Using Bankruptcy to Eliminate Merchant Cash Advance Debt

Bankruptcy does not merely pause merchant cash advance obligations. It eliminates them. The distinction matters because merchants who file for protection often assume they are purchasing time, a temporary reprieve from daily withdrawals while they reorganize. That assumption underestimates the instrument. In the bankruptcy court, a merchant cash advance agreement becomes something it resisted being everywhere else: a debt subject to judicial examination.

The examination, once initiated, tends to produce a particular result.

A merchant cash advance agreement characterizes itself as a purchase of future receivables. The funder advances capital. The merchant surrenders a percentage of future revenue. The agreement insists, in provisions drafted with the precision of a quarantine protocol, that this transaction is not a loan. It is a sale. The word "loan" does not appear. The word "interest" does not appear. The reconciliation clause suggests flexibility. The absence of a maturity date suggests contingency.

But in In re Williams Land Clearing, Grading, and Timber Logger, LLC, the Bankruptcy Court for the Eastern District of North Carolina examined those same assurances and found them insufficient. The court identified an effective annual interest rate of 101.1 percent. It declared the agreement void ab initio. The debtor recovered payments already rendered. The funder's claim was extinguished.

What the court applied was a three-factor inquiry into the substance of the obligation: whether a reconciliation provision existed and operated, whether the repayment term was finite, and whether the funder retained recourse against the merchant in the event of insolvency. On each factor, the agreement revealed itself. Fixed daily payments. A reconciliation clause that had never been invoked. A personal guarantee that survived the business itself.

This was a loan. It had always been a loan.

Once the court recharacterizes a merchant cash advance as a loan, the consequences arrive in sequence. The funder's claim is treated as unsecured debt. Under Section 510(c) of the Bankruptcy Code, the court may subordinate that claim if the funder's conduct was inequitable. In cases where the effective interest rate exceeds the criminal usury threshold, the agreement may be declared void, which is to say the claim ceases to exist at all.

And the preference analysis compounds the exposure. In Williams Land, the court found that a payment of $30,159.42 made by the debtor's customer to the funder within 90 days of the petition date constituted an avoidable preference. The estate recovered that amount. For the funder, the proceeding produced not merely a reduction in claim but a net financial loss.

The merchant cash advance agreement purports to own a portion of the merchant's future revenue. In the ordinary course of business, that claim operates through a split of daily credit card receipts or ACH withdrawals from the merchant's account. In bankruptcy, the claim encounters a structural impossibility.

Future receivables generated after the petition date do not yet exist at the time of their purported pre-petition sale. They cannot be sold because they have not been created. Any revenue that materializes after the filing becomes property of the bankruptcy estate under Section 541 of the Code. The funder's contractual entitlement to those receivables dissolves upon contact with the automatic stay and the estate's superior interest.

In March of this year, with the ground still cold and creditors' committees still forming, a merchant in the Eastern District discovered that the $14,000 in weekly ACH withdrawals that had consumed operating capital for eleven months could be redirected, in their entirety, to the reorganization effort. The funder objected. The court did not sustain the objection.

A traditional Chapter 11 proceeding permits the debtor to propose a plan that modifies the terms, duration, and amount of merchant cash advance obligations. The funder votes on the plan as a member of its creditor class. If the plan satisfies the requirements of confirmation, including feasibility and the best-interests-of-creditors test, the court may confirm it over the funder's objection through the cramdown provisions of Section 1129(b).

Subchapter V, enacted as part of the Small Business Reorganization Act of 2019 and expanded to cover businesses with debts up to $7.5 million, offers a compressed procedure. There is no creditors' committee unless the court orders one. The debtor proposes a plan within 90 days. Confirmation does not require creditor acceptance. The debtor retains control of the business and dedicates projected disposable income to creditors over a period of three to five years.

For merchants burdened by merchant cash advance debt, Subchapter V has become the preferred instrument. One healthcare business in Texas eliminated $555,136 in MCA obligations through a Subchapter V filing. The funder received a fraction of its claim. The business continued to operate.

Why would a merchant endure daily withdrawals of capital when the statute provides a mechanism to convert those obligations into a manageable installment over years.

Upon the filing of a bankruptcy petition, Section 362 imposes an automatic stay that prohibits all collection activity against the debtor. The daily ACH withdrawals cease. The UCC-1 liens, while not automatically removed, become subject to the court's authority. Lawsuits pending against the merchant are stayed. Confessions of judgment that have not yet been filed cannot be filed. Those that have been filed may be vacated as part of the proceeding.

The stay is immediate. It does not require a motion or a hearing. It operates by statute upon the filing of the petition. If your bank account has been subjected to daily extractions of $800, $1,200, $2,400, the stay produces an effect that is less legal than physiological. The hemorrhage stops.

And the funder that violates the stay faces sanctions, damages, and the court's pronounced displeasure.

In January 2025, the New York Attorney General announced a $1.065 billion settlement with 25 entities controlled by Yellowstone Capital. The settlement cancelled over $534 million in merchant debt. It vacated legal actions. It terminated liens. It distributed $16.1 million in restitution to more than 18,000 affected businesses across the country. The principals received permanent bans from the merchant cash advance industry.

That settlement did not emerge from a contractual dispute. It emerged from an investigation that determined the Yellowstone entities were operating a fraudulent lending operation disguised as a merchant cash advance program. The interest rates were, in the Attorney General's characterization, astronomical. The court's characterization was consistent.

But here is the thing that the Yellowstone matter establishes beyond the facts of its own proceeding: the state regards the merchant cash advance structure, when constructed to eliminate risk to the funder, as a species of predatory lending. Bankruptcy courts have arrived at the same conclusion through different doctrinal channels. The convergence is not coincidental.

Since February 2026, New York's FAIR Business Practices Act has amended General Business Law Section 349 to extend protections against unfair and abusive acts to small businesses. The Attorney General may now pursue enforcement against collection tactics that were previously insulated from regulatory scrutiny: aggressive demand correspondence, improper UCC-1 filings, account freezes initiated through bank notification rather than court order.

For a merchant in bankruptcy, the FAIR Act creates a secondary front. The funder that violated the automatic stay, that contacted the merchant's bank, that filed a blanket lien without adequate basis, now faces exposure not only to the bankruptcy court's sanctions but to a state enforcement action under an abusive-practices standard. The cost of aggressive collection has increased. The cost of compliance with the stay has not.

A merchant who files for bankruptcy before the funder initiates litigation occupies a different position than one who files after a confession of judgment has been entered. A merchant who requests reconciliation under the agreement and receives a denial has generated evidence that a merchant who simply stops paying has not. A merchant who files under Subchapter V within the debt ceiling retains advantages that a merchant who exceeds the threshold cannot access.

The sequence matters. It always matters in restructuring proceedings, where the procedural posture of the case often determines its substantive outcome, but it matters with particular force in the merchant cash advance context because the agreements are designed to foreclose the merchant's options before the merchant recognizes that options exist.

We have represented merchants who arrived at the initial consultation with a bank account that had been reduced to double digits by daily withdrawals. The agreements they carried contained personal guarantees, confessions of judgment, waiver-of-jury-trial provisions, and forum-selection clauses requiring litigation in a county the merchant had never visited. Every clause was designed to produce a single effect: the merchant's silence.

Bankruptcy is the refusal of that silence. It is a federal proceeding that supersedes the contractual architecture the funder constructed, that subjects the agreement to examination under standards the agreement was written to avoid, and that permits the merchant to reorganize under the protection of a court that owes the funder nothing.

The obligation that could not be questioned becomes the claim that must be proved. Most of them cannot be.