Most merchant cash advance agreements are written to look like a purchase of future receivables. But if your MCA has fixed daily payments, a personal guarantee, and no real way to adjust payments when revenue drops, it may actually be a disguised loan — and that changes everything.
When a court recharacterizes an MCA as a loan, the effective interest rate (often 100% to 300%+ APR) becomes criminally usurious under both New York and Texas law. The entire contract can be voided, and the funder may owe you penalties instead of the other way around.
Why the Loan vs. Sale Distinction Matters
MCA companies structure their agreements as "purchases of future receivables" specifically to avoid lending laws. If it is a purchase, there is no interest rate, no usury cap, and no licensing requirement. But courts look past labels to the economic reality of the transaction.
If the MCA operates like a loan in practice, it is a loan — regardless of what the contract calls it.
The Three-Factor Test (New York)
New York courts — which govern most MCA agreements — use three factors to distinguish a true sale from a disguised loan:
Factor 1: Reconciliation Right
Does the agreement allow the merchant to request lower payments when revenue declines?
- True sale: Payments automatically adjust with actual revenue, and the merchant has a genuine right to request reconciliation
- Disguised loan: Payments are fixed regardless of revenue, or the "reconciliation" clause requires so much paperwork and approval that it is effectively useless
Many MCA contracts include a reconciliation clause in name only — requiring the merchant to submit months of bank statements within a 3-day window, subject to lender approval. Courts have found these illusory reconciliation clauses insufficient to support a true sale characterization.
Factor 2: Fixed Repayment Term
Is there a definite time by which the merchant must repay?
- True sale: No end date — the funder collects a percentage of revenue until the purchased amount is received, however long that takes
- Disguised loan: The contract projects a specific term (e.g., "estimated 6 months"), or default is triggered if repayment is not complete by a certain date
If you can calculate a definite payoff date from the contract terms, that strongly suggests a loan with a fixed term, not an open-ended receivables purchase.
Factor 3: Risk of Loss
Does the funder bear the risk if the business fails and generates no more revenue?
- True sale: If the business closes, the funder simply does not collect. Business failure is the funder's risk.
- Disguised loan: The funder demands the full purchased amount regardless of business performance, pursues the personal guarantor, or accelerates the balance upon closure
Key contract language from many MCA agreements states: "Seller going bankrupt or going out of business does not constitute a breach." This language is critical — if the funder later sues for the full balance after a business closes, they are contradicting their own contract and treating it as a loan.
How Texas and New York Courts Have Ruled
Champion Auto Sales v. Pearl Beta Funding
The court found that an MCA with fixed daily payments and no meaningful reconciliation was a loan, not a sale of receivables.
LG Funding, LLC v. United Senior Properties
Established the three-factor test that New York courts now use to evaluate MCA agreements.
K9 Bytes, Inc. v. Arch Capital
Court held that when the MCA funder had full recourse against the merchant regardless of receivables, the transaction was a loan subject to usury analysis.
JPR Mechanical (Bankruptcy)
A bankruptcy court recharacterized an MCA as a loan, finding that the fixed payment structure and personal guaranty showed the funder bore no real risk of loss.
What Happens After Recharacterization
Once a court determines the MCA is actually a loan, the consequences for the funder are severe:
Usury Analysis
Calculate the effective APR by comparing the total amount repaid (or demanded) to the amount advanced, over the actual or projected repayment period. Most MCAs produce APRs between 50% and 300%.
New York Usury Caps
- Civil usury: Above 16% APR — borrower can void the interest
- Criminal usury: Above 25% APR — the entire contract is void and unenforceable (NY Penal Law §190.40)
Texas Usury Penalties
- Above 18% APR for commercial loans — usurious
- Penalties: Forfeiture of all interest charged, plus potential treble damages
- If the rate exceeds twice the legal maximum, the lender forfeits all principal and interest (Tex. Fin. Code §305.001)
Building Your Recharacterization Case
To support a loan recharacterization argument, gather:
- The MCA agreement — highlight fixed payment terms, personal guarantee, UCC lien, and any COJ clause
- Payment records — show that payments were identical every day regardless of actual revenue
- Reconciliation requests — if you ever asked to adjust payments and were denied or ignored, document it
- Communications from the funder — any emails or calls referring to the advance as a "loan," demanding "repayment," or threatening collection on the "balance"
- Calculated APR — have your attorney or a forensic accountant compute the effective annual rate
The Strategic Advantage
A recharacterization defense flips the power dynamic. Instead of your business defending against a collection claim, the MCA funder becomes the one facing liability — potentially owing you money under usury penalty statutes. This leverage often drives settlements at 30-50 cents on the dollar or less.
Even if you do not ultimately go to trial, raising a credible recharacterization argument in your answer and counterclaims tells the funder: "Your entire business model is at risk in this case." Nothing brings an MCA company to the settlement table faster than the word "usury."
This article is part of the MCA Defense Guide. Call (469) 607-8552 for a free consultation.