Small businesses often turn to merchant cash advance (MCA) funding because of the ease with which such transactions can close. Oftentimes, the MCA funder does not engage in traditional due diligence typically undertaken by banks, allowing financing to close extraordinarily quickly. With respect to an MCA agreement, a funder advances a lump sum to an entity, and the entity agrees to remit a fixed percentage of its future receipts until a substantially larger "purchased amount" is repaid, usually through daily or weekly ACH debits over a short window. Most MCA agreements expressly state that the transaction is a sale of future receivables and not a loan, which is relevant because a genuine sale may place the purchased receivables outside the bankruptcy estate. On the other hand, a loan remains a debtor’s obligation. For an entity in bankruptcy, the purchase-versus-loan question determines whether the funder ends up with estate assets or whether the debtor can claw value back.

For a business already burdened by an MCA obligation, or for the trustee who steps into its shoes upon a bankruptcy filing, the recharacterization fight often involves two related theories/causes of action. The first is usury. New York law, which governs the vast majority of MCA agreements, treats loans bearing interest above 25% per year as criminally usurious and void. Once an MCA is recharacterized as a loan, the effective interest rate is frequently well above that threshold and subject to being declared “void.” The other category of claims involves avoidance actions under the Bankruptcy Code. Pursuant to section 548 of the Bankruptcy Code, a debtor or trustee can avoid obligations and transfers made within two years of filing if the debtor received less than reasonably equivalent value while insolvent. A debtor does not necessarily have to win the usury argument to prevail on these avoidance theories. For example, if the funds paid to an MCA funder are greater than the funds received by the debtor, a lack of reasonably equivalent value may be implicit. This dynamic has played out in several recent decisions and one of the clearest examples comes from Crosby Tugs, L.L.C. v. Meged Funding Group (In re Crosby Marine Transportation, LLC), Case No. 26-10678, 2026 WL 1765197 (Bankr. E.D. La. June 17, 2026).

In that case, the debtors filed chapter 11 bankruptcy and brought an adversary proceeding against a number of MCA funders. The debtors moved for partial summary judgment against one MCA funder, Aqua Capital LLC, asking the bankruptcy court to recharacterize the parties’ “Revenue Purchase Agreement” as a disguised loan and to declare that the purchased receivables were property of the estate pursuant to section 541 of the Bankruptcy Code. Pursuant to that agreement, Aqua advanced $350,000 in exchange for $543,750 of the debtors’ “Future Receipts,” collected through daily ACH sweeps from the debtor’s deposit account. Importantly, the agreement did not tie repayment to any identified customer or receivable. In addition, the agreement and related documents granted Aqua a security interest in all of the debtors’ assets, required a personal guaranty from the debtor’s principal, and included a confession of judgment and gave the funder the right to debit the debtors’ accounts upon a default. The matter moved to summary judgment, as both sides agreed there were no disputed facts.

Despite a number of recharacterization tests, each test basically asks the same question: who bears the risk that the “sold” receivables go uncollected, the funder or the debtor? Bankruptcy courts generally look to substance over form and the mere fact that the agreement is labeled a “sale” is almost never dispositive. Usually, an MCA agreement will be treated as a loan if the advanced funds (plus interest) must be repaid, regardless of the debtor’s collections (or lack thereof). The most common test is the three-factor test from LG Funding, LLC v. United Senior Properties of Olathe, LLC, 181 A.D.3d 664, 122 N.Y.S.3d 309 (2020), which looks at: (a) whether there is a meaningful reconciliation provision; (b) whether the agreement has a finite term (i.e. a definitive endpoint); and (c) whether the funder has recourse if the merchant files bankruptcy. Courts increasingly treat those factors as a guide rather than a checklist, looking to the totality of the circumstances of the agreement.

When analyzed in connection with the LG Funding test, the MCA agreement in Crosby read exactly like a loan. Because Aqua’s recovery was not dependent on the recovery of any specific customer’s receivable, Aqua bore none of the collection risk, as it would if the agreement was a true purchase. Aqua’s collateral package, pursuant to its UCC-1 security interest, extended beyond the receivables purportedly sold and included all of the debtors’ accounts, equipment, general intangibles, and inventory. The bankruptcy court noted that this collateral package had the hallmarks of a lending relationship, rather than a purchase of receivables. In addition, the personal guaranty of the principal, the confession-of-judgment authorization, and Aqua’s ability to accelerate the debt and sweep all funds gave Aqua recourse well past the four corners of any sale. The reconciliation provision also indicated a lending relationship. Although the debtors could request an adjustment to the weekly remittance, the total amount owed was never revised based on the debtor’s actual collections. Moreover, a single missed payment could trigger a default that foreclosed reconciliation altogether. The court therefore described the reconciliation provision as arguably “illusory.” While the term was not stated directly in the MCA agreement, there was a de facto fixed schedule that could easily be calculated by dividing the balance by the daily payment. Reading these provisions together and applying the LG Funding test, the bankruptcy court concluded that the debtors bore the entire risk of nonpayment and granted summary judgment recharacterizing the Aqua agreement as a disguised loan under New York law, with the receivables remaining property of the estate.

The lesson for borrowers is that bankruptcy courts look to the substance rather than the label given to MCA agreements. For a distressed company, recharacterizing an MCA obligation as a loan can convert the debtor’s payment obligation into a source of recovery. Indeed, a usurious loan may be void, payments may be avoidable and recoverable under sections 544, 548, and 550 of the Bankruptcy Code, and the receivables a funder allegedly purchased may revert back to the estate. Thus, a borrower that is already a party to an MCA agreement should not assume that the “sale” described in the agreement is a true sale. As Crosby demonstrates, with the right facts, a debtor or trustee can recharacterize the transaction, avoid and recover the transfers, and recapture receivables the funder believed it had purchased outright.

Debtors and trustees who come into contact with or are a party to an MCA agreement should have that agreement reviewed closely for recharacterization, avoidance, and usury arguments before assuming the funder’s position is secure. If you are a borrower or trustee evaluating an MCA agreement in a distressed or bankruptcy context, FactorLaw can assess whether recharacterization and/or other claims are available.