Can a merchant cash advance be challenged as a usurious loan?

The term “merchant cash advance” is a fancy name for lending disguised to get around lending laws and licensing. These people should call themselves lenders, but they do not. Instead, they deny it. Call the papers “purchases”, the contracts are meant to avoid any law that restricts or governs lending. When a contractor gets in trouble and can’t pay, these people show up in the long line of suppliers and subs. The sureties have defenses and arguments they can raise to cut down or avoid their payments to an MCA. The surety has all of its usual defenses, too. If you borrow this way, you may look for a way out of your contracts. You ask: Can an MCA be challenged as a loan and a usurious one? Many courts have said they can. It depends on the terms. If your bank account gets debited every business day, whether the deal is legally a loan matters a great deal.

The Courts Pierce the Label

An MCA is a deal carefully disguised to look like a sale. The provider contracts to purchase some percentage of the business’s future receivables, and then every business day it subtracts some of those receivables by electronic debit. On the face of it, the contract is a sale. The contract spoke of purchases and receivables. But the Funder would come back every day and deduct funds regardless. The courts pierce the label, and call the substance what it is, a loan. The label matters because selling receivables does not have to obey usury laws, which govern lending. If a court calls these contracts loans, they can be challenged under those laws. An example is the Richmond Capital 2023 New York Supreme Court case. New York state brought suit against the lenders. The judge found that the 140 agreements were typical, and they were indeed loans. In AKF v. Western Foot and Ankle Center, 2022 in E.D.N.Y., a revenue purchase agreement was unenforceable as a loan. The usury defense killed it. In addition, in three 2022 rulings, courts recharacterized these agreements as loans. See Lateral Recovery v. Queen Funding, Haymount and Fleetwood Services v. Ram Capital. In Davis v. Richmond Capital, the 1st Department in 2021 ruled that the allegations were sufficient to show that the agreements were loans, subject to New York’s usury law. In Professional Merchant Advance Capital v. C Care Services, 2015 S.D.N.Y. the contract had a minimum weekly payment, regardless of receivables. This feature meant the funder had no downside. The contract could be a loan. Finally, see Crystal Springs Capital v. Big Thicket Coin (2023).

Courts outside New York tend to see things the same way. In Major’s Furniture Mart v. Castle Credit, a 1979 decision, the Third Circuit federal appeals court called the deal a secured loan. The parties called the receivables sale a sale, but it worked like a loan. In 2011, in Qualia Clinical Service, the Eighth Circuit bankruptcy panel agreed. The accounts receivable sale contract was actually a disguised financing deal, and the debtor kept ownership of the accounts. In Shoot the Moon in Montana, a bankruptcy judge in 2021 reviewed 18 MCA contracts and applied a multipart test to see whether they were actually loans. The court found that they were, so it awarded usury damages. Here is a key point. These decisions look to how a deal works. The tests do not care what the name of the contract is. The Siskey Hauling bankruptcy (N.D. Ga. 2011) took the same approach. Courts routinely call these deals a loan, not a sale, the court noted, when the buyer has substantial recourse, shifting the non-collection risk to the seller. The legal question for you is this. Courts say that when the funder can come after the business or its owner if customers do not pay, the deal is more like lending than purchasing.

The States Are Themselves Suing These Funders

Certain kinds of lenders, those that arrange to “buy” receivables, ran into the full forces of law in late 2020. The State of New Jersey sued eight entities that took part in MCA lending. Now not only is the question raised in lawsuits filed by the parties to these agreements. The States are themselves suing these funders for illegal lending and on other grounds.

The New Jersey court complaint all but paints the lender as duplicitous. It charges that the contracts hid unconscionable, predatory terms. They pretended to purchase an interest in the merchant’s receivables but left out the material fact that the daily payments bore little relation to the receivables. The complaint returned over and over to one central fact. Payments were fixed, and payable without regard to the merchant’s sales. Consequently, business and the owners bore the risk if sales were bad, not the funder. The state calls them unlawful, usurious, predatory loans.

New Jersey settled its case by consent order dated Dec 27, 2022. The State of New Jersey posted a $27 million settlement that forgave $21 million in MCA loans. That sounds like a lot until you look at the State of New York suit filed in March 2024 against 30 defendants. That one seeks damages of over $1.4 billion from several big MCA lenders and individuals who are part of the alleged scheme. The size of New York’s claim shows how serious the state regarded the case.

New York’s Attorney General charges that MCAs involve short-term, high-interest funding for small businesses. They can run for 60 or 90 days, with fixed daily debits. They are predatory and fraudulent, according to the state, and in effect have interest rates as high as 820% a year. What do rates of up to 820% interest mean for an MCA borrower? You tell me. They don’t sound like a purchase of receivables.

Usury Defenses

Treatment of an MCA contract as a loan opens up another line of attack. The interest is very likely well above the legal limit. Say a shop wants $20,000. The funding contract reads: “funder purchases $29,600 in future receivables.” It keeps $1,299 to cover fees, and the take-home to the merchant is only $18,701. Doing the math, the contract interest, $29,600 minus $18,701, is $10,899. The funder gets that sum for holding the money for 115 days, roughly four months. Calculating the APR, the annual percentage rate is around 117%. The huge interest, 117% in a year, easily breaks the legal limit on loans.

For New York, if you can’t find some rule that applies, the lending ceiling in New York is 16% a year (Banking Law 14-a). Above that is civil usury. Rates above 25% are criminal usury, Penal Law 190.40. The 117% example would sit far past the 16% civil usury line, and past the 25% criminal usury line. New York and other states treat usurious loans as void and unenforceable. In Adar Bays, the court said a criminally usurious loan was wholly invalid. You may be able to call the entire deal invalid. In Seidel, in 1992 the state’s high court ruled that the borrower owed no further interest or principal, and the securing mortgages were cancelled. The business that took the money may keep it.

So you should look at the details of the MCA agreement against whatever laws govern it. It might turn out it’s unenforceable. Look at your merchant cash advance contract and ask: Does the funder get a fixed payment every business day, and it gets that sum whether or not customers pay? Does the MCA lender have recourse against the business or the owner for any losses? When these conditions are both true, your contract fits the pattern. Courts often call contracts like that a loan. Not every MCA is illegal, and many courts, including New York’s, uphold some. Still, this is one more defense for you to investigate.