If you are a small business owner who took out a merchant cash advance (MCA), you know how aggressive debt collection can get. It is normal to look for the rules that govern it and see what the law says. If you do that search, you are probably going to run across the Fair Debt Collection Practices Act (FDCPA) first. That is a reasonable place to start, but it is probably not where your answer is. Debt collection laws can be complicated, and there are many different types of laws that might apply to your situation depending on the type of debt. You will also hear that the FDCPA is a “consumer protection statute,” which is a way of saying it was built around everyday people trying to manage their households and personal loans, not businesses dealing with capital or receivables. A merchant cash advance is a commercial deal, and some of the strongest protections consumers have simply do not reach the agreements business owners sign.
A Purchase of Future Receivables
To see why, look at how these deals are built. Merchant cash advances are notorious for very high fees, often above the limits set by usury laws. Cash advance companies insist they are exempt from state usury and licensing restrictions because the transaction is not a loan but a purchase of future receivables. In their telling, because their fee is paid to buy a percentage of that revenue, it isn’t interest and it is not regulated by state usury laws. The fine line between being a creditor and being a supplier can be blurred. Contracts with different lenders vary, and those that were written with the “sale of future receipts vs. loans” distinction in mind have held up well against lawsuits by borrowers. From the funder’s side, the lesson is simple. In short, an MCA agreement must avoid even the suggestion of a lender-borrower relationship. It is clear, in our experience, that this distinction matters. So the big question is whether you should believe the companies saying they are not regulated creditors at all.
Confession of Judgment
Then there is the confession of judgment, a clause that many MCA companies require you to sign. A confession of judgment (COJ) is a legal document you sign that authorizes another person to use it to obtain a judgment against you. In simpler terms, a COJ is a pre-approved judgment. Basically, you waive a whole bunch of your legal rights by signing the contract. Like having a trial. Or the ability to contest the lawsuit in court. In short, you’re giving up a lot. Normally, you have the right to get a copy of any impending case filed against you and in that case, you have the right to defend yourself. With a confession of judgment, you have waived your right to due process, and if you don’t repay the MCA, they can seize the assets in your business to pay off the debt. It’s extremely powerful. And for an MCA provider, it’s essential. Without a confession of judgment, an MCA provider would have to file a lawsuit to enforce a debt. They might win the judgment, but they would also have to bear the cost of a lawsuit and risk you being insolvent by the time the trial occurred. Companies prefer them because it saves time if you don’t pay.
Here is the part that matters for anyone hoping consumer law will step in. A confession of judgment is prohibited in consumer contracts, but it is still legal in commercial deals. The truth is, if an MCA company tries to seize your assets based on a confession of judgment, you may not have many defenses against their claim.
Bloomberg News, which published a run of articles on the industry, also reported that some MCA companies rely on forged paperwork, lie about how much you owe them, or start seizing your money even when you haven’t missed any payments. It is fair to ask: How can this even be legal? Who do I complain to? You see, there’s a phenomenon in business and life called “profitable immorality.” In other words, just because something is wrong (scooping up small businesses’ hard-earned revenue, for example) doesn’t mean it can’t be profitable.
Not all merchant cash advance products are issued out of New York or to New York companies but the Empire State became the contract home of choice because it was easy to obtain a confession of judgment in New York courts. Since 2012, merchant cash advance companies have received more than 25,000 judgments against businesses in New York for an estimated $1.5 billion, according to Bloomberg. Many of the judgments were won in a few courts in upstate New York.
The publicity drew a response. The attorney general for New York state, Barbara Underwood, who held the office at the time, initiated an inquiry into possible abuses by the industry and put a subpoena on one of the largest merchant cash advance providers in the country. “If a company is engaging in fraudulent and deceptive conduct, we want to know,” she told Bloomberg. New York legislators were also reported to be reviewing the laws that allow predatory lending. On Dec. 6, 2018, Senators Sherrod Brown (D-OH) and Marco Rubio (R-FL) introduced the Small Business Lending Fairness Act, which would expand the Federal Trade Commission’s ban on confession of judgment in consumer loan agreements to small-business borrowers. From New York to Washington, it seems the public outcry is finally making waves. It won’t happen overnight, but it shows that some people at the top of government understand that there may need to be a change in how the law handles MCA’s. The question is, what will they decide? Until a change actually covers your contract, assume the old rules apply.
Go Through Your Contract
So what should you do? If you have taken out an MCA, you should go through your contract and see if there is a confession of judgment clause. Most businesses rush through the contract, signing it without clearly understanding the agreement. Now is the time to read it properly. Take it apart word by word, clause by clause. Go over the definitions, the length of the term, how the payback works, and any explanatory notes within the contract itself. Pay particular attention to the section outlining the recourse the financier has if you breach the terms. Look at whether the deal is written as a purchase of future receipts, because that is how the funder will defend its fees. If the MCA company you are dealing with is taking aggressive action, you may have to move quickly to try to stop it. If you haven’t paid back the advance and are worried about what’s to come, you should consult with an attorney. They should be able to review the MCA agreement and help you assess the risks. A settlement firm can also talk to the funder for you. Depending on how you handle it, the company may want to negotiate instead of going to court.
For small business owners who face debt collection after receiving a merchant cash advance, the problem of aggressive collection practices is real. But the chances that consumer law will be a reliable ally to you are not that great. When you are the borrower, you are at a disadvantage. Still, knowing where the real leverage sits, in the contract and the confession of judgment rather than in the FDCPA, puts you in a much better position to protect what you have built.
