Merchant cash advances often require owners to personally guarantee them. If business takes a downturn, the owner may get concerned that the Funder will come after his or her personal assets, and ask whether the personal guarantee can be settled.
The honest answer is yes, in the sense that you can ask the funder to settle it and they can either agree or decline. But legally? It depends on the guarantee. Is it aligned with the business obligations, or does the personal guarantee make the business owner liable in case there’s not enough to pay for the MCA? How much the owner will have to pay off the guarantee depends on the wording of the guarantee itself. To understand personal guarantees, it is first necessary to discuss how an MCA works.
A Sale of a Business’s Future Receivables
The theory is that a merchant cash advance is not really a loan - it’s a sale of a business’s future receivables. Take Colonial Funding Network v. Epazz, a case in the U.S. District Court for the Southern District of New York. The merchant was making daily payments equal to 15 percent of its daily collected receivables, and it drew the payments out of a designated bank account. In the Colonial Funding decision, the Court held that a valid merchant cash advance is not a loan. It was the first federal case to do so. So if you think you are borrowing money when you sign up for an MCA, think again.
Why does the label matter? The only way interest can be considered “illegal” or “usurious” under New York law is if you have to give the money back, no matter what. The court says that here the funder’s right to get its money back depended on a key question: whether or not Epazz was still getting money from its customers. Payment of the revenue only comes when the receivables are collected.
The Epazz agreement also had a reconciliation clause. If a daily withdrawal came to more or less than 15 percent of what Epazz had actually collected that day, the funder had to credit or debit the difference. The funder’s obligation to reconcile its withdrawals to the bank statements and credit any overpayments was defeated if it received no bank statements from the merchant. If the merchant doesn’t supply bank statements, the funding company is allowed to just assume that it did everything right. The court stressed that it was Epazz, not the funder, that controlled whether the payments got reconciled.
Put those pieces together and you get a rough test. To prevent the agreement from being considered an illegal usurious loan, all repayment must come directly from the collected receivables, and the contract needs a provision to ensure payments match the amounts collected. The court contrasted an older New York case, Clever Ideas v. Restaurant Corp., where the contract also didn’t make the payments contingent on the receipts and had no reconciliation provision at all.
The Personal Guarantee
That brings us to the personal guarantee. In Platinum Rapid Funding Group v. VIP Limousine Services, a New York state court looked at the guaranty signed by the merchant’s principal owner. The court found that the fact that the owner had personally guaranteed the contract didn’t make it a loan. So long as that guarantee wasn’t any greater than what the business was obligated to pay and didn’t require the owner to pay any more than the business, it’s not a loan. Personal guarantees don’t automatically turn fundings into loans.
In Colonial Funding, the guarantor had to put the daily revenue in the account but didn’t have to top it off out of his own pocket. Topping it off would have been a loan. If the company’s income isn’t enough to pay for what is owed, the guarantor doesn’t have to contribute any money to fill in the gap.
So pull out your agreement. Look for a promise to cover a deficiency in your guarantee.
As long as the guarantee follows the merchant’s obligations, the owner’s personal liability follows the receivables sold, and the funder has assumed the risk of declining sales. Another New York court, in Merchant Cash & Capital v. Transfer International, said the funder takes on the risk that if your receipts come in low you’ll be paying him back over a longer time, and earning a lower return. That is worth knowing before you sit down with the funder.
If the guarantor has to come out of their personal pocket to pay the deficiency, the picture changes. That is the kind of term the Colonial Funding court said would have made the deal a loan, and only a loan can be usurious. At first blush, many of the points of distinction seem subjective and fact-bound. It’s a fine line between a merchant cash advance and a loan. Epazz stopped making deposits, was sued, and its usury counterclaim got tossed. Don’t assume a usury defense is going to prevail.
One More Practical Point
One more practical point. If you stop sending your bank statements to the funder, you won’t get your payments reconciled. Keep sending them - even when your receipts go down - and request reconciliation when it’s not automatically occurring.
Delancey Street is not a law firm. We are a business debt settlement company. We negotiate with funders on behalf of clients. Review your agreement with a lawyer to understand your obligations. Come here for a debt negotiation strategy, come to a lawyer to have a contract explained to you.
