Maybe you’ve been paying for months - maybe a year - and the more you paid, the more you owed. Now, you’re drowning, and you’re worried about going under. You took a merchant cash advance, and it didn’t save your company. It only bought you time, and you can’t pay it back. You’re stressed, and you need help. So, what do you do?
The short answer is yes. When a business files for Chapter 11, the automatic stay goes into effect. And with that comes a halt to merchant cash advance payments. However, it’s a bit more complicated than that. To see why, it helps to start with what you actually signed.
A Merchant Cash Advance Isn’t a Loan
A merchant cash advance isn’t a loan, even though the people who sell them often call it one. It’s an advance on future receivables. You receive cash upfront, and in exchange the MCA provider gets a percentage of your future sales. The money comes straight out of your bank account every day or week, or straight out of your credit card receivables. Those rules, regulations and protections that cover normal business loans usually don’t apply.
When they’re promoted, they’re pitched as a miracle solution: fast money, no collateral, paperwork you can do in your head. If you’re drowning, it sounds like salvation. But it’s a wolf in sheep’s clothing. If something feels too good to be true, run.
It’s priced in a factor rate, not an interest rate, so it’s hard to tell what the real cost of the money is. But you can bet it’s a lot. A factor rate is just a number you multiply against your advance amount to figure out how much you’ll pay back, and it’s usually between 1.1 and 1.5 or higher. That means for a $100,000 advance you’ll have to pay back anywhere from $110,000 to $150,000, depending on your contract. The APR could be 70% to 400%. On top of that, there may be an origination fee and administrative fees and any number of other hidden costs that make it even more expensive.
A lot of businesses run into a rough patch and take an MCA just to get some cash in the door quickly. The payments are so high that things get even tighter, so they take a second one to cover the first, then a third to cover the second, and so on. Pretty soon they’re drowning in debt and can barely make the payments anymore. A lot of owners tell me later, “It was the worst decision I ever made.”
The Automatic Stay
One thing happens when a business stops paying the Merchant Cash Advance: the MCA companies start sending restraint letters to all the customers. Your customers are now being told to send all their payments to the MCA, and not to you. In addition, the MCA sends restraint notices to credit card processors. You just lost your main sources of cash flow, and now you can’t cover basic expenses, even payroll, for your most valued employees. Your business is paralyzed.
This is where Chapter 11 comes in. When a business files for Chapter 11 bankruptcy (assuming it is eligible), it gets a nice quiet period called the automatic stay. It is allowed to stay in business while it reorganizes its debts. This is the purpose of Chapter 11. Small businesses may be eligible for a special Chapter 11 called Chapter 11 Subchapter V. All collection efforts, including the MCA’s daily withdrawals, threatening phone calls and restraint notices, immediately stop. After your business files for Chapter 11 the MCA is legally required to retract its restraint letters. The business is able to use its cash flow for operation instead of paying a gun for hire.
So the payments stop. But the debt itself does not simply disappear, and that is the part that is a bit more complicated. Chapter 11 gives the business a chance to come up with a reorganization plan to resolve all of its debt, not just the MCA. The business can emerge from the process in a better position than it was in when it started. A stay can give the business the breathing room it needs to make this happen.
If It Acts Like a Loan, It Is a Loan
A lot of businesses take on an MCA thinking it’s harmless, just a purchase of future receivables. But recent rulings, including a case in New York, are starting to show that courts are taking a hard look and saying the label doesn’t matter. If it acts like a loan, it is a loan. That opens the door to loan protection laws, and it can even mean the debt might not be allowed in bankruptcy court, giving you a chance to fight back.
For some businesses, negotiations with the MCA will do the trick. Many business owners are loath to file bankruptcy and spend a lot of money attempting to take other routes, which may prove to be a waste of time and money. Bankruptcy may be a more affordable option that can keep the business alive and allow it to rebuild. Speak with an MCA debt professional to see if bankruptcy is right for you.
