Just because you signed a merchant cash advance agreement and failed to pay doesn’t mean you have no defense if you’re sued. One possible defense is that the cash advance isn’t really a sale of future receivables at all, but instead a disguised loan that is criminally usurious. That defense depends on the agreement’s specific terms. To see why, start with how these deals are built.
Contracts to Purchase Future Receipts
The criminal usury laws now have a hole in them wide enough to drive a Camry through, and funders who want to get a return above the criminal rate are filling that hole with their money. Or, more precisely, with the kind of contract they make to obtain the return. These are contracts to purchase future receipts, known as merchant cash advance agreements. The funder is supposed to be a purchaser of future receipts, and the merchant supposed to be a seller of future receipts. Not a lender, or borrower, as the case may be. The funder gives you money up front and gets it back (with a large fee) from your future receipts, electronically debited from your bank account. But the effective rate usually ends up being a lot higher than is permitted under our usury laws, which is probably why this type of financing arrangement doesn’t look or sound like a loan.
These types of agreements typically say that the provider is not a lender, agree in a vague way to reduce or forgive payments in the event of an inadequate flow of receipts (a reconciliation clause), and provide security for the payment obligations by obtaining a confession of judgment and personal guaranty from the merchant’s principal. No matter where the merchant is located, the agreements usually call for disputes to be litigated in New York, and as a result, the New York courts have had to consider many suits in which merchants have contended that the arrangements were in fact loans in the guise of sales.
So the core defense is usury. That’s the “interest rate is too high” argument. It might get made if the funder sues the business. It might be raised in a motion to vacate a confession of judgment entered against the owner. It might be part of the business’s own lawsuit against the funder, under RICO or otherwise.
LG Funding
In March 2020, the Appellate Division, Second Department, decided LG Funding v. United Senior Properties of Olathe. LG Funding gave the merchant about $100,000 and the merchant promised to let LG Funding take $129,000 from its bank account. The merchant raised the defense of criminal usury in its answer to LG Funding’s complaint. So LG Funding moved for summary judgment dismissing the counterclaim and the affirmative defense. The court dismissed the counterclaim but allowed the affirmative defense to remain.
The court applied a simple test: unless the money advanced is repayable absolutely, the deal is not a loan. So how do you tell? Courts usually weigh three factors:
- Does the deal have a reconciliation provision?
- Does the deal have a finite term?
- And does the funder have any recourse should the merchant declare bankruptcy?
In LG Funding, the reconciliation clause stated that the funder could, at the merchant’s request, change payments at “its sole discretion.” Moreover, the agreement stated that the merchant’s written admission of inability to pay, or the merchant’s bankruptcy, would be an event of default giving the funder the right to demand immediate full repayment of the unpaid purchase amount, enforce the owners’ personal guaranty, and enter a confession of judgment for the purchased amount. All of these provisions could be read to suggest that the funder did not assume the risk of low or no merchant revenue. This is a lawyer’s way of saying the funder didn’t have to assume the risk that sales would be disappointing or that they wouldn’t come in at all. Your contract may say the same thing. An agreement with no definite end, or one that allows the funder to recover in full if the merchant goes bankrupt due to a guaranty or confession of judgment, points toward a loan, and so does a reconciliation clause the funder can simply decline to apply.
The LG Funding decision came down when the Covid pandemic started, but the facts are from before Covid. The number of defaults under MCA agreements has likely spiked due to Covid, so this topic will be with us for a while. That is why the same three questions still frame the defense in 2026. Take a hard look at every merchant cash advance agreement you have:
- Is the reconciliation clause mandatory, or does it merely give the funder an option?
- Does the agreement expire?
- Does the funder have collateral, such as personal guarantees or confessions of judgment, which protect it from the merchant’s insolvency?
Give Your Agreement to a Lawyer
The moral of the story for business people caught up in one of these disputes? Give your agreement to a lawyer. The language of the “reconciliation” provision, the length of the contract, and the security interest will dictate whether a usury claim is possible.
