How can a senior lender use a UCC Article 9 sale to wipe out MCA debt?

A sale under UCC article 9 can mean life or death to a small business. Such a sale, through Article 9 of the Uniform Commercial Code, is an often overlooked solution that a senior secured party can offer. For a struggling business with MCA debt, UCC Article 9 can be a better solution to full shut down. A UCC sale gives secured lenders the flexibility to cut a deal.

Collateral Damage

The direct effect of a merchant cash advance on a company’s operating accounts can come as a surprise. MCAs can suck up cash directly from operating bank accounts. No intercreditor agreement is necessary to do so. Perfected collateral is effectively unsecured. If your senior lender has an intercreditor agreement, forget it. If your priority list is in place, forget that, too. The MCA goes around it. A senior lender was never supposed to agree to these advances.

The collateral damage from the MCAs is on two levels. A merchant cash advance can sweep an operating account clean without a court order even from a junior position. When that happens, the business can stop. A stopped business is worth only half to a tenth of a running one. For asset-based lenders (ABLs) and non-notification factors, the receivables are going first, leaving other lenders second in line. The damage will reliably extend to the rest of the collateral base.

At early signs of trouble, a merchant cash advance may write to the borrower’s customers or clients directly asking them to remit payment to MCA. These notices are called 406 Notices after UCC Article 9-406. A merchant cash advance is simply the purchase of future revenue. It grabs pledged or factored receivables. There are no courts, judges or clerks. Often, there are not even lawyers. The customers will simply pay the MCA or freeze the funds. Regardless of whether the customers actually pay the MCA or freeze its funds, either action can cripple the business and the senior relationship.

An MCA is not a loan, so lender rules don’t apply. Lawmakers are still far behind the MCA industry. MCAs will continue to creep into lenders’ problem loans. Don’t count on regulation.

Lenders cannot stop their clients from taking MCAs. Suing the MCA sounds good, but it is impractical, will cost too much and take too long. Any business with MCAs will likely fail before a court rules in its favor.

Businesses are only taking Merchant Cash Advances when they have to. When no other financing is available. When everything else has failed. At that moment in time, the borrowers are insolvent, and the MCA is their last resort.

The MCAs Are Wiped Away

When an insolvent company can’t handle its debt any other way, it can use a UCC Article 9 short sale to remain open for business and have all subordinated debt washed away. Article 9 does not mean shut down or liquidation.

Few people know the Article 9 option even exists. They should. Borrowers and lenders would do well to consider it. Owners turn to CPAs, lawyers, and turnaround professionals when they are troubled. These are the professionals who should be offering the Article 9 option.

In an Article 9 sale, the senior creditor may sell the collateral by private sale without court.

The assets of a running business get sold to a buyer who keeps the business running.

In a UCC Article 9 sale, the title to the property passes free of all subordinate liens.

Once the sale is closed, the MCAs are wiped away. The business, jobs, and enterprise value move with it to the new owners in a new company, with no subordinate debt.

A Real Fresh Start for All

For the debtor, not filing bankruptcy means survival of the company and its employees. The owners could work for the new company or serve as a consultant, which would let them draw some money from it. The income can be devoted to settling personal guaranties. They will cooperate with the senior lender because they get the whole problem solved, not just one part of it.

Meanwhile, the senior lender gets its collateral out of the path of the daily or weekly withdrawals and account sweeps of lower-ranking MCAs. The new company gets a fresh start, and their whole asset base is unencumbered and can be financed in first position. It’s a real fresh start for all.

For factoring and asset-based lenders whose clients or collateral are in danger of a MCA, an Article 9 reorganization may be an option to consider when looking for the quickest, cleanest way to remove business distress.