It’s Monday morning and your bank account is empty. Again. The last merchant cash advance payment got pulled out at 7 a.m., and your sales have tanked. You’re wondering if there’s any legal way to stop the payments or at least slow them down. There are a few, but not as many as you’d like. It depends entirely on the contract you signed and whether a judge views the deal as a true sale or a loan. That’s the starting point.
When you get an MCA deal, think of it this way: you’re selling your future income today. You get a lump sum, and the lender takes a share of every credit card sale you make until the debt is paid off, plus their fee. Or the funds come out of your bank account every day or week. It’s like a payday loan, but for your business. The usual terms are six to twelve months, and by the time you’re done, you’ve paid a lot more than you borrowed.
Merchant Cash Advances can be extraordinarily expensive compared to loans or lines of credit. The fee varies by how much risk the MCA company sees in your business, and most run a factor rate of between 1.2 and 1.5. In some cases, that could translate into an annual interest rate of as much as 200% of the amount you received as an advance. That means that if you took a $10,000 advance you would have to pay back $12,000 to $15,000. Many businesses fall into the trap of taking out new advances just to pay off the ones that came before, and end up buried in debt.
A True Sale of Receivables or a Loan
The one important legal question to ask when challenging MCA payments is whether the advance is a true sale of receivables or a loan secured by and paid from future receivables. That distinction determines whether usury laws apply, whether the MCA company is a secured creditor, and whether payments can be reclaimed as preferential or fraudulent transfers in bankruptcy.
When your business starts missing payments, your first stop should be your MCA agreement, and not for the usual reasons. There’s a little-known section called the reconciliation provision. It lets you downsize your daily payments to match your daily sales if they’ve gone south. Many courts use this clause to say your purchase wasn’t a loan in the first place, but this part gives you a lifeline if your revenues have tanked. Make sure it’s there, and make sure it works the way it’s supposed to.
If you took an MCA advance, check the contract to see which state’s law governs. Recent cases have been coming down out of New York state courts, and the trial courts there have largely ruled that MCAs are not loans but rather sales of future receivables. MCA providers know this, and you’ll find a lot of them tucking a choice of law provision into their contracts referencing New York.
Courts look at a few things to decide if it’s a true sale, like
- whether the advance has a reconciliation clause,
- whether the contract is for an indefinite term (since the future receivables are contingent),
- whether the provider has recourse in case the merchant goes out of business or declares bankruptcy,
- whether the provider requires the filing of a UCC-1 financing statement,
- and whether the provider asks for a personal guaranty.
At the end of the day, it all comes down to whether the investor is depending on the company’s future success to get its money back. If the investor’s chance of getting repaid is tied to the company’s future sales, so that the investor is assuming the risk that it might not get paid, then the court is more likely to rule the transaction is a true sale rather than a loan. That’s true even if the investor filed a UCC-1 or obtained a personal guaranty, so long as the personal guaranty is no broader than the company’s obligations (i.e., the owner doesn’t have to pay if the company has no future income).
Some California courts have looked past the form of the deal and found that a purchase-sell arrangement was, in fact, a loan in disguise. A court could look at the purpose of the transaction. Where that purpose is to lend money at a usurious rate of interest, those courts treat the deal as a loan, not a sale. Most state and federal courts haven’t decided the issue one way or the other, but may weigh similar factors when determining the validity of a loan. So while a usury and predatory lending defense can and will be raised by a merchant in a lawsuit by an MCA provider, it’s likely to fail. In other words, don’t count on the usury argument to stop your payments.
Ordinary Course Payments
What about bankruptcy? The question there is usually whether the payments you made to the funder were preferential transfers that can be clawed back. Bankruptcy law has a built-in exception for ordinary course payments, found in section 547(c)(2) of the Bankruptcy Code. If the debtor has been using MCAs for a while, and the payments have been regular, then courts are going to say it’s ordinary course. Debtors and trustees have had little luck recovering MCA payments. But one case went the other way. The bankruptcy court ruled the payments weren’t ordinary course because the relationship between the debtor and the provider had only existed for two and a half months. There was no established routine, and deals were only made when the debtor was in desperate need of cash. If your history is short and the pressure is high, that can be your best argument.
What You Should Do
Let me sum up what you should do.
- First, look at your contract for a reconciliation clause. If it’s there, demand your advance payments be adjusted to match what you actually brought in.
- Second, check the choice-of-law clause to see which state’s rules you’re dealing with.
- Third, understand that usury and disguised-loan claims aren’t likely to help you, particularly if your contract says New York law applies.
- Fourth, don’t count on bankruptcy to save you from the MCA payments you’ve already made.
- Finally, don’t jump into a new advance just to cover the old one. Look at your options and get the right advice before you make your next move.
