Merchant Cash Advances Piling Up in Small Business Bankruptcies

Merchant cash advance funders are increasingly being listed as major creditors when small and even midsize companies file for bankruptcy, highlighting a surge of activity in a largely unregulated area of alternative business financing.

The revenue-based funding model, where merchants hand over a portion of future credit card sales in exchange for a quick cash infusion, has fast become a staple of small business bankruptcy practice in parts of the country.

“I can’t think of a case in a long time where I haven’t seen them,” said Florida attorney and small business bankruptcy trustee Kathleen DiSanto of Bush Ross PA. “And nobody has just one. They all have multiple.”

MCA funders often don’t show up to court to fight against the debt discharge process, attorneys say. But even when they do, it can be an uphill battle for them to maintain a revenue purchase arrangement or convince a judge that their debts must be paid back.

In an opinion earlier this month, a Houston bankruptcy judge allowed a trustee liquidating oil and gas contractor Anadrill Directional Services Inc. to advance a suit accusing an MCA funder of violating usury laws and disguising a loan as a purchase of future sales.

“I’m loath to think of an instance when bankruptcy isn’t the best solution for a debtor who has multiple merchant cash advance loans,” DiSanto said.

Growing Industry

After expanding in the US as bank lending practices tightened in the wake of the 2008 financial crisis, MCAs exploded in popularity more recently in response to the pandemic and shrinking of government-backed relief. Funders blanketed social media with advertising and offers for quick cash without extensive credit checks.

Analysts estimate the US market size to be around $20 billion and to eclipse $30 billion in the near future.

“It is definitely very prevalent in the small business world,” said New York-based debt relief attorney Leslie Tayne of Tayne Law Group PC. “And it comes with heavy repercussions.”

Because MCAs aren’t designed or marketed as traditional loans, interest rates don’t enter into the terms of a deal. Instead, funders reap a return through “factor rates,” typically 1.1 to 1.5, which are multiplied by the originally advanced sum to create a fixed amount of money that the merchant pays back through daily or weekly payments.

In some cases, a factor rate can have the functional effect of a 100% or even 200% annual interest rate, Tayne said. And trying to restructure funding arrangements with aggressive funders can be “like negotiating with the mob,” she said.

Businesses that receive cash advances but aren’t able to keep up with repayment often take out additional advances to dig themselves out of a financial hole. Such “stacking” has increasingly become a precursor to collapse for struggling MCA recipients.

When Rogers Landworks LLC filed for Chapter 11 in December, the Florida-based land clearing and trucking company told the court that its bankruptcy “was necessitated by accumulated MCA debt and aggressive MCA collection activity.” The company listed 21 pre-bankruptcy MCA financing deals totaling over $3.6 million.

“I can’t remember the last case I saw where there weren’t four or five of these,” said Tampa bankruptcy attorney Daniel Etlinger of Underwood Murray PA. “Debtors are using these MCAs as sort of their last Hail Mary to stay out of bankruptcy.”

Uptick in Filings

Bankruptcy cases showing debts to merchant cash advance firms surged in 2023 and peaked last year with over 230 filings, according to Bloomberg Law data.

Cases involving MCA creditors have largely clustered in Florida and Texas bankruptcy courts, which have seen growing numbers of small business filings since the pandemic. Still, more than half of the nation’s federal districts were busy with cases involving MCA debts last year.

Even larger companies have started showing up in bankruptcy court with MCA liabilities.

Celebrity makeup artist Pat McGrath’s eponymous cosmetics company filed for Chapter 11 relief last month, owing more than $3 million in MCA payments in addition to $43 million in outstanding secured loan debt. Also in January, a Subway franchise business with 43 stores entered bankruptcy owing $1.4 million from an MCA loan and revenue purchase agreement with a 94% annualized return rate.

Last year, the bankruptcy for Avant Gardner, the former owner of the Brooklyn Mirage event space, was marred by fights with MCA funders who previously provided the company with $11 million.

Seeking Relief

Bankruptcy has become necessary especially when funders enforce a default that comes with high-priced fees or decline to settle.

“The MCAs are very ruthless until a bankruptcy petition is filed,” DiSanto said.

Funders that show up in a bankruptcy proceeding to fight the designation of being a lender don’t always prevail, and they also run the risk of creating unwanted precedent.

In an October ruling in the US Bankruptcy Court for the Middle District of Florida, Judge Tiffany Geyer approved an Orlando-area fertility clinic’s restructuring plan that discharged MCA obligations. She ruled that the debts were incurred more like loans than purchase agreements and the clinic didn’t have property interests to convey in future revenues.

“There’s a lot of caselaw that recategorizes them as loans, but it’s not universal or automatic,” said Ohio-based bankruptcy attorney Patricia Fugée of FisherBroyles LLP. “I think MCA funders are losing on the sale versus loan argument more often than they’re winning.”

Bankruptcy often serves as a “quick litmus test” to see how an MCA funder postures itself, Etlinger said. That can be a useful indicator for business owners, who in many cases are on the hook for repayment when the business defaults, he said.

Fugée said what she’s seeing is concerning.

Although there are instances where the funding could help, “in my experience it is a terrible thing,” she said. “It begs for regulation. It begs for education. I wish there was a way to educate small businesses before they seek this sort of assistance.”