When a small business is struggling financially, they may find they are unable to obtain credit from traditional lenders. In order to obtain the capital to keep the business operating, they may procure a Merchant Cash Advance. In this blog, we will look at Merchant Cash Advances and the debt relief options available to business owners who have personally guaranteed this type of business financing.
What is a Merchant Cash Advance?
A Merchant Cash Advance or MCA is an alternate form of lending where a lender provides funds to a business and receives an interest in the future sales/receivables of the small business in return. As part of the process, MCA lenders obtain UCC liens against the small business’ assets including bank accounts and they take daily or weekly payments directly from the bank account of the business. Typically, an MCA lender will require a personal guarantee which makes the owner personally liable for the debt. In some cases, a confession of judgment may be required as well. This makes debt collection much easier for the lender as it avoids the need to bring a lawsuit against a business that is in default.
Additionally, this type of financing has very high interest rates which may create a cycle of debt for the debtor, requiring new MCAs to pay off older ones. MCAs also have exceedingly high default rates, which can range from 20% to 30%. Often, the MCA payment requirements completely consume a small business owner’s account receivables and income. They typically do this through two possible payment options, either the MCA company will take a fixed percentage of the business’ daily sales or by withdrawing an estimate of monthly sales directly from the business’ bank account. These withdrawals can make it very difficult to continue running a business.
Merchant Advance lenders tend to argue that the type of funding they provide is not a loan but rather is more akin to an investment in the business or an interest in a receivable. By classifying the funding as something other than a loan, they are able to remove many defenses small businesses owners may use upon default.
Some Common MCA Lenders include the following:
BFS Capital
Bizfi
Can Capital
CapAssist
Capify
Colonial Funding Network
Core Business Finance, Inc.
EBF Partners LLC
FB Funding, LLC
Fundera
Funding Circle USA Inc.
Fundzio
IBIS Capital Group
Kabbage
Lending Club
LG Funding
Merchant Capital Partners
Merchant Cash & Capital, LLC
ML Factors Funding
Next Level Funding
OnDeck Business Loan
Platinum Rapid Funding Group
RapidAdvance
Retail Capital, llc d/b/a/ Credibly
Swift Capital
Yellowstone Capital
In fact, two of these lenders are presently being sued by the New York Attorney General for fraudulently making loans under the guise of MCAs. On March 5, 2024, New York Attorney General Letitia James filed a lawsuit against Yellowstone Capital, Delta Bridge Funding, and several other individuals for exploiting small businesses through fraudulent loans at incredibly high interest rates disguised as merchant cash advances. The Attorney General is seeking a minimum of $1.4 billion in interest and fraudulent fees that were collected from small businesses, and a court order for the companies to stop their alleged illegal activities.
What is a Personal Guarantee?
Providing a personal guarantee on a business debt means that if the business becomes unable to repay the debt, the individual signing the guarantee assumes personal responsibility for the balance that remains. Personal guarantees are typical for small businesses which lenders may view as risky. Lenders often require personal guarantees on a loan to obtain an extra level of protection. If the loan goes into default, the lender may sue the guarantor and pursue any personal assets to help satisfy the outstanding business debt.
What is a Confession of Judgment?
A confession of judgment (COJ) gives a lender the right to quickly enter a legal judgment into public record without filing a lawsuit. Since a signed COJ essentially means the business owner has already admitted liability, the lender does not need to file a lawsuit and can move straight to the enforcement of a judgment against the signatory of the COJ. Recently, this type of requirement for an MCA has become less common due to an amendment to NYCPLR § 3218 banning COJs for out of state defendants in New York. However, some unscrupulous lenders still may use them.
What are UCC Liens?
A UCC Lien is a document that lenders use to establish their legal right to assets that a borrower uses to secure a loan. These notices allow the lenders to seize the borrower’s collateral in the case of default. UCC Liens are often secured against a business’ assets including bank accounts.
What Are a Small Business Owner’s Options for Debt Relief?
Once a small business is sued by an MCA lender, they have a few options for debt relief. These include negotiating a settlement with the lender, fighting the lawsuit in State Court and bankruptcy.
Negotiating a Settlement with an MCA Lender
It may be possible to negotiate a settlement with an MCA Lender for less than the full balance owed. Typically, the loan will have to be in default and the lender may request financial information to document the hardship. The lender may want a full lump sum payment in exchange for a discounted loan payoff, but a payment plan may be possible as well.
Fighting an MCA Lawsuit in State Court
If a settlement is not a viable option, a small business may try to fight the default of their MCA agreement in State Court. If a company is facing an MCA lawsuit, an experienced attorney will need to thoroughly assess the language used in your agreement with the MCA lender to analyze the claims against the business in order to prepare a proper defense. Depending on the circumstances of the loan or advance, a business owner may be in a position to successfully challenge the validity of the MCA agreement and dispute the claims made by the MCA company in their lawsuit. This is much easier to do if the MCA agreement is characterized as a loan, as opposed to a contract to purchase future receivables. New York courts have developed a three-factor test to determine whether a merchant cash advance agreement should be considered a loan as opposed to a purchase of future receivables.
Under this test, courts evaluate: (1) whether there is a reconciliation provision in the agreement; (2) whether the agreement has a finite term; and (3) whether there is any recourse should the merchant declare bankruptcy. Principis Capital, LLC v. I Do, Inc., 201 A.D.3d 752, 160 N.Y.S.3d 325 [2d Dept. 2022].
MCA lenders have been crafting their agreements to satisfy this test and make it harder for debtors to challenge their validity. In fighting the lawsuit, many business owners are simply delaying the inevitable, a judgment against them and their business.
Bankruptcy Can Provide Debt Relief to Struggling Small Businesses
A small business owner may also consider bankruptcy in order to obtain necessary debt relief. There are two forms of bankruptcy that can help a small business owner facing financial difficulty. First is Chapter 7 bankruptcy, which is often referred to as “liquidation.” Chapter 7 bankruptcy may be filed for the business or the individual business owner since they often have personal guarantees of MCA debt. This form of debt relief is typically used by a business owner when closing a business. A personal Chapter 7 bankruptcy by the business owner stays all collection, including MCA lawsuits, and can discharge a business owner’s personally guaranteed debt, including MCA personal guarantees, and provides a fresh financial start. On the other hand, a corporate filing provides a stay to the business and stops any MCA lawsuits but does not discharge the business owner’s debt at the end of the process. This form of bankruptcy is not always necessary if the business is being closed but can be useful to stay any litigation or the enforcement of judgments against the business. Often, a business owner’s best option is to file a personal chapter 7 bankruptcy, discharge their debts and receive a financial fresh start. They can then rebuild their credit and if desired, potentially start new business ventures.
If a small business owner is determined to keep their business afloat, they may be interested in filing for bankruptcy under Subchapter V of Chapter 11. This option is typically more expensive than Chapter 7 bankruptcy and can make sense if the business is viable or valuable. Subchapter V bankruptcy streamlines various processes in Chapter 11 bankruptcy and reduces costs for small business owners. In order to qualify for Subchapter V bankruptcy, a business’ combined total debts must be equal to $7,500,000 or less (including both secured and unsecured debts). Subchapter V bankruptcy may allow a small business to restructure their debt, in an attempt to save the business. Subchapter V bankruptcy is by no means a guaranteed means to save a business, as cases presently have a confirmation rate under 50% and even less actually complete their plans of reorganization.
Contact the Law Offices of David I. Pankin, P.C.
At the Law Offices of David I. Pankin, P.C., we have over 28 years of experience helping small business owners facing financial difficulty. If you are a small business owner in need of debt relief, please contact our office to schedule a free consultation at (888) 529-9600. You may also contact us using our easy online contact form.
