With an MCA it’s easy to think that you can miss a few payments and go unnoticed, but that isn’t how it works. Most owners ask how many payments they can skip before the funder sues them. In most cases the answer is none. The day you miss a payment is the day you default. Once there’s no longer enough cash in your account to cover the funder’s payment you’re automatically in default. You’re then required to immediately repay the whole debt. That is why, at Delancey Street, we tell owners the number to watch is not missed payments before a lawsuit. It is the first one.
A Merchant Cash Advance (MCA) is what happens when a funder buys your future accounts receivable in exchange for a lump sum. You, as the owner, can use that lump sum however you would use a short-term loan. Think of it like a payday loan for businesses: a small amount of money in exchange for future earnings. A payday loan is repaid out of your next paycheck, and an MCA is repaid through daily withdrawals from your business bank account.
Daily payments can be tough for some business models, like contractors. Contractors get paid at intervals, sometimes 30 to 60 days after a job is done. They do not have daily income, so daily withdrawals can put even a successful business under severe financial strain. Funders tend to have very little sympathy, even if the business has enough future receivables to pay off the entire debt.
Dodd-Frank Act
So why do so many owners end up in MCAs? After the 2008 recession, Congress passed the Dodd-Frank Act in 2010. It was intended to prevent risky lending and protect American families. It created the Consumer Financial Protection Bureau in order to keep mortgage companies and payday lenders from exploiting consumers. It made lending safer in a lot of ways. Unfortunately, its ripple effect opened the door to a new kind of exploitation.
Small businesses often can’t get the commercial and industrial (C&I) loans that big companies take for granted. A 2018 working paper from the National Bureau of Economic Research looked at why lending to small businesses fell after Dodd-Frank. The paper by Michael Bord and John Duca found that the share of C&I loans issued as small loans by large banks was down 9 percentage points since 2010, and it dropped twice as much at small banks. The cost of compliance makes small loans unattractive to banks. But small businesses still need the short-term debt, so many turn to alternative funders instead, who aren’t regulated by Dodd-Frank. That is the gap the merchant cash advance grew into.
Whether an MCA Is a Loan or Not
Funders don’t call an MCA a loan. They say they’ve bought your future receivables. Under the law, that advance may not be considered a loan, so it may not be treated like a loan in a Chapter 11 bankruptcy, and that label affects who gets paid and how much. The battle over whether an MCA is a loan or not is not only semantics.
In September of 2021, the case of CapCall LLC v. Foster, In re Shoot the Moon LLC landed before the U.S. Bankruptcy Court in Montana. CapCall is an MCA funder out of New York that asked the court to declare that it owned $228,449.93 in segregated funds from the bankrupt company’s estate. If the court agreed, CapCall would be allowed to jump ahead of the bankruptcy trustee. The trustee had already sold off almost all of the business’s assets for an amount that was much smaller than the amount owed to several secured creditors senior to CapCall. If CapCall won, it would be paid before any of them.
The case hinged on a single question: were the deals between CapCall and Shoot the Moon sales or loans? CapCall said they were sales, but the trustee Foster said they were loans. If they were sales, CapCall owned the receivables outright and would be paid first. But if they were loans, CapCall only held a security interest, which meant it was behind the other creditors.
You’ve probably heard that if it looks like a duck, swims like a duck and quacks like a duck, it probably is a duck. The court applied this principle, examining CapCall’s paper claims that the deals were in fact sales and comparing it to the reality on the ground, asking does it look like a loan, read like a loan, act like a loan. Judge Whitman L. Holt concluded the agreement was too close to being a loan to be a true sale. CapCall also broke Montana’s usury laws, which protect against predatory interest rates. CapCall had no ownership of the estate.
So, this ruling put a crack in the way MCAs are viewed under the law. One case will not, however, bring wholesale change to the MCA industry. But this is the first legal victory for people injured by MCAs, and it’s worth watching how this area of law develops as more small businesses feel recession pain and get steered toward MCAs.
You might wonder why a Montana bankruptcy case matters to you, especially when you’re behind on your Merchant Cash Advance payments. The funder’s entire case hangs on a single word: they say it’s a sale, you sold them your receivables. The court saw through that, though, and looked at how the deal actually worked. Still, whether yours is a loan is a question for an attorney, not a guess.
Debt Settlement Company
Don’t wait for the default to happen. You can contact a debt settlement company before your account runs dry. At Delancey Street, our senior advisors negotiate with funders on your behalf to reduce the balance below the full amount owed. They don’t give you another loan. Our firm was founded by an attorney and former merchant cash advance industry executives. We are not a law firm. If a lawsuit or a bankruptcy is the right call, we refer you to an independent attorney. If you can’t make a payment to your funder right now, you better figure out what to do today or tomorrow, don’t put it off to later.
