For every complex problem, there is an answer that is clear, simple, and wrong." – H.L. Mencken

The Bankruptcy Court in the Southern District of New York has been busy over the last several months. In three cases, JPR Mechanical, Williams Land, and Global Energy Services, Merchant Cash Advance (MCA) agreements were analyzed under New York's legal standards. With outcomes hinging on the three-factor test (reconciliation, set repayment schedule, and recourse), of the three cases, only Global Energy Services appeared to have workable reconciliation provisions allowing the MCA to be treated as a true sale of future receivables. The MCA providers in JPR Mechanical and Williams Land were effectively told to pound sand, with JPR Mechanical formally recharacterized as a loan, and Williams Land reflecting similar judicial scrutiny. Couple this with the early 2025 ruling securing the New York Attorney General with a $1.065 billion judgment against Yellowstone Capital, permanently banning them from issuing MCAs and canceling over $534 million in debt owed by roughly 18,000 small businesses, and there is blood in the water. And it isn't necessarily from prey.

These rulings reinforce a trend for how MCA debt could be treated by the bankruptcy courts and land a direct blow to the predatory lending sharks.

In business distress, especially for small operators, MCAs swarm like mosquitoes in a nudist colony. They are a quick turn "non-loan" injection of cash into a small business in exchange for future receivables, or so they say…until now. They have become a quick fix for small businesses that no longer qualify for traditional financing, and because they are fast, loosely underwritten, and unregulated, they often look like a short-term fix for a long-term cash flow challenge. You can find more information from a previous note here: Merchant Cash Advance H-E-Double Hockey Sticks | ABL Advisor.

The reality is that MCAs can prime a lender's security interest on a borrower's depository bank accounts through daily or weekly cash sweeps of the depository accounts. When multiple MCAs are present, known as stacking, they siphon off cash operating capital, which represents proceeds from the sale of a lender's collateral, pushing lenders further back in the capital stack. For some lenders, particularly those with loose or no covenants or only annual review of their borrowers' annual financials, they will not even know their primary source of repayment has been impaired until it's too late. Behind a stack of MCA debt, any lender having a first UCC lien position can quickly find themselves effectively in 4th, 5th…8th security position over cash depository accounts (the primary source of loan repayments) in a matter of months if not sooner.

In re JPR Mechanical: Wanna Play Sale or Loan? 

This was not about semantics, but rather economic reality. In the JPR Mechanical case, was this truly a receivables sale or a loan dressed up to avoid regulatory scrutiny and bankruptcy complications?
The court applied several factors for consideration:

• Reconciliation Was Illusory: The MCA provider claimed that they would adjust payments if revenues dropped, refunds on over-collections weren't enforced, and the provider was guaranteed payment regardless of performance. The provider bore no risk, which makes it a loan. Check!

• Term Was Effectively Fixed: Despite the claim that the repayments were based on future sales, the provider knew the end date. Predictable payments and duration make it a loan. Check!

• Ample Recourse: Personal guarantees, acceleration clauses, and enforcement rights are how lenders operate, not receivables buyers, making it a loan. Check!

• Risk did not Transfer: The business's bank account was drafted daily regardless of sales, thereby taking priority on cash flow, making it a loan. Check!

• Proofs of Claim: The MCA provider regarded itself as a "creditor" in its own loan docs, and claimed liens on ALL payments, not specific receivables. Could this be any more like a loan? Check!

So, what happened? The court ruled that the MCA was to be recharacterized as a loan and allowed the Chapter 7 trustee to claw back the payments as preferential transfers that had gone to the creditor within the 90-day window before bankruptcy.

Fecklessness Breeds Recklessness

While MCA providers engineer contracts that mimic sale language while preserving the behaviors of lenders, including fixed repayment, risk insulation, and personal guarantees, there is no shortage of desperate small businesses grasping at high-risk capital without fully being aware of the consequences. MCA agreements have long leaned on the language "sales," but to the benefit of many, the courts are now looking harder, especially when repayment terms and risk allocation paint a different picture.

If the courts continue to determine that MCAs are loans, this could lead to a full-on repositioning of where parties stand in bankruptcy proceedings. While the ruling undoubtedly should concern MCA providers who may be faced with revising the language in their agreements, if not their entire business model, it also affects lenders who have no clue that their security has been impaired, advisors trying to restructure debt, and business owners who have turned to MCAs as a last resort, often blind to the legal and financial risks. 

There is little reason to expect these rulings will suddenly cause MCAs to change their ways. Not happening. MCA debt is still largely predatory and a potential coffin nail. However, the legal momentum shows the courts are increasingly disregarding form labels and evaluating MCAs based on substance, bringing significant preference liability risk. This could lead to thousands of small businesses having their MCA debts significantly modified or, in extreme cases, even canceled.

The sharks are still circling, but the courts just knocked out a few more of their teeth. And they don't appear to be done swinging.