An MCA lender might offer a settlement of the advance – paying less than the full balance – before you file bankruptcy. So, can you? Let’s be clear: yes, you can settle your MCA debt before bankruptcy. It is not automatic, and the advance will typically have to be in default before a funder will talk. However, this usually requires giving the lender certain financial documents to prove you’re struggling. You’ll also have to make a lump sum payment at a discount or agree to a payment plan.
Merchant Cash Advance
To see why this is worth trying, it helps to know what you are dealing with. No one sets out to say, “I’m going to secure an MCA!” Small businesses often don’t qualify for bank loans, so when they are struggling and need a cash infusion, they have no choice but to turn to a merchant cash advance. An MCA funder will pay you for a percentage of your future sales. The MCA funder will debit your bank account daily or weekly to ensure it is paid. They will file a UCC lien on your business’s property. They will usually obtain a personal guarantee. They may also obtain a confession of judgment. Funders will obtain repayment from their clients by one of two methods: a percentage of each day’s sales, or a calculation based on an estimate of a business’s total sales for the month withdrawn from the business’s bank account. In either case, a company’s receivables and income are often exhausted by the payments.
That personal guarantee is the part that should worry you most. Small businesses are particularly likely to see personal guarantees demanded by lenders, as the businesses are typically viewed as risky. If the business can’t pay, the person who signed one is personally liable. The funder can take legal action against the owner to collect. Your personal bank accounts and assets are not protected.
A confession of judgment is worse still. When you sign one, you are admitting liability in advance, which means the lender can go straight to a judgment without a lawsuit. They are less common these days, since New York amended CPLR § 3218 to prohibit judgments by confession for out of state defendants, but unscrupulous funders still use them.
Another problem is the rates are insane, meaning business owners have to take new loans to repay old ones. They never seem to get out of debt. The default rate of MCAs is estimated at 20% to 30%. MCAs are not loans, according to the funder. The funder buys future receivables from the borrower and the borrower loses the benefit of many defenses. Regulators have noticed. On March 5, 2024, the New York Attorney General filed suit against Yellowstone Capital and Delta Bridge Funding alleging fraudulent loans masquerading as MCAs, and demanding recovery of at least $1.4 billion.
I would love to be able to tell you that putting an MCA advance to rest is simple. As you can tell, it isn’t.
How a Settlement Usually Works
Here is how a settlement usually works. With most funders, they will want the advance to be in default before it talks. They won’t want to talk until you provide the funder with financial information. They will want this information to prove you are unable to meet your obligations. Then you will have to make a payment. You can make a lump sum payment at a discount, or you can agree to a payment plan. While all of this is straightforward enough, it means you are telling the funder that you have financial trouble and need to settle. You will need to provide supporting documents to prove that. There may be a negotiation period where the funder wants more proof than you want to give.
If the Funder Won’t Settle
If the funder won’t settle, you still have two roads. You can defend the lawsuit in state court. At a minimum, a lawyer should review the agreement to develop a defense. It’s much easier if the agreement is actually a loan, not a purchase of receivables. New York courts apply a three-part test. They consider: (1) whether there is a “reconciliation provision,” (2) whether the agreement has a “finite term,” and (3) whether the funder has “recourse” if the merchant declares bankruptcy. The trouble is that funders know this test as well as anyone, and they have been getting around it by making sure that any provisions that make their agreement look like a loan are carefully omitted. The result is that new agreements don’t create a strong defense. Fighting the lawsuit usually does not accomplish much other than delay a judgment.
The second road is bankruptcy. Chapter 7, often called liquidation, is usually the choice when an owner is closing the business, and it can be filed for the business, for the owner personally, or both. Filed personally, a Chapter 7 bankruptcy stops all collections, including the MCA lawsuit, and discharges your personal guarantee. A corporate Chapter 7 stops the MCA lawsuits against the business but does not discharge the owner’s debt. A Chapter 7 for the business won’t touch the personal guarantee, and that’s a critical distinction. A corporate filing can still help if you need to halt litigation or the enforcement of a judgment against the business. For a lot of owners, though, the personal filing is the best way out. Once the debts are discharged, they get a fresh financial start, can rebuild their credit and, if they want, try a new venture later.
What if you want to stay in business and even save it? A Chapter 11 case under Subchapter V allows a viable business to restructure. It’s more expensive than a Chapter 7. It is limited to businesses with debts of $7,500,000 or less. Subchapter V was created to simplify Chapter 11 and give small businesses a flexible alternative for reorganization. It is no guarantee, though. Less than half of Subchapter V cases are confirmed. Fewer still see their plans through.
If you can settle for less than what you owe, why fight or file? But it isn’t that simple. There will always be an amount that is better than nothing. The trick is how much money you have, how much the funder will settle for, whether the advance is in default, what documents you are willing to share and, of course, what deal you think you can get.
So yes, try to settle first. Just know that a settlement before bankruptcy may or may not be the best option, and that if talks fail, bankruptcy is still there. In the end, your individual circumstances should drive your decisions.
