Merchant cash advances (MCAs) have become an increasingly popular way for small businesses to access quick financing. However, MCAs also come with high interest rates and aggressive collection tactics that can push borrowers into bankruptcy. Filing for bankruptcy may provide a path to eliminating overwhelming MCA debt.
What is a Merchant Cash Advance?
A merchant cash advance provides a business with a lump sum of capital in exchange for a percentage of future credit card sales. It is not technically categorized as a loan, so MCA companies can skirt consumer protection laws and charge higher fees.
MCAs appeal to small businesses because:
- Funding is quick – businesses can receive an advance in days
- Few business financials required – personal credit scores rarely checked
- Daily repayments – no large monthly bills
However, MCAs also have significant downsides:
- Extremely high effective interest rates – often over 100% APR
- Aggressive collections – threats to seize business assets or bank accounts
- Potentially predatory – targeting those with poor credit or few other options
With interest and fees piling up daily, MCA debt can quickly spiral out of control. But is bankruptcy an option for relief?
Can You Discharge MCA Debt in Bankruptcy?
Whether MCA debt can be discharged depends on how the advance is structured.
True Loans
Some MCA companies operate as true lenders, providing set-term loans at fixed interest rates. These would be treated like any other unsecured small business loans in bankruptcy. Such debts are eligible for discharge unless fraud or misrepresentation was involved in obtaining the financing.
Cash Flow Purchases
Many MCAs are structured as purchases of a percentage of future receivables rather than loans. This allows MCA firms to bypass state usury laws on interest rates.
The critical bankruptcy question is whether the MCA contract constitutes a true sale of receivables or merely a loan secured by receivables. Courts examine the economic reality of the transaction to make this determination.
Factors suggesting a true sale include:
- The business receives a lump sum up front rather than structured payments
- The amount advanced does not appear tied to the value of receivables sold
- Personal guarantees required from business owners
Where the contract is deemed a true sale, the MCA company owns the rights to future receivables and the debt cannot be discharged in bankruptcy. The MCA firm can continue collecting against post-petition sales.
However, if the transaction is deemed a loan rather than sale, the debt could potentially be discharged like any other unsecured claim.
Using Bankruptcy to Fight Back Against Predatory MCAs
The National Consumer Law Center has raised alarms over the predatory nature of many merchant cash advances. Small businesses can easily become trapped in debt spirals and abusive collection tactics.
Bankruptcy filings provide leverage to fight back, even where debts cannot be fully discharged. A Chapter 11 or Chapter 13 repayment plan can force concessions from MCA creditors.
Strategies include:
- Capping interest rates through court-approved plans
- Obtaining temporary collection relief through automatic stay
- Challenging security interests or liens
- Prioritizing payments to other creditors
While MCA creditors will strenuously object to such tactics, bankruptcy courts provide a forum to negotiate compromises under court supervision.
The threat of bankruptcy can also bring MCA companies to the table for out-of-court restructuring agreements. Creditors have an incentive to compromise rather than risk unfavorable court-imposed terms.
When Bankruptcy Filing Makes Sense
For small businesses overwhelmed by MCA debts, filing for bankruptcy protection may provide the only path back to viability. Signs a Chapter 11 or Chapter 13 bankruptcy could help include:
- Daily payments consume over 50% of revenue
- Harassing communications from multiple MCA creditors
- Threats of litigation, asset seizures or bank levies
- Falling behind on payroll, taxes or essential vendors
The automatic stay triggered by bankruptcy stops collections and provides time to develop a survival strategy. The business can seek debtor-in-possession financing to pay pressing needs while negotiating the treatment of MCA claims.
Chapter 11 Bankruptcy Benefits and Drawbacks
Under Chapter 11, the small business debtor typically remains in control of the company while operating under bankruptcy court protection. This provides time to develop a reorganization plan addressing MCA debts.
Potential advantages of Chapter 11 include:
- Breathing room from collections through automatic stay
- Ability to address multiple debts through single case
- Powers to recover preferential payments or challenge liens
- Court authority to approve new financing and payment plans
Drawbacks center on the legal complexity and costs inherent in Chapter 11. Professional fees for attorneys and advisors can be substantial. The debtor must also continue paying ongoing business expenses while in bankruptcy.
And if negotiations with MCA creditors fail, the case could still end up in liquidation.
When Chapter 13 Could Work Better
Chapter 13 is often overlooked as an option for eligible small business owners. It provides similar collection protections and negotiating leverage as Chapter 11, but with significantly lower legal fees.
Chapter 13 is only available to “sole proprietorships” where business debts are non-contingent and under $419,275. But within those limits, it offers a compelling alternative.
Benefits include:
- Basic legal fees around $5,000 vs. $100k+ for Chapter 11
- No required adherence to complex reporting rules
- Trustee oversight instead of direct court supervision
- Discharge of debts remaining at end of 3-5 year plan
The primary drawback is the lack of court authority to terminate contracts or recover preferential payments. But the cost-benefit tradeoff often favors attempting resolution first through Chapter 13.
Finding the Right Bankruptcy Attorney
The key to succeeding in either Chapter 11 or 13 is experienced legal counsel. Reorganizing a struggling business while simultaneously battling MCA creditors is complex.
Warning signs of an incompetent or unethical bankruptcy attorney include:
- Promises to make debts disappear or stop all collections
- Does not ask questions to understand full situation
- Vastly overstates chances of loan discharge
- Requests payment upfront before filing case
When screening possible bankruptcy lawyers, small business owners should:
- Ask about experience with business Chapter 11 and 13 cases
- Request examples of successful case strategies and outcomes
- Clearly explain objectives and get candid assessment
- Review what is included in fee structure
While cost is a consideration, expertise is even more critical. The cheapest attorney is rarely the best choice in complex bankruptcy litigation.
