Two Separate Legal Questions, Not One
When a funded merchant files for bankruptcy, a broker or funder is really facing two distinct legal tracks, and conflating them leads to confused expectations. The first is whether a court will recharacterize the MCA agreement itself as a disguised loan rather than a genuine purchase of future receivables. The second, entirely separate from the first, is what a funder’s UCC-1 lien does procedurally inside the bankruptcy case regardless of how that recharacterization question comes out.
Both questions matter, and they get resolved differently, which is worth understanding before assuming a bankruptcy filing automatically means one specific outcome for the funder.
What One Attorney-Reported Case Shows About the Recharacterization Risk
According to a 2026 legal analysis published by Lake Le Tag Law, a federal bankruptcy court in the Southern District of New York recharacterized MCA agreements as loans in a case the firm identifies as In re J.P.R. Mechanical, Inc., despite the agreements’ own sale-of-receivables labeling, and allowed recovery of over $3 million in payments the merchant had already made before the bankruptcy filing. That is a real, dollar-specific outcome as reported by a law firm summarizing the case for its own audience.
It is worth being direct about the limits of that sourcing. This detail comes from an AI-summarized reading of a law firm’s blog post, not an independent read of the court’s own docket, and the case caption, court, and exact recovered amount should be confirmed against a primary case-law database before anyone cites it as settled precedent in front of a merchant, a funder, or an attorney.
The Three-Factor Test Courts Reportedly Apply
Per Herrin Law’s own summary of the relevant case law, courts evaluating whether an MCA agreement is really a disguised loan look at three factors: whether the funder’s reconciliation right is genuine, whether there is a fixed repayment term rather than one tied to actual revenue, and who bears the risk if the business fails outright. The firm’s summary names several cases as examples of courts applying this test, including one it cites as Champion Auto Sales v. Pearl Beta Funding, decided in New York’s Appellate Division in March 2018.
As with the bankruptcy case above, these specific case citations were obtained through a secondary legal summary rather than an independent docket read, and should be verified against the courts’ own opinions before being treated as confirmed legal authority rather than a law firm’s own characterization of the case law.
Why the UCC Lien Question Runs on a Separate Track
Per a bankruptcy-focused guide published by Gina McDonald Law, a funder that has properly perfected a UCC-1 security interest in a merchant’s receivables can still hold a secured claim inside the bankruptcy case, independent of how the recharacterization question is resolved. In practice, that typically requires the debtor to provide what bankruptcy law calls adequate protection before it can use those receivables as cash collateral during the case.
That is a procedural, filing-based protection, distinct from the substantive legal question of whether the underlying agreement was ever a genuine sale in the first place, which is exactly why the two tracks need to be understood as separate questions rather than one combined outcome.
What This Means for a Broker Who Just Learned a Merchant Filed
None of this is a fight a broker is expected to litigate personally, and it should not be treated as one. What matters practically is setting realistic expectations with the funder rather than assuming either automatic full recovery or automatic total loss, since the actual outcome depends on the specific agreement’s structure, whether the security interest was properly perfected, and how a given court applies the recharacterization test in that jurisdiction. A merchant’s bankruptcy filing often raises a related, separate question for the broker directly too, since most commission agreements allow a funder to claw back some or all of a broker’s commission on an early default, a distinct financial consequence from either of the legal tracks described above.
The honest posture here is knowing enough to ask the funder the right questions, was the UCC filing properly perfected, what does the agreement’s reconciliation language say, rather than assuming any single outcome before those specifics are known.
Sources
The external data in this article draws on the sources below. Figures described in the text as estimates or industry triangulations are directional and are not attributed to a single dataset.
- Lake Le Tag Law, Merchant Cash Advances: Legal Landscape, Bankruptcy Recovery, and Litigation Support
- Gina McDonald Law, Merchant Cash Advances in Bankruptcy: Recharacterization, UCC Liens, and Cash Collateral Strategy, 2026 Guide
- Herrin Law, MCA Loan vs. Sale Recharacterization