Merchant cash advances can be a nightmare for business owners. All of a sudden one day there’s this friendly company offering to help. Then a payment is missed. The calls start coming in. This is the trap many owners do not see until it is too late.
You have probably heard the horror stories about your business checking account being frozen or someone named Gino from collections showing up at your door one day. The stories are true, but they are not the full picture. You still have rights, and here we will discuss what default really means and how to respond.
One missed payment and the lender can come for the business - and you. It’s a fact that a lender can move very fast if the borrower misses a payment. They don’t have to wait to act - in fact, their contract with you almost certainly gives them the right to do so almost immediately. Here is what they are allowed to do.
- It can sue to collect the amount.
- It can freeze your bank accounts.
- It can take property, vehicles, or other assets.
- It can file a UCC lien and that will redirect your revenue to it.
- It can contact your customers.
- It can go after your personal assets.
Which is worse? Well, all of these can do damage. The solution to the problem starts with understanding the deal to begin with. Here is an overview of how MCAs work.
Merchant Cash Advances
Merchant cash advances or MCAs, (sometimes referred to as “cash advance loans”) are money issued against future sales. (For simplicity’s sake, we will use the word lender.)
One of the main reasons that MCA companies claim it is not a loan is so they are not bound by state interest rate limits. What the contract says, if we look at this MCA from a law nerd’s point of view, is the business sells a certain amount of receivables at one time. Like factoring. You’re just borrowing against some or all of your receivables to come in the near future.
Okay so how does the funding process actually work?
At a minimum, a borrower should expect to pledge future income, assets and sign a personal guarantee. Funds come quick. In return, the borrower pays daily or weekly for 2-8 months. Each payment takes out some of your advance and a fair sized chunk more. These “loans” are a high risk form of financing. Easy to get, but with a price tag. Re-upping is also extremely common. That means getting more money before paying off the balance. Instead of making payments on one advance, the borrower can end up paying it back many times.
Let’s look at the math, starting with the interest rates. The payments are a percentage of sales. But the annual interest rate (APR) on the MCA can often reach 250% or more. The majority of small business owners are completely unaware of this.
MCA lenders come across as legitimate loan companies but they are not regulated like banks. The money can appear quick, and the collection tactics brutal, if you don’t pay back a MCA.
If You Think You Are Going to Miss a Payment
If you think you are going to miss a payment, let them know. A best practice before the account is delinquent is to reach out and ask for help. The lender may be willing to work with the borrower because they want to be repaid. In addition to doing that, the borrower should check the contract for instructions on how to do that.
Beyond reaching out, keep a few things in mind.
First, if you are struggling to pay the MCA: don’t borrow more. Many lenders will offer the borrower another advance or a reverse consolidation.
The last thing you need is to give the lender your last customer or sales list. That is what they are looking for. The rule of holes is, when you are in one, stop digging.
Borrow more? Are you kidding me? Adding to the stack makes your business that much weaker.
The second thing you should be aware of if you’re falling behind on the MCA is that, if they will not help you voluntarily, there’s something called recon. Those payments are based on revenue. So if there was a reduction in sales, then that amount of money doesn’t really exist for you anymore. That’s the way the payments are structured. A reconciliation is a way to make the payments more affordable based on reduced sales. Most contracts include one.
A reconciliation clause is not a kindness. It is an industry standard that helps prevent the advance from being deemed an usurious loan. If sales drop, the lender could be forced to lower payments based on the agreed share.
Even just missing one payment can put a borrower in “default” as the lender sees it. And that means they can start contacting clients, freezing business bank accounts, and file a UCC lien. They can also sue the business and you.
A personal guarantee on an MCA is common. It means the business owner can be personally liable for the balance. Savings, property, investment accounts, are fair game. Signing a personal guarantee can come back to haunt a merchant cash advance borrower. That’s because lenders may be able to go after the individual directly. So it is vital to work with an experienced, local business attorney.
A lender can threaten to sue for fraud, or lock up accounts, or hire a collector or inspector to visit the business. Or file a collection suit, or “confession of judgment,” or register a UCC lien. It is not a walk in the park. One of the things that makes default so scary is the speed at which the lender can and will act. Like day one you miss a payment and next thing you know the lender is coming at you with all of its heat.
Confession of Judgment
An MCA lender can move pretty fast, particularly if it has a confession of judgment (or some form of consent or agreed judgment.) Many borrowers think CoJs are illegal. They are not. They are just more restricted now.
And New York does not allow an MCA lender to file a CoJ in that state against an out-of-state business. So lenders turn to cognovit notes and agreed judgments. This also means fast seizure. Or they file in other states or an ordinary collection suit.
A few years ago nearly every MCA lender required a confession of judgment plus an affidavit. They were not always disclosed by the lender, and in fact usually found buried in the stack at the very back of the signing pages.
Many of your defenses go out the window if you signed a CoJ. The lender can leapfrog proving you owed and the amount by producing a document that says you admitted you owed the balance before. In fact, it can even have the CoJ, the confession of judgment, served against your bank account before the first-class mail notice ever reaches you.
An agreed judgment is like a confession of judgment. But unlike a confession of judgment, the agreed judgment is based on active consent. Yes - you gave permission.
So why in the world would a borrower consent?
Often a borrower does not know they are consenting. This happens in loan modifications and settlements.
A CoJ would raise red flags. Instead, the borrower confirms the full amount is owed by the business and the signer personally, and in exchange for that, the lender adjusts terms. How kind of it.
A cognovit note is a dangerous type of promissory note, where the borrower agrees in advance that if the borrower defaults, the lender can get a CoJ (and possibly even an agreed judgment) without giving any notice to the borrower.
Who would sign one?
Just about every owner who signs one signs one unaware.
How can they not know? There are two reasons.
One is that small business owners think the CoJs are outlawed. But the bans, for what it is worth, have to do with consumer transactions.
And lenders know the rules. The second reason is that few borrowers bother reading the fine print before accepting the cash over the phone. Everybody knows nobody reads the safety warnings. Lenders know that, too.
Good news: If it is a true MCA, the advance company will not be using a cognovit note because that would make the advance a loan. Bad news: Lookalike companies do use the coercive notes, while calling themselves real lenders.
If you signed a CoJ, agreed judgment or cognovit note, lenders can often freeze your business and personal bank accounts within days. You know that funny feeling you get when you realize you have no money? Now imagine you have no checking account.
The CoJ myth: not having a confession of judgment may not shield a borrower from swift and aggressive moves, many lenders resorting to the filing of a UCC lien.
If you did grant a lender unfettered access to your sales bank account, that means it can pull what it wants. Especially a history of customer and bank accounts. Once a lender files a UCC lien, it often asks a third party to freeze and hold your funds. Merchant accounts, PayPal, Venmo or Cash app are common targets. Then they may start to go to big customers and vendors.
Without a confession of judgment or agreed judgment, a lender should not be able to seize bank accounts right away, at all. What they can do is sue you for breach of contract over the payments. The lender should send the business owner the summons. How long you have to respond depends on where you’re located.
You have 30 days after receiving the papers to respond if the MCA lender sued you in New York. If someone hands the summons to you, you only have 20 days. Different states give different time periods. So please, please pay attention to where the lender filed the case.
Here’s a giant red flag for you: unscrupulous lenders begin to calculate the time to respond the second they send it. You might have less than you think.
The big danger is in missing the deadline. If you miss the deadline you can expect to receive a default judgment. That means a loss of the opportunity to mount a defense.
Just about any type of judgment gives the lender the right to pursue the borrower almost anyway imaginable. Here are some examples:
- Freeze your bank accounts
- Phone calls
- Contacting customers
- Social media harassment
Some MCA lenders send thugs to your place of business for absolutely no reason other than to intimidate and frighten you into paying. Yes - Gino walks into your business (unannounced of course) and tells you he needs to be paid. Get help now if the payments seem unworkable.
It’s extremely easy to lose your business bank accounts after a judgment. Don’t think you can do it alone. You could lose the business and more without a lawyer. Yes - a judgment is not a joke.
Even if the first or another payment was missed, you have rights. A business attorney who is licensed in your state may be able to help you come to terms. The attorney can help put a stop to harassment from the lender, if they are calling you. Attorneys sometimes negotiate what a borrower owes. Don’t let another day go by with daily or weekly payments that you are unable to pay.
When picking a law firm for MCA help, choose someone near you, as every state has different rules on lending and advances. Make sure that you take a lawyer who is licensed where you are. Not where the lender is. Can’t pay? Don’t wait until the business bank accounts get seized.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
