How Courts Are Recharacterizing MCAs as Usurious Loans

The funder called it a purchase. The court called it a loan. The interest rate was 268%. The agreement was declared void.

A growing body of case law is examining merchant cash advances under the same scrutiny applied to lending products. The central question in each case is the same: did the funder bear genuine risk that it might receive less than the full contracted amount of the purchased receivables? If the answer is no — if the funder insulated itself from every form of downside risk through personal guarantees, confessions of judgment, fixed payments, and unresponsive reconciliation practices — the court treats the transaction as a loan. Once it is a loan, the interest rate is calculated. Once the interest rate is calculated, the usury analysis begins. And once the usury analysis begins, the numbers speak for themselves.

The Risk Factor

In a true purchase of future receivables, the funder accepts the possibility that the business will generate less revenue than expected. The return fluctuates with the business’s performance. If the business fails, the funder loses its investment. The funder has skin in the game. That risk — genuine, material, undiluted — is what distinguishes a purchase from a loan.

Courts examining MCA agreements look at the contract and ask: where is the risk? They look at the reconciliation clause and ask: does the funder actually reconcile payments when revenue drops? They look at the personal guarantee and ask: if the business cannot pay, does the funder bear the loss, or does the owner? They look at the confession of judgment and ask: is the funder relying on the business’s revenue stream, or on a court’s enforcement power?

If the contract contains fixed daily payments regardless of revenue, a personal guarantee from the owner that covers the full obligation, a confession of judgment allowing the funder to obtain a court judgment without notice, mandatory arbitration with a broad waiver of defenses, a reconciliation clause that the funder ignores or renders impractical, and UCC liens on all business assets — the court finds no risk. The funder built a collection mechanism and called it an investment. The court disagrees with the characterization.

The Judicial Analysis

Several New York courts have examined MCA agreements and concluded that the absence of genuine risk renders the transaction a loan. The analysis typically proceeds in two steps. First, the court determines whether the funder bore real risk of loss. If the contractual provisions, taken together, ensure that the funder will collect the full amount regardless of the business’s performance, the court finds no risk and classifies the transaction as a loan.

Second, the court calculates the effective interest rate. This calculation accounts for the daily repayment schedule, the factor rate, the funded amount, and the total repayment amount. When the math is done, the effective annual percentage rate on the recharacterized loan routinely exceeds 100%. Rates of 200% or 300% are not uncommon.

When the effective interest rate on the recharacterized loan exceeds the state’s criminal usury threshold — 25% per annum in New York — the agreement is void and unenforceable as a matter of law. Not voidable. Void. The distinction is critical. A voidable contract can be ratified or enforced under certain circumstances. A void contract cannot. It is treated as if it never existed. The obligation to repay is extinguished. Payments already made may be recoverable.

The Trend

The trend is not isolated to a single judge or a single court. Multiple New York courts have reached similar conclusions applying similar reasoning. The analytical framework — examine the risk, calculate the rate, apply the usury statute — is becoming established. Federal courts applying New York law have adopted the same approach. The framework is migrating from novel argument to established doctrine.

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Outside New York, courts in other states are beginning to examine MCA agreements under their own usury statutes and consumer protection laws. The specific thresholds and legal standards vary by state, but the underlying question is universal: is the transaction what it claims to be?

What This Means for Your Agreement

Not every MCA will be recharacterized. The analysis is fact-specific and contract-specific. An MCA that genuinely adjusts payments based on revenue, that does not include a personal guarantee, and that allows the funder to lose money if the business underperforms may withstand scrutiny. But the MCAs that most business owners signed do not look like that. They look like the agreements courts have been voiding.

An attorney can calculate the effective interest rate implied by your agreement, assess whether the contract contains the features courts have identified as inconsistent with a genuine purchase, evaluate the funder’s actual behavior regarding reconciliation and collection, and determine whether a recharacterization argument is viable in your jurisdiction. The case law is building. The question is whether your agreement falls on the enforceable side of the line or the void side.