If your struggling business can’t get a normal bank loan, you can get a merchant cash advance to survive. When you get the funding for the first time it can look so good. Now, you’ve got some money in the bank. But then, suddenly, your bank account is melting away. MCAs are really expensive, so you may end up taking out new ones just to pay off the old ones. That is known as a snowball effect and many businesses find themselves caught in this trap without realizing it. Having a tangled mess of MCAs is a stressful situation. Worst of all, when your cash is being drained faster than you can replenish it, how do you expect to grow your business? You are also in crowded company: MCAs are defaulted on a lot—between 20% and 30% of the time. Three advances is a hard place to be, but you do have options, and choosing among them starts with understanding what you signed.
Merchant Cash Advance
An MCA is a type of funding where a funder offers you cash up front in exchange for a slice of your future revenue or payments. The MCA company then gets paid back by either withholding a fixed percent of your daily sales or by directly pulling a daily or weekly estimate of your monthly revenue from your business bank account. MCAs can quickly take all your incoming sales and profits, making it extremely challenging for a small business to operate and stay afloat. Merchant cash advance providers claim that they aren’t making a loan, they are instead investing in your business or buying a receivable. That label matters. Since it’s not a loan, a merchant can’t use the same defenses that would normally be available to a borrower.
Not everyone accepts the label. On March 5, 2024, New York Attorney General Letitia James filed a lawsuit against Yellowstone Capital, Delta Bridge Funding, and several other individuals, accusing them of using deceptive loans to defraud small businesses at extremely high interest rates under the guise of merchant cash advances. The Attorney General seeks a minimum of $1.4 billion in interest and fees paid by small businesses and an injunction to halt the alleged illegal activities.
With three advances you have three contracts, and each is worth reading for three things. The first is a personal guarantee. A personal guarantee is when you promise to pay back a loan personally if the business can’t. It’s a requirement for lenders because they see the small business as too risky otherwise. If the loan defaults the lender can sue the guarantor personally, and may come after personal assets to settle the debt. The second is a confession of judgment. A confession of judgment is when a lender sticks a court judgment in the public record without suing you, because you signed a document admitting you owe money; the lender skips the lawsuit and heads straight to collection. These clauses are less common now because New York changed CPLR 3218 to prevent them against out-of-state borrowers, but some dishonest lenders still use them. The third is a UCC lien. A UCC lien is the lender’s legal claim to specific assets that back up the loan (often business bank accounts), giving the lender the right to seize those assets if you default.
Try to Settle, Fight the Lawsuit in Court
Let’s say that an MCA lender sued your business and you want relief from the debt. You have several options: try to settle, fight the lawsuit in court, or file bankruptcy.
Start with settlement. You may be able to settle for less than the entire amount. To qualify, the advance is likely in default, and you may be required to provide proof of financial hardship. The lender may also want to see a lump sum payment in return for accepting a lower payoff. It may be possible, however, to set up a payment plan. With three advances, that conversation happens with each funder. You may be able to negotiate with them directly or you may want to do this through a third party debt negotiator.
What if you can’t negotiate a settlement? Well, a business can fight the MCA default in state court. A good lawyer will study the agreement to analyze the funder’s claims and plan a defense. Depending on the situation, a business owner can also argue that the contract is invalid and that the funder isn’t entitled to demand payment. It’s easier to do this if the contract is characterized as a loan rather than a deal to buy future receivables. New York courts will look at three things to determine if a merchant cash advance is a loan or a purchase of receivables: (1) does the agreement have a reconciliation clause, (2) does the agreement have a finite duration, and (3) does the funder have any recourse in the event that the merchant goes bankrupt. MCA lenders now write their agreements to meet this test, which will make challenging the MCA agreements much more difficult. In many cases, fighting these agreements just means delaying the inevitable (which is usually a judgment against the merchant and his or her business).
Bankruptcy
That leaves bankruptcy. Chapter 7, also known as liquidation, can be used for either the business or the owner, because owners typically personally guarantee MCA debt. It’s usually used when the owner is shutting down the business. A personal Chapter 7 filing stops all collection efforts, including MCA lawsuits, and can eliminate the owner’s personally guaranteed debts, including MCA guarantees, providing a fresh start financially. A filing by the business itself is different. For corporations, Chapter 7 stops collection against the company and MCA lawsuits, but it doesn’t erase the owner’s liability later. You don’t always need it when shutting down, but it can be helpful to block lawsuits or the enforcement of judgments against the business. Often the owner’s best choice is a personal Chapter 7: wipe out the debts, get a fresh start, rebuild credit, and perhaps start a new business.
If you absolutely want to hold onto your company, you could look at Subchapter V of Chapter 11. It costs more than a Chapter 7 liquidation, so it’s only a good idea if your business is still viable or otherwise valuable. Subchapter V simplifies Chapter 11 and reduces costs for small businesses. You are eligible only if your secured and unsecured debts total less than or equal to $7,500,000. It may allow you to restructure your debts, but it’s not a guarantee: the confirmation rate is under 50%, and fewer businesses ultimately manage to complete their reorganization plans.
So which road is yours? It depends on whether the business is still viable, whether you want to keep it or close it, and on what your three contracts actually say. Gather the agreements, look for the guarantees, confessions of judgment and liens, and get advice before the next lawsuit arrives rather than after.
