Are MCAs Considered Loans? The Usury Reclassification Argument

Congress passed the Dodd-Frank Act in 2010 in response to the 2008 recession and its causes. In theory, it was supposed to curb risky behaviors in the financial sector. One of its provisions created a Consumer Financial Protection Bureau to protect vulnerable consumers from unscrupulous mortgage and payday lenders, but it failed to account for ripple effects. While financial reform succeeded in some respects, it is also partly responsible for ushering in a new type of exploitation.

Small businesses face a great many difficulties competing with large companies. One of those problems is access to affordable loans. Small businesses have a harder time getting commercial and industrial bank loans than big corporations. That, in turn, limits their ability to compete with bigger businesses. An April 2018 National Bureau of Economic Research working paper by Michael Bord and John Duca shed some light on why.

Dodd-Frank’s rules affected business loans as well as consumer loans. They raised the cost of every small business loan a bank made. They raised the cost of just running a bank. Since 2010, small loans’ share of business lending fell 9 points at large banks. It fell twice that much at small banks. Small banks devote a larger share of their loan portfolios to small businesses than big banks do. After controlling for credit cycles and bank size, almost the entire decline can be linked to the regulation. Federal Reserve surveys show that credit standards tightened more for small firms than large firms in the wake of Dodd-Frank.

As a result of the burdensome regulation, small short-term business loans became unprofitable for small banks, unappealing for big ones, and less available for smaller firms. The unintended consequence was the loss of a simple way for growing companies to borrow money at a reasonable price. Worse, less credit to smaller borrowers means fewer resources and less money to start and grow their business ventures.

Short-term loans do fill a real need. Even the Amazons and Microsofts of the world need them sometimes. Businesses have always needed fast cash. The demand stayed, even when the banks withdrew. Someone has to fill that need, even if it’s with costly or semi-legitimate channels. Owners turned to MCA lenders not covered by the Dodd-Frank Act. Questionable lenders are circling this new demand like sharks. Unscrupulous lenders thrive in this environment and use regulatory trickery to avoid complying with lending regulations. MCAs are still a risky form of lending.

In an MCA agreement, a lender buys a firm’s future revenues for a lump sum, which the business uses like a short-term loan. By law, it may not technically count as a loan, and indeed the contract calls it a sale, not a loan. Courts often agree to this assertion that an MCA is a sale because the lender indeed purchases the business’s future receipts. If it isn’t a loan, the merchant might be unable to discharge it in a Chapter 11 bankruptcy.

An MCA is a lot like a payday loan for a business. A payday loan is cash advanced to a borrower against a portion of the borrower’s future salary or paycheck. Payday loans are repaid from a borrower’s next paycheck. An MCA is repaid through small, daily debit deductions from a business’s bank account.

These loans are a terrible fit for businesses without steady, dependable income, like a contractor who may have to wait 30 to 60 days to get paid for completed work. They must still make their daily payments even while they are going unpaid. Bills and payroll still have to be met even when income falls short. The pressure can get intense, even for a successful business with a steady stream of incoming orders. For small merchants, a missed payment often means default. That usually makes the entire debt due immediately. The lenders are unsympathetic, even when it would make sense to give a borrower more time or a more reasonable payment schedule.

CapCall V. Foster

In September 2021, the United States Bankruptcy Court for Montana handed down a landmark ruling questioning the legality of MCAs. That decision came in a case called CapCall v. Foster, which started as the bankruptcy of a company called Shoot the Moon. The United States Bankruptcy Court for Montana is part of the 9th U.S. Circuit.

The New York-based MCA lender CapCall sought $228,449.93 in segregated funds from the bankrupt Shoot the Moon, LLC. Foster had sold virtually all of the business’s assets. The proceeds were far short of the senior secured creditors’ claims. Besides CapCall, several other secured creditors had valid security interests ranked ahead of CapCall’s. With a win, CapCall would bypass the United States Trustee’s distribution of the proceeds of sale to the senior secured creditors.

CapCall said the deals were sales, but Foster said they were loans. If it was a sale, CapCall would have owned the revenue and been paid first. If the agreement was a loan instead of a sale, CapCall was only a junior secured creditor. Under § 506(d) of the Bankruptcy Code, whenever senior liens exceeded the collateral’s value, a junior creditor’s claim turned unsecured. The junior lender would lose its lien and be unable to enforce the claim. As a loan it would be junior to the other creditors and would get nothing.

If it walks like a duck, quacks like a duck, looks like a duck and swims like a duck, it’s probably a duck. Even if it does call itself a goose.

The court analyzed how the agreement read on paper with how it worked in practice. It can call itself whatever it likes. It could not justify calling it one thing on paper while acting a different way in real life. The point was if the deal behaved like a loan in real life, the court treats it as a loan no matter what the agreement said it was.

Judge Whitman L. Holt found that the agreement looked too much like a loan to pass as a true sale. CapCall had broken Montana usury laws and owned no part of the estate. Usury laws protect borrowers from predatory interest rates on loans. CapCall could not seize what it never owned. So the $228,449.93 was not CapCall’s to take.

This ruling undermines a long-held belief that MCAs were truly sales, not loans. So what does CapCall v. Foster mean for the future of MCAs? It doesn’t end the practice. One court’s judgment does not change an industry overnight, but it is the first important win for MCA victims. For an owner in an MCA, the label does not automatically define if the agreement is truly a loan. People in MCA agreements would be wise to watch developments closely.