If your business is drowning in merchant cash advance debits, you have probably heard the advice already: stop paying, hold funds in escrow, and let the negotiator handle it. All or nothing, quit and settle. It is a lot of pressure and unfortunately, there is a strategy out there that carries serious risks.
Stop paying your MCA funder to settle, right? Not necessarily. It’s not a requirement, but most settlement programs rely on it to get the job done. In practice, many people choose to stop payments, bank the savings, and negotiate settlements that way. Of course, you aren’t obligated to take that path. If you’re considering this strategy, understanding the potential implications is crucial.
Debt Settlement Company
When a debt settlement company pitches you, they harp on the fact that they can cut your payments in half. They’ll tell you to make one payment into an escrow account and they’ll settle the balances for less than owed. It sounds like a walk in the park, doesn’t it? Unless it’s in the fine print, the upfront fees are either misrepresented or ‘included in your monthly estimate’. Their savings estimates are usually rosier than the results, it’s all just to get you to sign on the dotted line. Some business owners hear that offer and rush to take it, thinking there is nothing to lose. That’s not always the case, though.
Here is how it often goes. A business owner decides to hire a settlement company, quits paying the funders, and the next thing they know the bank accounts and receivables are frozen up. They don’t have a dime to run the company with. So they call the settlement company and discover that they’ve made no progress whatsoever. The company’s real interest is its fees, and the owner is forced to let the settlement company go. After firing the settlement company, the owner tries to get back the fees paid, but they’re out of luck. The business is now in worse shape than before the owner hired the settlement company in the first place.
What a Funder Can Do Once the Money Stops
To see why, look at what a funder can do once the money stops. Most MCA funders will file a UCC lien against you if you stop paying. You signed away those lien rights when you took the advance. This can be worse than a judgment or a confession of judgment (COJ), since a COJ will let a funder freeze a bank account, but a UCC lien will let a funder freeze receivables before they even hit the bank account.
Your funder likely has your bank statements, customer list and trade references from underwriting. Within a day or two of filing the UCC lien, they’ll copy that list of people and companies that pay you, and they’ll send each person a letter telling them not to pay you anymore, but to pay them instead. The letters go to customers and merchant processors like Square and PayPal and Shopify and all credit card payment terminals. It’s an extremely embarrassing way to try to get a debtor to pay a debt. Not only that, but if you don’t start getting money from your customers you have no way to operate your business. And many of them may see the situation as a sign of weakness and pull up stakes and leave.
If you signed a confession of judgment, geography matters. A law change in New York means a COJ cannot be filed against an out-of-state business owner anymore. It can still be filed against owners living in New York, though, and the change doesn’t affect other states. Funders have started filing COJs in Pennsylvania, Illinois, and Utah, and those states have seen an increase in filings.
Calling a stop payment on an MCA can backfire big time. First, the contract typically imposes an insufficient fund fee, usually about $35, for each bounced debit. Then the MCA contract probably has a clause for a stop payment fee, which can be anything from $500 to $5,000. There may be additional fees for changing bank or merchant accounts, which might run anywhere from $100 to $2,500. You may also get a default fee of $2,500 to $5,000 or a third-party interference fee of $2,500 to $5,000. The balance continues to accumulate while you wait.
Litigation Can Be Defended
Lawsuits are the other likely result, and here the picture is better than most owners expect. Since New York changed its COJ law, more MCA lawsuits have been filed in New York. Litigation can be defended, and defending it gives you time to either work out a payment plan or discounted settlement. Even if you have no money for either, fighting the lawsuit can buy some time and may prevent the judgment.
A true MCA is not a loan. It is the purchase of receivables. The money is repaid over time as money comes in to the merchant account. If no money comes in, there is nothing for the funder to collect. A loan must be repaid absolutely. (Contracts do protect the funder if you close the account on purpose to avoid paying.) If there is a personal guarantee or confession of judgment involved, it could be construed as a loan. A NY court in Pearl Capital v RDN Construction in 2016 decided that when a personal guarantee was used, repayment was not contingent, so it was a loan, the interest rate was about 180%, and the contract was voided as usurious. Whether your own contracts hold up depends on how they were drafted.
If a broker arranged your funding, that matters too. Brokers make their money on the deal. If you don’t pay the funds back they don’t lose money so they don’t care. It is very common for brokers to stack the company with multiple funding advances from different funders, sometimes all at once. They can tell you that after the first month’s repayment they will get you a traditional loan, which will never happen. In a lawsuit, those misrepresentations can support claims against the broker.
Bankruptcy is another path some owners weigh. The problem with an MCA is that many have a personal guarantee. If the owner files personal bankruptcy, that obligation is discharged but the company’s liability stays. Now, the funder can still come after any collateral they have. A business filing raises the question of whether the company can keep operating day to day. That depends on many things including the type of business, the entity type, assets, payables, amount owed, cash flow etc.
So does settlement require you to stop paying the funder? No rule says it does, but most programs are built on it. Please understand that debt settlement can be wonderful for some business owners and a horrible idea for others. You really can’t know whether it’s the right thing to do for you without knowing how the settlement will affect you. Ask any settlement company what happens to your receivables and bank account once you stop paying, before you sign.
