How Courts Are Recharacterizing MCAs as Usurious Loans

A Loan or a Sale of Future Receivables

Most likely, when you took out the cash advance, your funder told you that it wasn’t a loan. Rather, it was a “purchase and sale of future receivables” or something like that. The “sale of receivables” label does not determine what your cash advance was. Courts will look at the substance of the agreement. In New York, a loan over 25% a year is usury - a crime, and a claim that can be wiped out in court. On the other side, if it’s really a sale, you’re stuck with it.

The laws are complicated, and courts look at many things, but in New York, the appeals court has laid down some guideposts. In 2020, a case called LG Funding LLC v. United Senior Properties of Olathe listed three things:

• (1) whether there’s a reconciliation clause tied to your actual revenue;
• (2) whether the contract can go on forever, or whether it has a definite, finite term; and
• (3) whether the funder has recourse against the business if it goes bankrupt.

Most courts consider how much risk the funder took in putting up the cash. In Kapitus (2026), the First Department applied the same LG Funding test.

One of the main characteristics of a cash advance in contrast to a loan is that in a cash advance, the amount to be paid back is variable, depending on the business’s actual receipts from credit card or cash sales. Compare that to a normal loan repayment term, where the funder gets a fixed payment every week or month no matter how the business is doing. For the financing to be a true sale, the funder should share the risk of loss if the business’s receipts fall short. It’s a huge deal whether your contract has a reconciliation clause, and whether the clause is illusory, or conditional on something, or unclear, or bogus.

The problem is that most of these clauses, when you read them closely, actually say that the reconciliation is conditional, or the amount of reconciliation, or whether a reconciliation can take place, are determined by the funder’s “sole discretion.” If the funder has a complete veto over whether a reconciliation is carried out, that means the “reconciliation clause” in the contract is worthless, and the contract was in fact just a loan. In LG Funding, the funder’s contract also defined “Merchant’s Default” to include a bankruptcy. The Court held that the trial court didn’t have enough facts to say whether a merchant cash advance was a loan or a sale of future receivables. So the usury defenses went forward.

There are dozens of legal theories you could try out. But as a practical matter, in negotiations, trials, and appeals, the big question comes down to whether or not you requested a reconciliation. If your contract does have a reconciliation clause, don’t forget to ask for the reconciliation. Make sure that the request is specific, and that it mentions the reconciliation clause specifically by name. Did you? Ask in writing? Usually the way it goes is that you get in trouble, you fall behind on your payments, and finally you call the funder’s representative and say, “Listen, I can’t make the payments. How about taking a look at our receipts and cutting us a break?” Maybe you say something about how this is a terrible economy and times are tough, or something else that doesn’t amount to a clear and simple statement to the funder: “I am requesting a reconciliation.” If you’ve defaulted, your funder will likely argue that you waived your rights to it by not bringing it up at the right time.

The second indicator is whether the advance had a fixed term (was it to last for a finite amount of time or did it have an indefinite term) and whether your payment schedule was fixed (did it require you to pay a certain amount every day or week or month, or were the payments determined by your actual receipts?). If the payments are the same regardless of the business’s receipts, then it doesn’t look like the deal’s repayment is tied to sales. Two bankruptcy cases below had both.

The last major indicator is whether the contract holds someone personally liable, such as a personal guaranty, or an automatic judgment, and whether the agreement makes you liable in the event of bankruptcy. Most importantly, does the agreement say that in the event that the business defaults or goes bankrupt, you’re personally on hook for the full amount of any shortfall? The agreement might say that the funder can come after you personally, even if the business has failed. That makes it look a lot like a loan. There are other indicators too, like whether the business gave the funder a security interest (the power to seize the business’s assets, and maybe even shut it down). If the funder is exercising these powers, that’s a sign that the deal is more of a loan than a sale.

Bankruptcy courts have come up with another test. They look at a particular hypothetical scenario: What happens if a business with an outstanding cash advance goes bankrupt? Who bears the risk that the business’s sales decline? Who’s legally on hook for the shortfall? If the funder is on hook, then the deal is likely a sale. But if the business or some third party is on hook, then the deal is likely a loan.

Three recent bankruptcy cases show this. Each of the businesses filed bankruptcy, and ended up trying to get rid of their cash advances by claiming that the financing deals were in reality illegal loans, and that the debt had to be thrown out under New York’s usury laws. The main question is whether the business gets stuck with the shortfall if things go wrong. If it can, as in Williams Land, then it’s a loan. If it can’t, as in Global Energy, then it’s a sale.

Global Energy was before a bankruptcy court, which did a deep dive into how the financing worked. The court found that the risk that the business’s receipts might decline was on the buyers, not the business. Its reconciliation tracked actual collections. The contract clearly took the risk off of the business and put it onto the funder. Bankruptcy wasn’t even a default.

If a court rules that your cash advance is a loan, then its consequences can be huge. Not only can your merchant cash advance loan be voided; it might be clawed back. If your business files for bankruptcy and your funder is listed as a creditor, then not only will it probably have its claim thrown out; your bankruptcy trustee may be able to force your funder to disgorge what it’s already been paid. In Williams Land, the court found a whopping 101.1% interest rate. The bankruptcy court threw out the agreement. JPR clawed back over $3 million. Global Energy’s usury claims were dismissed.

Bear in mind that your repayment schedule has to be figured by the year, not by the day or the week. If you pay every day, how much does that add up to by year?

For example, say you get a $100,000 advance. You expect to pay back $140,000, and you expect it to take six months.

As long as the funder isn’t charging more than 25% interest on its cash advance, it has nothing to worry about. But once it crosses that threshold, then it might be committing criminal usury, and the cash advance becomes unenforceable. Knowingly doing so is a class E felony. Corporations generally raise only criminal usury.

One way to spot a possible loan is to look at the APR. New York requires an estimated APR. It gives you a way to check the actual interest rate you’re being charged.

This article focuses on New York, but laws vary state to state. Not all states’ usury laws are as strict as New York’s. Check your state’s laws. Illinois has none for corporate borrowers.

If your business is going into bankruptcy, you have the opportunity to challenge your merchant cash advance agreement. Your trustee has the power to pursue anything of value, including getting rid of a merchant cash advance or seeking a recovery against the funder.

When you fall behind on your payments, you might start seeing messages from your customers saying they’ve gotten payment demands from your funder. Your customers are probably surprised to hear they owe anything to the funder. UCC liens permit this without judgment.

Negotiating Power

Whether your contract is technically a loan or not, the distinctions can make a difference in your negotiating power. Especially in states where the law is unclear, funders may agree to settle when faced with the risk that a court might determine the advance is a loan. First and foremost, you want to show the agreement’s payment schedule, including a recalculation of the payments to make sure the agreement is calculating the interest correctly and that the effective interest rate is above New York’s 25% usury limit. If the funder is already actively going after you, and has you in court, it might be the best thing to negotiate a settlement. The chances of winning outright are iffy. It might be safer to take a settlement offer, as long as the offer is fair.