Can a business survive defaulting on a merchant cash advance? Some do. But the honest answer starts with an uncomfortable fact: merchant cash advances aren’t actually loans, which means that traditional definitions of “default” don’t quite apply. While merchant cash advances can be useful to a cash-strapped business in need of fast liquidity, they are often expensive and predatory. That’s because they aren’t real loans, and so do not have to comply with most lending laws. The industry describes its deals as advances against future revenue, which keeps the word “loan” out of the paperwork, and because the customer is a business rather than a person, consumer protection laws don’t apply either.
A Confession of Judgment
The bigger problem is a document most owners signed without a second thought. Before you were funded, you were probably asked to sign a confession of judgment. In plain terms, you gave up your right to defend yourself if the lender took you to court, and you agreed that the lender could file judgment without any prior notice. In a sense, you handed the funder the keys to your business.
Lenders like confessions because they are fast. The lender’s lawyer sends the confession to a county clerk in New York, along with a sworn statement explaining the default and how much is still owed. The clerk doesn’t check to see that the confession is valid but by the rules simply admits it and certifies it, giving it the same force as a court judgment. No judge looks at it, and no proof is demanded. In one case reported by Bloomberg Businessweek, a clerk approved the judgment less than a day after the lender’s lawyer asked for it. That document is all the funder needs to start garnishing your bank account. All of these documents create a scenario where you might not see the lawsuit until it’s too late.
Being Current on Your Payments Is No Protection
Being current on your payments is no protection either. Doug and Janelle Duncan of Florida owned a real estate agency in the Tampa suburbs. They had borrowed $36,762 and agreed to pay it back by $800 daily debits to the lender. They signed those confessions without seeing a lawyer, but they had every intention of paying on time. They were still paying. The lender filed a suit in a court in Goshen, N.Y., nearly 1,000 miles away, alleging that they had failed to pay. A clerk signed the order in less than a day, with no judge and no hearing. On Monday they were locked out of their bank accounts. Within a week, the $52,886.93 had been taken, mostly money the Duncans had collected in rent and held on for their landlords.
Here’s what happened next. The lender sent the judgment over to a marshal in New York City. There are 35 of them, appointed by the mayor, empowered to collect private debts for a 5 percent fee. Technically they can only operate in the five boroughs, but there’s a loophole: they can demand out-of-state funds as long as the bank has an office in the city. A few banks refuse, most just pay up. The Duncans’ bank froze their accounts and a few days later gave the marshal a check for the judgment plus a 5 percent fee. The lender later refused to return the landlords’ money. That’s how this type of legal intimidation typically works.
Could the Duncans have fought back? In theory. But borrowers often don’t try. Few lawyers will take on a client who already has no money left. And it can take months to get a ruling, too long for the desperate. The Duncans’ lawyer checked the court records in New York, and found that borrowers who tried to overturn judgments almost always failed. The judges said they waived their rights when they signed. He told them it would cost $5,000 just to hire a lawyer to travel to the county. He said it wasn’t worth it. Had they tried, they might have discovered that their filed confessions had been altered to fix a drafting error.
A Cycle of Borrowing and Debt
The Duncans scrambled. Doug took out another advance, this one bigger, from a different company, to survive. But the daily payments were too much, and they ran out of cash. Employees fled. A month after the bank seizure, the agency went bankrupt. They lost their retirement savings along with the agency, but kept the house. This is the pattern that sinks so many owners: you might find yourself forced to accept another MCA or a cash advance for emergency funds to cover the payments on the previous MCA. This situation can easily trigger a cycle of borrowing and debt that spirals out of control. Jerry Bush from Roanoke, Va., ran a plumbing business. He had signed confessions to at least six advances, one after another. He went up to $18,000 per day in payments. He closed the business, let 20 employees go, and stopped paying the advances. The lenders seized the accounts, and one lender got to his father’s retirement money.
The Duncans’ case is unusual in one respect: the Duncans say they were never behind. Still, most people interviewed had fallen behind on the repayments, and the consequences were just as devastating for them, including divorce, broken friendships and medical debt. Richard Schilg, an owner of an Ohio human resources business, took at least six advances and, like others, had judgments against him for as long as he maintained a business or a personal checking account. He was so limited in his access to money he had to sell his furniture to buy groceries. Some lenders forged documents, lied about the size of what was owed, and manufactured defaults, borrowers said. The industry has eluded state and federal regulators.
It also helps to understand why a lender may be in no hurry to let you catch up. With a confession in hand, a lender stands a chance of full recovery even when a borrower defaults. And by tacking on additional fees, it could make even more money. Collections had become a profit engine. In the Duncans’ case, as a result, the lender collected ahead of schedule and then added $9,990 in legal fees. In about three months, it almost doubled its money.
So, can your business survive? Some small businesses can survive an MCA default. In the cases described here, though, the businesses did not, and what survived was what owners saved outside the business, like the Duncans’ house. Most of the damage comes from speed: frozen accounts before you know a case exists. If you are not there yet, the lessons are simple. Check the documentation before you take the advance, do not sign a confession of judgment without consulting a lawyer, do not take a second advance to cover the first. Keep bank records: the Duncans’ bank records show that the lender was still collecting $800 a day, even after the court case started. If you’re behind on advances or are about to stack, get help before the judgment, not after.
