If a merchant cash advance company has sued your business, a lawsuit doesn’t always mean negotiation is off the table. You can sometimes negotiate a settlement for less than the full amount, especially if it makes sense for both sides. Suing can feel intimidating and can trigger panic for many small business owners. Being served does not mean that you have lost the fight, you still have your rights. You have other options for debt relief. There are three options for relief if you receive a lawsuit. They are negotiating a settlement with the lender, fighting the case in state court, and filing for bankruptcy. Before looking at each, it helps to understand the debt itself.
A merchant cash advance is an alternative to a small business loan or line of credit. With a cash advance, a funder gives you cash and takes a percentage of your receivables or sales. A funder files UCC liens against your business assets including your bank account. Cash advances work by taking money out of your bank account daily or weekly. Cash advances carry extremely high costs. Business owners often get stuck in a cycle of cash advances. Borrowers must take new advances to pay off old ones. Default rates range from 20% to 30%. Funders also argue that an advance is not a loan at all but a purchase of receivables, which takes away many of the defenses an owner might otherwise raise after a default.
Most funders also require the owner to sign a personal guarantee. When you signed that personal guarantee, you became personally liable for whatever the business still owes on the loan if it doesn’t pay. Lenders use personal guarantees when they view a small business as risky. If the loan goes into default, they can sue you personally, and use your personal assets to satisfy the business debt. Some contracts go further with a confession of judgment. A confession of judgment allows the lender to immediately place a judgment on a public record without filing a lawsuit. Once the owner signs a confession of judgment, they have admitted liability and the lender can bypass filing a lawsuit and immediately try to enforce the judgment against the signing party. While confession of judgments are less frequently used in MCA deals after New York amended CPLR 3218 to prohibit confessions of judgment against non-residents, these can still occasionally be used by unscrupulous lenders.
Settle Your Lawsuit for a Reduced Amount
So what about settling once the suit is filed? While it may seem like they’re doing their best to take everything, an MCA lender does not necessarily have to collect the full balance amount. An MCA lender may be willing to settle your lawsuit for a reduced amount, even after it has been filed. However, in most cases, an MCA lender can only begin this process after an MCA loan is in default. They may even require you to provide them with financial records to prove that you are in some kind of financial hardship. While some MCA lenders are only interested in a lump sum payment in exchange for a discounted payoff, a payment plan may also be possible.
Fight the MCA Lawsuit
Settling is not the only route, though. A business does not have to accept a settlement offer from the MCA funder. Instead, it can take the issue to state court and fight the MCA lawsuit. An attorney who has experience with MCAs will carefully review the language of the agreement and the claims it asserts in order to build a defense. Depending on the situation, an owner may have an argument against the validity of the MCA agreement and be able to fight the MCA funder’s claims. That is much easier when an agreement is found to be a loan, rather than a purchase of future receivables. New York courts apply a three-factor test to determine if an agreement is a loan or purchase of receivables: (1) the existence of a reconciliation provision; (2) a finite term; and (3) the funder’s recourse if the merchant goes bankrupt. (Principis Capital, LLC v. I Do, Inc., 2d Dept. 2022.) However, today, MCA funders write their agreements to satisfy that test, which makes them much harder to challenge. For many owners, fighting the case only delays the inevitable: a judgment against them and their business.
Bankruptcy Is the Third Option
Bankruptcy is the third option. Chapter 7, or liquidation, can be filed either by the business or individually by the owner since business owners often personally guarantee MCA debt. It is usually used when the business is closing. A personal Chapter 7 bankruptcy filed by the business owner stays all collection, including any lawsuit by the MCA, and also discharges the personal debt guaranteed by the owner, including his or her guarantee of the MCA. This allows the business owner a fresh financial start. A corporate Chapter 7 stays the business’s MCA lawsuits but does not discharge the owner’s debt. A corporate Chapter 7 is not always necessary when closing a business, although it can be helpful to keep litigation or enforcement of a judgment against the business on hold. For a lot of owners whose business is closing down, the best way out is a Chapter 7 bankruptcy. It discharges their personal liabilities, including any personal guarantees on their merchant cash advances (MCA), and allows them a financial fresh start. Then they can restore their credit and if they choose, get back in the business.
If you want to keep the doors open, Subchapter V of Chapter 11 may be available to you. It is typically more expensive than Chapter 7 and should be considered if the business is viable or has some value. Subchapter V reduces the complexity and costs of a Chapter 11 bankruptcy for a small business. Qualifying requires that total secured and unsecured debts of the business are $7,500,000 or less. Subchapter V provides an opportunity for the business to restructure its debt in an attempt to save the business, however, there is no guarantee. Less than 50% of Subchapter V cases have had a plan confirmed, and an even smaller percentage have actually completed their plan.
So, can you negotiate with an MCA after being sued? Yes. What does that look like in practice? You can ask for a discounted payoff or a structured settlement plan. This is typically available after the account is in default and you provide documentation of financial hardship. If settlement is not a good option, can you defend the lawsuit? Yes. You can defend the lawsuit in state court by hiring an attorney to fight the funder’s claims. MCA funders write their contracts to withstand those legal challenges. Are there bankruptcy options? You can consider a Chapter 7 or a Subchapter V bankruptcy. Each of these paths has a cost, and the right one depends on whether your business can still be saved.
