When sales dipped, the daily remittances didn’t. Asking for a reconciliation was the right move, and the funder’s refusal to do it still matters. The daily debit you agreed to when you were doing well has started to feel like a loan payment because your deposits aren’t what they used to be. And that feeling isn’t just emotional - it has a legal side, because one of the main things courts use to decide whether an MCA is actually a loan is whether the funder would have accepted reconciliation. We’ll walk through what a reconciliation is, why the denial is significant, and what your options are.
One-time Purchase of Future Receivables
A legitimate MCA isn’t a loan; it’s a one-time purchase of future receivables for a specified price. It’s technically a form of factoring, which means that the money is only worth its price as long as the business is doing well. The merchant has no absolute obligation to repay the advance; if the business doesn’t generate any receivables, then the merchant simply doesn’t send any to the funder. Merchant cash advance providers are supposed to assume the risk of not being repaid.
Fixed daily payments are not really fixed either. They are just one estimate based on an agreed percentage of average daily receivables. The merchant can request a different remittance amount if average daily receivables go down, and the agreement does not state that an interest rate is being charged.
Disguised Loan
But why would a funder want a reconciliation provision in the first place? Many of these contracts are written under New York law, and New York has a criminal usury cap of 25% on loans to corporations. The funders argue that an MCA is not a loan, and so the cap does not apply. The merchants reply that it is a disguised loan. Because the payments are daily and annualized, it is easy to get an effective rate well above 25%. However, when the agreement included a reconciliation provision, most courts have dismissed the merchants’ lawsuits. Many courts have come to the conclusion that despite contractual protections - security agreements, personal guaranties of performance, and confession of judgment clauses - funders are still at significant risk of never recouping their investment if the business doesn’t succeed; agreements providing for a reconciliation of payments that are up or down depending on how the business is performing are usually not loans.
Before the decision in LG Funding, New York courts largely sided with funders. In 2018, the First Department in Champion Auto Sales appeared to confirm the enforceability of an MCA. However, Champion Auto Sales did not provide a framework that distinguished between a valid MCA and a usurious loan.
The Second Department’s decision in LG Funding v. United Senior Properties of Olathe, 2020 is worth a look if you’re trying to determine whether your MCA is really a loan. The court adopted a three-part test:
- Is there a reconciliation provision?
- Is the agreement for a set term?
- Does the funder have recourse if you go bankrupt?
In that case, the court zeroed in on the word ’may’ in the reconciliation clause because it could give the funder discretion. From there, the courts are paying close attention to whether reconciliation is actually a merchant’s right or if it’s just at the funder’s option. If the agreement at issue reads like a loan agreement, courts have denied funders’ motions to dismiss and granted preliminary injunctions to merchants.
The First Department in May 2021 decided that Davis v. Richmond Capital Group could proceed past the motion stage. The court held that the agreement might have really been a loan because the merchant was only allowed to reconcile at the funder’s discretion, the funder allegedly refused to allow reconciliation, and the daily debit did not appear to be a good-faith estimate of the merchant’s receivables. The agreements also stated that two or three bounced debits would be treated as a default with the entire amount due and payable, and if the business could not pay or went bankrupt, the personal guaranty could be enforced.
After Davis, trial courts are likely to analyze other provisions beyond the three LG Funding factors. So even if an MCA agreement was technically valid when signed, a funder’s later failure to provide a reconciliation could be not only a breach of contract, but could also demonstrate the funder treated the advance as a loan. This is the key point for an owner whose request was denied.
The same funder name turns up in a second case. In a lawsuit against Richmond Capital Group and its principals, the New York Attorney General made the argument that their agreements were actually loans because the funders conducted the business in a loan-like manner. Refusing to do reconciliations was one of the complaints, but the AG also accused the funders of filing confessions of judgment for a single late payment, double dipping with daily debits, and submitting false affidavits. Its petition also pointed to how the deals were sold: sales calls, emails, ads and webpages describing the deals as “loans,” discussions of payment periods and underwriting based on credit ratings and bank balances instead of past receivables. On June 2, 2021, Justice Andrew Borrok denied the funders’ motions to dismiss and rejected their ‘form over substance’ argument.
Once a Funder Denies a Reconciliation
If a funder simply said no when you asked to reduce payments after your receivables dropped, that can be a breach of contract. And courts and the New York Attorney General have looked at the refusal to reconcile as a factor pointing toward a loan transaction. But you’ll need to prove it, and it’s going to hinge on the wording of the contract and the specific facts of the case.
Once a funder denies a reconciliation, the first thing to do is open the contract and read the reconciliation clause. It will tell you whether the funder only “may” adjust your payments or has to, and the rest of the agreement sets out what happens in a default, whether there’s a personal guaranty or a confession of judgment. Save the written request and the funder’s denial, and keep copies of any bank statements that show the receivables went down. Then check your agreement and your experience against the Davis list. Was the daily payment a good-faith estimate of receivables, or was it way over the top? Do two or three bounced debits put you in default and make the whole balance due? And if the business can’t pay, can the funder go after the personal guaranty? Also think back to how the deal was sold: was it referred to as a loan in calls or emails? Did the funder check a credit score and a bank balance instead of past receivables?
Lawmakers are paying attention too. Some states, including New York, have introduced or passed laws that require MCA funders to disclose certain terms before the contract is signed, for example, an annual percentage rate and repayment term. This is very strange, because a true MCA doesn’t have either. And if you had either, it would defeat two of the three LG Funding factors.
A denied reconciliation request is not the end of the road. It may very well give you leverage with the funder. See an attorney regarding any possible legal claims and talk to a debt settlement firm regarding your ability to negotiate with the funder. It is important to act before any defaults and judgments arise.
