Am I personally liable for my business’s MCA debt?

If a struggling small business can’t get a bank loan, they may choose a merchant cash advance as an alternative. These advance payments come at a high price, one you can end up paying with your personal finances as well. Here we cover what you can do when personally obligated for an advance and what relief options may be available.

A merchant cash advance (MCA) is a loan, sort of. The lender “advances” money for an interest in future sales or receivables. To cover their own backs, they file UCC liens against the business assets, including the bank account. They then take daily or weekly “payments” from that account to pay off the loan. Merchant cash advance companies usually want the owner’s personal guarantee. Some also require the signer to “confess judgment,” so they do not have to sue to get their money. So when the money runs out and the payments keep coming in, personal assets may be at risk.

When you factor in the fees and rates, the cost of a MCA is very high. When the payments become unmanageable, you may be tempted to take a new advance to pay off the old one. Default rates are in the 20% to 30% range. Payments can eat up all the receivables or sales, leaving nothing but the headache: they are based on a set percentage of daily sales or a withdrawal based on the expected sales for a month. It becomes very hard to operate the business on that basis.

Even so, merchant cash advance companies insist that an advance is not a loan but a purchase of receivables.

Here we list some well-known merchant cash advance lenders:

• 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 (doing business as Credibly)
• Swift Capital
• Yellowstone Capital

On March 5, 2024, the NY Attorney General Letitia James announced a lawsuit against two merchant cash advance lenders, Yellowstone Capital and Delta Bridge Funding, plus individuals. She said they disguised high-rate loans as cash advances. James alleges the companies have been taking advantage of small businesses. She is seeking at least $1.4 billion in interest and fraudulent fees, as well as a court order against the practice.

A personal guarantee means that the signer is responsible for the balance due if the business fails to pay the loan or cash advance. It is common to have to sign a personal guarantee for small business loans, especially if the company is high risk. This is just one more provision in the contract which is written to make sure the lender gets its money, if not from the business, then from the signer. The lender can sue the owner if they fail to pay, and take their personal assets in order to collect.

A confession of judgment (COJ) lets a lender obtain a judgment against a borrower fast, without suing. When you sign a confession, you are admitting liability, the lender just records their judgment against you, which they can easily do without suing you, then go right to collecting. An amendment to NYCPLR § 3218 banned confessions of judgment against defendants out of New York State. The practice was reined in, and now only truly scummy lenders use it.

The UCC filing protects the MCA lender’s rights over the collateral. It’s a form that gives them the right to seize it when the borrower is in default. UCC liens often cover other business assets, and a default can put much of what the business owns within reach.

So what should you do if a merchant cash advance lender sues you? There are three main routes to dealing with that situation. You can try to settle with them. You can defend in court. Or you can file bankruptcy.

It may be possible to settle the balance for less. Usually the loan or advance has to be in default. The lender may ask for evidence of hardship. Generally they would like to get a lump sum payment, though a payment plan may be allowed.

If you are not able to settle with the cash advance company, you can fight the lawsuit in state court. But first you should find an experienced attorney to examine the language of the agreement. Depending on the circumstances, you may be able to challenge the validity of the cash advance agreement. There is much more room for challenge if it is deemed a loan. New York courts use a three-factor test to make that determination. How the court labels the deal will shape all of your defense.

Here are the three questions that need to be asked about the cash advance: Does the contract include a reconciliation provision? Is the term finite? Does the lender have recourse in the event of the business’s bankruptcy? This is the three-part test used by the 2nd Dept. in Principis Capital v. I Do, 201 A.D.3d 752, decided in 2022.

Now that the agreements are being drafted to pass the test, it is harder to challenge the agreement.

Two Types of Bankruptcy

So if you can not settle, if you can not fight it off, then there is one last option left. And that is to file bankruptcy. There are two types of bankruptcy that can help the small business owner dealing with a personal guarantee on a MCA debt.

Chapter 7 is liquidation bankruptcy. It can be filed by the company, or by the owner. It usually means the business is closing. The personal Chapter 7 will stop all collection activity, including that merchant cash advance lawsuit. The money you owe from a personal guarantee can be discharged, but if the case is filed under the company’s name, it only stops the suits against the company.

The corporate Chapter 7 does not give the owner a discharge. The owner is still on hook for the money. But since the owner signed for it, only a personal bankruptcy filing will cover the personal guarantee. If you are going to file bankruptcy, you may be able to get away with filing personally and not filing the company. Filing a personal Chapter 7 is often a better option for you if you do not plan to continue in business. You can rebuild your credit and possibly start new companies. When you are shutting down, the Chapter 7 is a fresh start.

Sometimes, you can file a Chapter 11 Subchapter V to save the business. It is generally more expensive than Chapter 7. Still, it may be possible to do a streamlined, less expensive Chapter 11. But this only works if you are trying to save a viable or valuable business. Subchapter V can allow the business to reorganize debt and try to make a go of it. Less than half of Sub V cases are confirmed, fewer complete plans.