The Restructuring Report

Small businesses facing financial distress increasingly encounter two converging pressures: the proliferation of merchant cash advances (MCAs) as a financing tool and the reduced debt ceiling for Subchapter V eligibility under Chapter 11. These factors substantially influence small business debt management with downstream implications for litigation strategy, restructuring alternatives, bankruptcy eligibility, claims analysis and the debtor’s survival through reorganization. It is important for counsel handling small business clients to understand the landscape of these issues and how regulations may develop in the future.

Merchant Cash Advance Lenders

What Are MCAs?

An MCA is purportedly a form of revenue-based financing, akin to factoring, in which a funder provides a business with upfront capital in exchange for a share of its future receivables or revenue. However, unlike a true factoring arrangement, repayment is usually made through daily or weekly ACH transfers at a set dollar amount (rather than calculated as a percentage of the merchant’s sales), with a fixed maturity date, and no involvement by the funder in actual collection of the account receivables. Whether an MCA constitutes a true sale of receivables or exists as a disguised loan remains a contested issue.

MCAs are typically marketed to small businesses that cannot obtain conventional bank financing because of limited credit histories, poor credit scores or irregular revenue, among other reasons. Fast and convenient funding — often within days and available through online application portals — and minimal underwriting requirements make MCAs particularly attractive to distressed businesses seeking immediate cash. But frequent repayments and aggressive collection tactics after default can worsen a merchant’s financial distress rather than relieve it. Additionally, MCAs normally include a personal guaranty by the small business owner, with such personal liability adding to an already stressful situation. For example, due to an MCA’s nature as a commercial rather than consumer debtor, a small business owner is not afforded the protection of the Fair Debt Collection Practices Act upon default.

Effect of MCAs on Small Businesses

MCAs can deepen a business’s financial distress by draining cash through daily or weekly ACH withdrawals at the very moment when liquidity is most critical. Although a business may initially use an MCA to cover a short-term cash need, repayment structures that do not meaningfully adjust to actual revenue can turn a temporary cash-flow problem into a broader financial crisis. For instance, a local coffee shop that obtains an MCA to restock coffee beans and replace broken equipment may find itself paying thousands of dollars each week, negatively impacting its cash flow.

MCA obligations can also make restructuring and bankruptcy planning more difficult. The aggressive collection tactics and personal guarantees make it difficult to negotiate an out-of-court restructuring, especially when an existing secured lender asserts a security interest in the accounts of the small business and refuses to allow the business to make payments on the MCA. The stakes of MCA characterization in bankruptcy are significant. Whether the transaction is treated as a true sale of receivables, a secured loan or an executory contract can affect cash collateral disputes, claims litigation, preference actions, dischargeability proceedings, lender priority, fraudulent transfer claims and Subchapter V eligibility. Consequently, if a small business client has MCAs, counsel must consider how the MCAs impact an overall settlement outside of court or a bankruptcy filing.

The Subchapter V Debt Limit

The Current Debt Limit: $3.42 Million

To qualify for Subchapter V, a debtor must be engaged in commercial or business activities (other than primarily owning single-asset real estate) and must have aggregate noncontingent, liquidated, secured and unsecured debts of $3,424,000 or less as of the bankruptcy filing date, at least 50% of which arose from commercial or business activities, excluding debts owed to affiliates or insiders. That figure reflects the most recent statutory adjustment under 11 U.S.C. § 104, effective April 1, 2025, which increased the threshold from $3,024,725 based on the Consumer Price Index for All Urban Consumers change for the three-year period ending immediately before January 1, 2025. The next adjustment is scheduled for April 1, 2028.

The Prior Higher Limit and Its Expiration

The current $3,424,000 threshold is far lower than the temporary $7.5 million limit that applied from 2020 until June 2024. Congress first raised the Subchapter V debt limit to $7.5 million through the CARES Act in March 2020, expanding access to the streamlined reorganization process for financially distressed small businesses. The Bankruptcy Threshold Adjustment and Technical Corrections (BTATC) Act later restored that higher threshold. But the BTATC Act included a two-year sunset provision. When that provision expired at midnight on June 21, 2024, the Subchapter V debt limit returned the next day to the lower inflation-adjusted amount, which was then $3,024,725.

This change has had significant practical consequences. Businesses with debts between roughly $3.4 million and $7.5 million — including many established small and mid-size companies — no longer qualify for Subchapter V and must instead proceed under traditional Chapter 11, which is typically more expensive, complex, and creditor-driven. For businesses already strained by MCA obligations, the lower debt ceiling can be especially problematic because multiple MCA debts may push total liabilities above the current eligibility limit.

Counsel should therefore evaluate Subchapter V eligibility early and with caution. That review should account for all secured and unsecured obligations, including MCA debt, tax liabilities, trade payables, landlord claims, equipment financing and litigation claims that are noncontingent and liquidated as of the petition date.

Looking Forward – Potential Future Developments

Current Court Trends for MCAs

Courts have been split when classifying MCA cash advances in bankruptcy and RICO claims. Some courts have found MCAs to be disguised loans, particularly where reconciliation provisions are illusory, the funder bears no genuine risk of non-collection and effective interest rates far exceed usury limits. In 2019, the Minnesota Court of Appeals held that a revenue-based factoring agreement was a disguised loan where the funder bore no risk and the effective interest rate was approximately 84%. However, other courts have upheld MCAs as true receivables purchases where reconciliation provisions put the funder at genuine risk.

Additionally, it is notable that some government agencies have acted against MCA vendors. On June 8, 2026, New York Attorney General Letitia James sued an online arbitration platform, alleging fraud for presenting the platform as a neutral forum without revealing that it was working with the MCA industry to disadvantage small businesses. This action follows Attorney General James’ January 2025 settlement with Yellowstone Capital, which led to the cancelation of $534 million in merchant debts after the Office of the Attorney General alleged Yellowstone provided illegal high-interest loans disguised as MCAs and used deceptive techniques to collect on them. These enforcement efforts reflect heightened scrutiny of both MCA lending practices and ancillary services that support the industry’s collection efforts.

What can be inferred by the current court trends is that legal treatment of an MCA often depends on its economic substance. Courts and regulators consider a variety of factors, including:

1. Whether payments actually vary with revenue;
2. Whether the funder assumes the risk of non-collection when receivables decline;
3. Whether the agreement includes a meaningful reconciliation process;
4. Whether the repayment term is open-ended or fixed; and
5. Whether personal guarantees, default provisions or collection remedies cause the transaction to operate more like a loan than a receivables purchase.

Regardless of whether an MCA is treated as a loan secured by future receivables or as a sale of future receivables, UCC Article 9 applies. MCA funders may still be treated as creditors in bankruptcy despite characterizing the transaction as a sale, because the Bankruptcy Code broadly defines a “claim” to include these arrangements.

Pending Legislation To Raise the Subchapter V Debt Limit

On March 3, 2026, the Bankruptcy Threshold Adjustment Act of 2026, S. 3977, and the corresponding bill within the House of Representatives, H.R. 7730 were introduced in the Senate and the House, respectively. If enacted, the bills would revise the Subchapter V definition of “debtor” in 11 U.S.C. § 1182(1) by raising the eligibility cap to $7.5 million in qualifying secured and unsecured debt, measured as of the petition date or order for relief. The bills would continue to exclude debts owed to affiliates or insiders and would require that at least half of the debtor’s qualifying debt arise from commercial or business activity.

Some commentators view the proposal as a realistic candidate for enactment. Bankruptcy legislation often attracts bipartisan support, including the Small Business Reorganization Act of 2019 and the 2020 increase of the Subchapter V debt limit to $7.5 million. A similar effort to preserve the higher threshold in June 2024 reportedly came close to approval by unanimous consent but failed after one senator objected. Economic pressure may also increase support for the bills because broader financial distress tends to make bankruptcy relief more salient to both businesses and individual constituents.

If the $7.5 million threshold had been permanent from the outset and adjusted for inflation under the Consumer Price Index, the current limit would now be above $9 million. If S. 3977 becomes a permanent amendment rather than another temporary increase, the debt limit should continue to rise through the periodic inflation adjustments required by § 104, giving the threshold greater durability over time.

For now, S. 3977 and H.R. 7730 remain pending legislation. S. 3977 has been introduced and placed on the Senate Calendar; H.R. 7730 has been referred to the House Committee on the Judiciary. Practitioners should therefore base advice on the existing Subchapter V debt limit while continuing to track the bills’ status.

For more information or questions, contact Steve Kinsella.