The goal of this article is to help you understand, what does default on an MCA actually mean? What are the actual consequences of defaulting on an MCA. These aren’t simple questions to answer, every situation is different – every business has different vulnerabilities. Don’t kid yourself, thinking a cookie cutter solution will work; it won’t. Many people think – I’ll just switch banks, the assumption that personal guarantees won’t be enforced, that’s all nonsense. The objective of this article is to show you how complicated it actually is.
There’s a difference between an MCA default and other commercial debt distress. Bank loans go 30 day late, 60, 90, and then eventually you get a notice of default, with acceleration, and potential litigation, which is all measured on a timeline of months, with a lot of time at every interval, and opportunity to negotiate, slow walk, etc. With MCA’s, that’s all compressed into a week potentially. One bounced ACH, and a default is declared the next morning. If there’s a COJ in place, then a judgement can land in 24 hours. Your bank accounts can be seized within the same week of a missed ACH payment. That’s serious. There’s no leverage at all for the business owner. You lose your revenue, and bank account, before you even understand what’s happening.
01What a default is
The consequences of an MCA default aren't deferred consequences, like a bank loan. They are already in the contract, and ready to deploy, the minute the first bad thing happens. Let's begin with what a default is. It's a contractual term, and it's not up to you to define what a default is.
For example, a default can be:
- Missed, returned ACH payment
- Closing, or changing bank accounts without telling the lender
- Revenue dropping, and missing payments
- Spending money from the business on personal expenses, instead of servicing the debt
- Taking on additional financing (stacking)
- Bankruptcy filing
- Material lies on the application
- Breach of any rep, warranty in the agreement
When you sign the contract, default has been defined for you. The document you signed, controls when the funder is allowed to go from being your friend, to an adversary trying to collect their money. The triggers are in the contract.
02Let's talk about the timeline
Many people truly don't understand how quickly the MCA default process and timeline when the lender can start being punitive is. I'm going to walk you through a typical sequence:
- Day 0: ACH bounces, and default is declared. It's all automated. The funder's system flags the file.
- Day 0-2: Lenders do repeat ACH attempts. Often lenders will try 3-5 times in rapid succession, to capture any deposits which hit the account. You are stuck with overdraft fees.
- Days 1-5: The MCA lender will issue a demand letter, and demand full balance. Per the MCA contract, the full balance can be accelerated. They can also include other fees, like default fees, attorney fees, and other default multipliers.
- Days 2-7: The COJ is set up and can be filed. Judgement can be entered without notice, without a hearing, without you ever being given the opportunity to appear in court.
- Days 5-10: Lenders can issue a restraining notice, or levy, on your bank accounts. In New York, the restraint can freeze your bank account up to 2x the amount of the judgement. They make it practically impossible to operate with that much money on lockdown.
- Weeks 2-4: Even if there's no COJ, a breach of contract lawsuit will be filed, with a summons and complaint issued. Response deadlines are usually 30 days, depending on the state/city. If you miss it, and don't reply, then a default judgement is entered against you.
03Confessions of Judgement
Let's talk about what a COJ is: it's an affidavit that you signed at funding, in which you consent to a judgement, which can be filed, in the event of a default. The lender doesn't need to file a lawsuit, go to trial, or give you notice. Unfortunately, it was excessively abused by MCA funders, and as a result New York courts outlawed its use against out of state merchants.
Unfortunately, it didn't eliminate COJ's against NY merchants, and it didn't retroactively unwind judgements filed before the amendment. It also didn't stop funders from moving to other states where COJ's are valid. If you are not in NY, but a COJ was inserted into your contract, it's likely not valid and can be challenged.
04UCC-1 Liens and the Squeeze
The next item that's important to cover when considering an MCA default, is the UCC liens. When you take an MCA, the UCC-1 financing statement is filed, often same day as the receipt of the funds. It's a notice of security interest, not an enforcement tool. Almost all MCA funders file it, covering all of your business assets and receivables. This is what usually blocks you from getting an SBA loan, and other traditional refinancing options. SBA lenders usually run UCC searches in underwriting, an active MCA blanket lien is one of the most common reasons SBA files are denied.
Under Article 9, the funders can send a notice to your customers, instructing them to pay the lender instead of you. This is the 9-406 notification, and it's absolutely horrible because it doesn't require a judgement - you are instantly choked off, of funds you need. This is essentially the most effective way for lenders to garnish revenues, without ever winning in court. It destroys your customer relationships, and signals instability in your business, to other counterparties you work with.
05The Personal Guarantee
Almost every single MCA agreement has a P.G. in it. This is an obligation, that you as the business owner are guaranteeing the advance. These guarantees are drafted as unconditional, and unlimited. The lender will hold the owner liable on day one of the default. The minute you default, it triggers the guarantee, and reasons for default can be like: missed payments, breach of representation, closing the business, bankruptcy, switching processors, etc.
The guarantee typically survives the business. You can dissolve the LLC, close doors, declare bankruptcy, but the personal guarantee still survives. The PG is the ultimate insurance policy the lender has in the event of an MCA default. What it allows is for the lender to restrain your personal bank accounts. Your personal real estate can have judgement liens attached. Bottom line is this, if you signed the PG, the funder's collection team can go after the business, and go after you.
06When facing an MCA default, many owners frequently get it all wrong
They read information online, that consists of half-truths, but is ultimately wrong. Many think they can switch bank accounts, and the lender won't be able to find it - this is false. Many don't realize closing the account, is, in most MCA contracts, considered a default. Also, many borrowers think that they'll be able to get their MCA contract voided, due to usury laws - because some websites will give cookie cutter advice. Unfortunately, this has not been a consistent defense. Many MCA agreements are intentionally written to avoid loan characterization. Another defense many people think is that reconciliation will protect them. While this is true, the clause has to be invoked intentionally, and at the right time. If you do it AFTER DEFAULT, it has no weight, and cannot be used.
Bottom line: every day you delay, your options go down. By the time the bank restraints arrive, all your leverage is gone, and it's likely your 200% APR MCA is now going to be 300-400% APR, with all the default and punitive fees.