Most business owners who take MCAs never fully realize what they signed. When the dust settles, the recurring deductions leave the owner with a nagging question: can the funder come after me personally if I can’t keep up with the payments?
Guarantees in an MCA agreement force a business owner to consider two things: First, how much am I personally on the hook for if the business can’t pay? And second, is the guarantee so broad that the advance is actually a loan subject to state usury laws? The second question shapes the answer to the first, so it helps to start with what an MCA is supposed to be.
A Merchant Cash Advance (MCA) is where a company (the buyer) buys the future credit and debit card sales of a business (the seller). The seller will have to pay back an amount based on the amount of sales they make. MCA is not a loan because the company buying the future receivables is accepting the risk that the seller won’t pay them back. If an MCA is set up right, it won’t be treated as a loan and it won’t fall under the usury laws of the states. Merchant cash advances (MCAs) were invented to give small businesses an alternative to getting a bank loan. Unfortunately, we’ve seen predatory lenders who use MCAs to get around state usury laws by disguising a loan as a cash advance so they can charge a rate that’s too high. A lender can’t dodge legal consequences just by putting a different name on their agreement.
A court hasn’t spelled out the exact rules to decide when a deal that looks like a sale of a company’s future sales is actually a loan. Instead, judges look at several things, including:
- whether the buyer takes the risk that the receivables might be worthless, or that risk stays with the seller;
- whether the buyer can collect more than the principal and interest;
- whether the seller is still collecting the receivables and can mix them up with other money;
- whether the MCA provider is guaranteed to get its money back no matter what;
- whether the contract can go on for an indefinite period, showing that the repayment was never certain; and
- whether the buyer has any rights to the money if the merchant goes bankrupt.
The big issue is whether the merchant or the MCA company bears the risk if the merchant doesn’t pay. If the MCA company bears the risk that it will not get repaid and it has no legal right of recourse against the merchant, then the agreement is not a loan and it is not subject to usury laws. One thing that courts have always said is that a loan isn’t usurious if the amount you borrow doesn’t have to be paid back no matter what. If it’s payable only if something happens that might not happen, and that really means the lender could lose their money, then the loan can’t be usurious even if it charges more than the legal rate. Unless, of course, the lender’s risk of not getting their money back is so small that it has nothing to do with how much interest they charged. The merchant has the burden of proving the agreement is a loan. In the Pearl Capital Rivis Ventures case, the MCA turned out to be a loan because the buyer could not point to a nonrecourse provision that would make it assume the risk of non-payment.
Personal Guarantee
So how does the personal guarantee relate to whether the transaction is a loan or a sale? It’s all about risk. When a guarantee allows the funder to demand the full amount from the owner personally every time the business doesn’t sell enough, the funder has shifted all the risk of not getting its money back to the merchant and owner. That means repayment is guaranteed, and the deal looks like a loan instead of a receivable purchase.
Many MCA agreements have guarantors. A guarantor by itself doesn’t turn a valid MCA into a loan. But the guarantor’s obligations have to be the same as the merchant’s. In the case of Platinum, the New York Supreme Court found that the obligations of the merchant and the guarantor (who was the principal owner) weren’t unconditional, and the only way the MCA would be repaid was from deposits made from future sales. Since the guarantor’s responsibilities were no broader than the merchant’s, the MCA wasn’t a loan.
In the Colonial Funding case, the guarantor, along with the merchant, had to deposit the money they collected from receivables each day into a special account. But the guarantor did not have to make up for any shortfalls out of his own pocket, so that agreement was not a loan. The MCA will not be a usurious loan as long as the obligations of the guarantor are the same as those of the merchant.
If you’re a business owner who signed a personal guarantee on an MCA, you need to read the fine print. If the guarantee says that you just have to make sure the merchant does everything it has to do — like deposit every day’s sales into the right account — that’s consistent with a true sale of receivables. But if the guarantee says that you have to pay any shortfalls out of your own pocket, or that the guarantee is enforceable every time the merchant fails to pay, that means the funder can go after you personally, and that’s evidence that the transaction is a loan.
In Gencarelli Pizzeria and Restaurant, Inc. v. Altcess Funding Management, Affinity Capital Funding, and Advantage Platform Services, the pizzeria’s attorneys claimed that one loan was actually disguised as a Merchant Cash Advance to allow the defendants to charge a 117% annual interest rate. The real gripe was that there were two extra big, sweeping guaranties that would apply if the pizzeria failed to repay. The agreement also established a set amount of time the pizzeria had to repay the money. Together, those terms gave the funders some teeth. On October 6, 2020, the case got settled and the interest charges got taken out. The funders denied wrongdoing.
If you have a merchant cash advance and you’re not going to be able to pay it, it’s tempting to think that because you signed a personal guarantee, you have to pay it all. That’s not necessarily true. If the MCA you’re dealing with has a broad personal guarantee and a fixed payback period, you could argue that the contract is really a loan with an illegal rate of interest. That could give you some leverage to get a better deal with the MCA provider. Before anything else, pull out the contract and see what the personal guarantee actually requires you to do. Compare it with what the business itself promised, and see if there’s a way to turn the tables on the funder.
