 342 (1945) (“to call the transaction a sale of accounts did not alter the fact that it was merely an advancement of money to be repaid with interest at a rate greater than allowed by law”).
9. [1] See In re Hill, 589 B.R. 614, 621 (Bankr. N.D. Ill. 2018) (holding that the payments made to the merchant cash advance provider were made in the ordinary course because the debtor had used so many merchant cash advances that the transactions had become an ordinary part of the debtor’s business); but see In Matter of Cornerstone Tower Servs., Inc., No. A17-4051, 2018 WL 6199131, at *8 (Bankr. D. Neb. Nov. 9, 2018) (holding that the merchant cash advance provider had failed to meet its burden of proof on the ordinary course of business defense where the history between the debtor and the provider was only two and half months long, there was no established routine, and the transactions occurred only when the debtor was in financial straights).

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