Introducing a Merchant Cash Advance
A merchant cash advance is a relatively new type of financing for small business owners. It does not operate like a traditional loan. Instead, it is an agreement that requires a business owner to sell a portion of its credit card sales for a quick injection of cash. Once an application has been made, the business is approved and an offer is accepted, the system is set up to receive daily payments on the account in the form of a percentage of the credit card payment. If credit card sales begin to decrease , so do the payments. But if sales increase, the lender continues to receive payments until the entire advance is paid back. Each lender has a different formula for calculating the amount of the advance. However, there is no disputing that a merchant cash advance is fairly simple to obtain, requires no collateral and can be used for anything the business owner chooses.
Popular Legal Pitfalls
Despite the common use of merchant cash advances in the small business sector, there are a number of legal issues that can arise between a borrower and a lender.
If you are in the position of having an MCA dispute, you should retain a qualified lawyer to represent your interests. The most common legal issues relate to: CONTRACT INTERPRETATION – The contract between a lender and a borrower is a loan agreement dressed up in merchant cash advance language. As a general rule, courts will not enforce usury laws against lenders who structure their loans as merchant cash advances, and the term "money advanced" is substituted for "interest" on the loan. Despite the variations in language, the contract may be interpreted as a loan agreement under state law and most courts have enforce usury laws against all lenders under all circumstances. You will need an experienced litigator to properly explain this in court.
PRE-JUDGMENT INTEREST RATES – Some lenders charge interest rates of 40% or more. Under certain circumstances these interest rates may be considered usurious in some states because they exceed the state usury limit. If you know how to interpret the contracts that are used for merchant cash advances, you will begin to see some of the provisions in the contracts that may increase the effective interest rate well beyond what is allowed under the law. Experienced attorneys that are well versed in these contracts are able to identify and explain these provisions to you and your attorney in order to prepare you for settling or litigating your case.
FORUM SELECTION – At some point you may decide that you want to litigate rather than settle. If that’s the case, you may be surprised to learn that the lender maintains the right to select the forum in which your case will be heard. If you are in default, this may mean that you will have to hire an out of town attorney to represent you geographically far away from your home or business. Although you may be able to successfully transfer the venue, you should retain an experienced litigator who can assist you in overcoming the obstacles that are often placed in the way of a successful litigation strategy.
Usury & the Merchant Cash Advance
One of the main distinctions between a merchant cash advance and a loan is that the merchant cash advance is not regulated by usury laws. The usury laws are like ‘interest-rate caps.’ Most states have usury laws, which limit the amount of interest that can be charged for loans. In general, usury laws get rid of loan contracts with unconscionable interest rates. Personal loans are considered loans, no matter what platform they are delivered on, including credit cards.
The problem with merchant cash advances is that the advance is booked as a sale of future receivables, not as a loan. In fact, some deals even include a list of goods sold, and a list of fees pursuant to the purchase and sale agreement, which are also "factoring" fees. The merchant cash advance company sets up an account with a merchant services provider that facilitates taking the payments from the merchant’s point of sales system.
The difficulty is that usury laws apply only to loans and advances, but because each deal is a sale of future receivables, there is no loan or advance. Consequently, there aren’t any restrictions on the interest rate.
Validity of Agreements
Enforceability agreements become issues when litigation arises and someone wants out of the deal. One person claims he didn’t know what he was signing or he thought it wasn’t legal or he was coerced into signing it. Or the parties have a dispute over what was agreed upon. One party sees the agreement in a different light than the other does and confusion reigns supreme.
The enforceability of an agreement depends on the laws of the state under which the parties entered into the contract. Most states allow agreements for the sale of accounts receivable and do not require a license to buy, sell or negotiate such accounts. A contract to purchase accounts receivable can be enforced, against the seller and a buyer who is not a licensee. If the buyer is a licensee, the contract may be subject to the licensing requirement of the state.
Many courts have considered whether an agreement constitutes a license or a loan and have come to differing conclusions. For example, the Illinois Court of Appeals for the Second Circuit held that an agreement to buy a contingent future interest, such as an account receivable, constitutes a transaction for the sale of receivables, rather than a loan. Other jurisdictions, however, have held that these transactions are loans. Key factors to consider in determining whether an agreement is an enforceable contract for the sale of future receivables or a loan or an unlawful assignment of wages under state law will be the parties’ intent and practices.
The federal courts in New York, applying New York and New Jersey law, have generally held that agreements for the sale of accounts receivable are enforceable and not usurious loans. They explain that a transaction to purchase or discount future receipts is not a loan because the future receipts are not advanced until the merchant makes them available to the buyer.
Several other factors may also be relevant in determining whether an agreement to purchase future receivables is enforceable. State laws also vary regarding the disclosure of fees and settlement amounts. Many states require certain disclosures in contracts for loans at interest rates in excess of a certain percentage. Starion Retail, Inc. v. Baker discusses the enforcement of a merchant cash advance and explains the analysis courts conduct in determining whether an agreement is a lawful transaction.
Outcomes and Dispute Process
A common question that arises in the area of merchant cash advances is whether certain legal remedies are available to a business and/or to the attorney if you believe you have a case pertaining to a merchant cash advance dispute. Many decisions are required to be made when deciding on your next steps.
Should the business pursue litigation? Should only the attorney pursue litigation? Does it make any difference? Should the business file an action as a plaintiff or should business wait to be sued and then enter into a settlement agreement? Should the agreement provide terms for attorney’s fees if you win and provide for the payment of attorney’s fees if you lose? Should a defense be raised in litigation by the business and not the attorney?
I will address the aforementioned questions, and others as they arise throughout this discussion.
Litigation is expensive no matter which way you slice and dice it. An attorney who takes on a case for a flat fee is still expending fees and time. Even if the attorney wins the case, as I often do, it could take more than a year to get paid. Litigation, moreover, has its own risks as well. The defendant may raise a counterclaim, the defendant may have a viable defense that results in a complete loss to you, and/or a judgment may even be entered against you and, therefore, negate any wins you have obtained.
In the event that an attorney enters into a successful settlement on behalf of the business, attorney’s fees will be negotiated as part of the settlement documents. However , that does not mean that the fees will be paid right away. Rather than going into the nuances of negotiating attorney fees in a settlement agreement with a defendant, suffice it to say that the negotiation of attorney’s fees usually involves some give and take and, once again, it may take longer than anticipated for you to receive payment on the case. Nonetheless, being able to avoid the expense of litigation, as well as the angst that goes with it, can certainly make a settlement agreement worth its weight in gold!
If you sign a settlement agreement, that agreement will remain valid even if you are sued. You cannot be sued for breach of a settlement agreement if you are a "good citizen" who pays obligations on time pursuant to the terms of the settlement agreement.
You should be aware, however, that although a defendant may agree to pay pursuant to a settlement agreement, you still have exposure to being subjected to a lawsuit to collect on the judgment at a later date. The defendant may sell his/her assets for minimal value to a family member or related party who takes over the business. The defendant may transfer stock or may file for bankruptcy. These are just some of the possibilities that a plaintiff must address. Once again, there are lawyer fees involved with litigating these issues for collection purposes.
As noted, although an attorney may retain a defendant’s payments on a flat fee basis, that does not mean that a business or the attorney should pursue litigation. In addition to possibly taking a long time, litigation may involve a lot of costs. You must carefully weigh the projected costs and be sure to account for the time necessary to achieve your goal.
Legal Prevention Techniques
There are several preventive legal strategies that a business should consider when contemplating entering into a merchant cash advance transaction. While such transactions can take a variety of forms, the most common one is a purchase and sale agreement for a portion of a borrower’s future credit card receivables. Merchants should be aware that because cash advances are virtually unregulated, it is imperative that a merchant negotiate and execute a purchase and sale agreement that is transparent, equitable and beneficial to both the merchant and cash advance lender. Notably, courts routinely void or rescind merchant cash advance agreements that fail to adhere to state and federal laws, such as usury, or if the underlying loan was not properly disclosed to the borrower and is therefore considered pursuant to the court to be hidden or unconscionable. Key components of a properly drafted and transparent merchant cash advance purchase and sale agreement include a well-defined, carefully described and lawful purchase price, payment structure, recoupment period, right of return, amounts withheld, events of default and remedies for merchant and cash advance lender. However, even with a properly drafted and fully transparent merchant cash advance purchase and sale agreement, merchants should be cautioned that while courts have ruled that such transactions are essentially unsecured business loans, they have also held that under certain circumstances merchant cash advances transactions are subject to regulation under various state and federal statutes. For example, courts in California have ruled that merchant cash advance transactions are subject to laws governing loans and moneylending and must be reduced to writing. In order to avoid falling victim to the uncertain legalities and ambiguities surrounding merchant cash advance transactions, merchants should retain counsel to review any and all proposed agreements with merchant cash advance lenders before entering into a transaction.
Trends in Merchant Cash Advances
A number of factors suggest that regulation of merchant cash advances will likely continue to develop, and possibly in more detail than has yet been established. The McGee case has triggered a flurry of recent state regulatory initiatives seeking to regulate merchant cash advances, largely based on the need to protect small business owners from abusive lending practices. While the specific focus of these initiatives has largely been disclosure and transparency, as evidenced by the New York Department of Financial Services’ recent draft regulation requiring disclosures that are much more detailed than those presently provided in New York-based merchant cash advance contracts, it suggests that consumer protection oversight of merchant cash advances will gain momentum . Further, the National Association of State Attorneys General convened a forum on February 5, 2016, to address predatory lending and small business financing. These developments together with the heightened attention on consumer financial protection, regulation of payday lending, and recent enforcement activity with respect to high-cost installment lending all suggest that state regulator activity in the small business finance space will continue to broaden, particularly in the area of disclosure, even if no wholesale upgrade to an integrated, overarching state licensing and oversight framework occurs.