Unwinding an MCA When Your Business is Failing or Closing

The business is not going to recover. The owner has known this for some time, perhaps since the third merchant cash advance was stacked on top of the second, each one funding the remittance obligations of the one before it, the operating account serving as a corridor through which money passes without remaining. What was once a business with receivables is now a structure designed to service MCA withdrawals. The question is no longer how to sustain the enterprise. The question is how to dismantle it without permitting the funders to dismantle the owner.

A merchant cash advance is, by its contractual terms, a purchase of future receivables. If the business ceases to generate receivables, one might suppose the funder's recourse is limited to whatever receivables remain. The funder purchased a percentage of future receipts. There are no future receipts. The transaction, by its own logic, has concluded.

That supposition is correct in theory and almost entirely inapplicable in practice. The MCA agreement contains provisions that extend the funder's reach well beyond the receivable stream. The personal guarantee. The UCC lien on business assets. The confession of judgment, if one was executed. The default provisions that accelerate the unpaid purchased amount upon cessation of business operations. Each of these instruments survives the closure of the business, and each attaches to assets or obligations that exist independently of the enterprise.

A restaurant owner in March who locks the doors and walks away has not resolved the MCA obligations. The owner has activated them.

When the business was operating, the distinction between a loan and a purchase of receivables may have seemed academic. With the business closing, that distinction becomes the central question of the owner's financial survival.

If the MCA is a loan, it is subject to usury limitations. Under New York law, a loan carrying an interest rate above 16 percent is civilly usurious, and a loan above 25 percent is criminally usurious. The consequence of criminal usury is not merely a defense to collection. It renders the agreement void. The principal is unrecoverable. The funder has no claim.

Courts apply a three-part test to determine whether an MCA agreement is a loan or a purchase of receivables. Does the agreement contain a genuine reconciliation provision that adjusts payments based on actual revenue. Does the agreement have a finite term, or does repayment continue regardless of duration until the purchased amount is satisfied. Does the funder have recourse if the merchant declares bankruptcy, which would indicate the funder bears no risk of loss, which is inconsistent with a true receivable purchase.

In State of New York v. Richmond Capital Group, the court examined 140 sample agreements and determined that the MCAs at issue were loans, not legitimate purchases of accounts receivable. The Yellowstone Capital settlement, in which the Attorney General obtained over $1 billion in relief, rested on the same determination: the MCAs were loans, the interest rates were predatory, and the agreements were unenforceable.

If your agreement fails the reconciliation test, the instrument that the funder will attempt to enforce against you after closure may be void from its inception.

MCA funders file UCC-1 financing statements against business assets as a matter of course. The filing creates a security interest in the business's receivables, inventory, equipment, and in some agreements, general intangibles. For a closing business, the UCC lien represents the funder's claim to whatever remains.

But a UCC lien is not a judgment. It is a perfected security interest that establishes priority among creditors but does not, by itself, authorize the funder to seize assets. The funder must still proceed through commercially reasonable disposition under Article 9 of the Uniform Commercial Code, or obtain a judgment and execute against the collateral through judicial process.

And the lien's scope is limited to what the business actually owns. Equipment subject to a prior purchase-money security interest. Inventory already pledged to a senior lender. Receivables that, because the business is closing, will not be generated. The UCC filing may encompass everything on paper and attach to very little in fact.

There is a difference between a lien and a recovery. The funder who filed a UCC-1 against a business with $340,000 in outstanding MCA obligations and $22,000 in depreciated equipment has a lien on $22,000 in depreciated equipment.

For the business that cannot continue and the owner who faces personal liability through guarantees, bankruptcy provides the most orderly mechanism for unwinding MCA obligations. The options are Chapter 7 liquidation, Chapter 11 reorganization, and, for businesses with less than $7.5 million in aggregate debt, Subchapter V of Chapter 11.

The filing of a bankruptcy petition triggers the automatic stay under 11 U.S.C. Section 362, which immediately halts all collection activity, all ACH withdrawals, all lawsuits, and all enforcement of confessions of judgment. The stay is not a request. It is an order of the federal court that supersedes state court proceedings.

Subchapter V has become the preferred vehicle for small businesses burdened with MCA debt. The process is faster and less expensive than traditional Chapter 11, and it permits the debtor to propose a plan without creditor approval, subject to court confirmation. In documented cases, businesses owing in excess of $2 million in MCA obligations have confirmed plans paying less than one percent of the outstanding balance. Not one percent per month. One percent in total.

Equitable subordination under 11 U.S.C. Section 510(c) provides an additional mechanism. Where the funder engaged in inequitable conduct, the bankruptcy court may subordinate the funder's claim below those of general unsecured creditors, which in a Chapter 7 liquidation or Subchapter V plan may result in the funder receiving nothing. The court's authority to recharacterize the MCA as a loan, and then to subordinate the resulting claim based on the funder's conduct in originating or servicing that loan, creates a pathway to elimination of the obligation that does not exist outside the bankruptcy context.

The business owner's fear, the specific fear that suppresses rational decision-making and prolongs the deterioration, is the personal guarantee. The owner believes that even if the business closes, even if the entity's obligations are discharged or settled, the guarantee remains, an irreducible personal liability that will follow the owner into whatever comes next.

That belief is not entirely wrong. But it is incomplete.

The guarantee is a contract, and contracts are subject to defenses. If the underlying obligation is void as usurious, the guarantee of a void obligation is unenforceable. If the funder materially breached the MCA agreement through unauthorized withdrawals, failure to reconcile, or failure to comply with the Commercial Finance Disclosure Law, the guarantor may assert the funder's breach as a defense. If the confession of judgment was obtained from the guarantor while the guarantor resided outside New York, it is voidable under amended CPLR Section 3218.

In an individual Chapter 7 bankruptcy, the personal guarantee obligation can be discharged along with other unsecured debts, provided the debt is not of a type excluded from discharge under 11 U.S.C. Section 523. MCA guarantee obligations are not among the excluded categories. The owner who files an individual petition emerges without the guarantee.

And outside of bankruptcy, the guarantee is subject to negotiation. A funder pursuing a guarantor after the business has closed is pursuing a judgment against an individual whose assets may be partially or fully exempt under state law. The funder's recovery, after the cost of litigation, may be less than a negotiated settlement. Funders understand this arithmetic, even when they do not acknowledge it in their initial communications.

There is a correct order of operations for unwinding MCA obligations when the business is closing, and the order matters as much as the substance.

First, secure and preserve all documentation: every MCA agreement, every amendment, every broker disclosure, every bank statement reflecting withdrawals, every communication with the funder. Second, analyze each agreement for characterization vulnerabilities, disclosure deficiencies, and evidence of overcharges or unauthorized withdrawals. Third, revoke ACH authorizations through the bank, not through the funder, because the bank's obligation to honor a revocation is independent of the funder's consent. Fourth, evaluate the viability of a bankruptcy filing, considering both the entity's obligations and the owner's personal exposure. Fifth, if bankruptcy is not the chosen path, negotiate with funders from a position informed by the legal deficiencies identified in the analysis.

The owner who reverses this sequence, who negotiates before analyzing, who closes before preserving, who files bankruptcy before revoking authorizations, will achieve a worse outcome. Not marginally worse. Substantially worse.

The end of a business is not a legal event. It is an accumulation of legal events, each of which produces consequences that outlast the enterprise. The MCA funder's UCC lien remains on the public record until it is terminated. The confession of judgment, if entered, remains a judgment until it is vacated or satisfied. The personal guarantee remains enforceable until it is released, defended, or discharged. The tax consequences of any forgiven debt remain an obligation of the individual under IRC Section 108, mitigated only to the extent the individual was insolvent at the moment of cancellation.

None of these consequences is inevitable. Each of them can be addressed, reduced, or eliminated through mechanisms that the law provides and that MCA funders prefer their merchants not to understand.

Our firm represents business owners in the process of closing operations while confronting MCA obligations, personal guarantees, and the collection apparatus that activates upon default. The instruments the funders hold are real, but the defenses available to the owner are equally real, and the resolution depends on which side understands the full position with greater precision.