Federal Bankruptcy courts and it’s trustees have recently been on the forefront of aggressively pursuing MCA creditors to return fees paid to them back to the bankruptcy estate. In addition to the recent case rulings from the Southern District of New York that we wrote about, another recent bankruptcy court case in Houston is drawing attention to the growing use of merchant cash advances (MCAs) by small businesses. These MCA financing deals give a business a lump sum of money in exchange for so-called future receivables but often come with steep repayment terms because of interest rates that can far exceed 100%. Most businesses must also deal with aggressive collection tactics that ensue by the MCA companies as well as the filing of UCC liens, litigation and even judgment enforcement.
In the case In re Anadrill Directional Services, Inc., the court said that a bankruptcy trustee could continue a lawsuit against an MCA lender. The judge found it was possible that the MCA was really a loan disguised as a sale of receivables. If that’s proven at trial, the money the borrower paid could be taken back and used to repay other creditors. This follows a pattern of multiple other cases that have found similar decisions in bankruptcy and other courts around the country.
The court kept three key claims alive those involving fraudulent obligations and transfers under the Bankruptcy Code and reinforced that what a contract is called doesn’t always define what it is. Even if a deal says “sale,” courts will look deeper to see if it actually functions like a loan. If the deal is a loan instead of the purchase of receivables then the usury rate would also apply making these sort of loans illegal.
This ruling is important because it supports other bankruptcy trustees and struggling small businesses who want to challenge high-cost MCAs. It also serves as a warning: before taking out a merchant cash advance, small business owners should carefully check the total cost and get financial and legal advice to fully understand what they’re agreeing to before taking the risk of MCA collection and litigation being pursued against them.