If you are behind on a merchant cash advance, the funder has probably told you that what you signed was never a loan. In an MCA transaction, the funder is not a lender of money but a purchaser of future payments that are to be made on sales. The financed party is not a borrower but a seller of future sales to a third party (the funder). The funder pays a sum of money now to the business and in exchange the business agrees to give back a larger amount of money that the lender electronically debits from the business account. Fees get debited too. The difference between what the merchant gets and what it repays is usually way more than criminal usury law would permit. That’s probably why they structured the deal like this.
Typically, the agreement says it’s not a loan, and it vaguely says if the business doesn’t make as much money as it expected to the repayment amounts may be reduced or even forgiven (a reconciliation clause), and it includes security like a confession of judgment and a personal guaranty by a principal of the business. These three sections constitute the marketing and legal “cover your behind” defenses for MCAs. Owners under pressure tend to worry most about the security and skim past the reconciliation language. At Delancey Street we think the two belong together, because courts look at both when deciding whether an advance is really a loan.
The favored forum in these agreements, wherever the merchant is located, appears to be the courts of New York State. And so, New York courts have plenty of disputes where the merchant claims that the purchase and sale is just a cover for paying too much interest. The usury defense can be raised in lawsuits brought by the funder, or it can be raised in motions to vacate a confession of judgment against the principal, and occasionally it shows up as part of the merchant’s own claim, under RICO or otherwise, against the funder.
LG Funding V United Senior Props. of Olathe
The March 2020 decision of the Appellate Division, Second Department, in LG Funding v United Senior Props. of Olathe is a seminal case, as the merchant received about $100,000 but agreed to have its bank account charged $129,000 and argued criminal usury as a defense. The finance company sued to collect a defaulted advance and asked the court to dismiss the merchant’s affirmative defense and counterclaim for criminal usury. The case has nothing to do with Covid, since its facts predate the pandemic by several years, but Covid has probably pushed up the number of MCA defaults, and that’s a problem that’s likely to keep surfacing.
The Court Will Consider Three Things
If it’s a loan, then you owe the principal amount no matter what. If the amount advanced to the merchant is not something that has to be paid back for sure, then it’s not a loan. Normally, the court will consider three things: does the deal have a reconciliation clause, a limited term, or recourse if the business goes bankrupt?
In LG Funding, the agreement said the funder “may, upon [United’s] request, adjust the amount of any payment due under this Agreement at [its] sole discretion and as it deems appropriate.” The part about “at [its] sole discretion and as it deems appropriate” is key. The funder can decide to adjust the payment amount that you owe, and that decision will be at their sole discretion; it’s not a hard and fast requirement. Under that kind of clause you could ask, but it was their call, not yours. In other words, the funder was very much in control.
The contract says if the merchant admits in writing it can’t pay or it goes bankrupt, the funder can demand full repayment immediately, enforce the personal guaranty, and enter a confession of judgment. The funder wasn’t betting that the business would have low revenues, so the court said that the merchant could keep its defense that the deal was a criminally usurious loan. The judge tossed out the counterclaim but let the affirmative defense stand. Notice that the security, the guaranty and the confession of judgment, is part of what undercut the funder’s position.
An MCA deal should be reviewed for whether the reconciliation clause is absolute or at the funder’s option, whether the deal is for a limited period, and whether the funder reserved security, like a personal guarantee or confession of judgment, that shields it from the effect of the company’s insolvency. So if you’ve got an agreement, pull it out and go through it with those three questions in mind. None of this makes an advance automatically a loan; LG Funding only held that there were factual issues worth fighting over.
Business Debt Settlement
At Delancey Street, we are a business debt settlement company, not a law firm. Whether your agreement supports a usury defense is a question for an attorney. We refer clients to a vetted independent attorney if that’s what they need, and otherwise negotiate with lenders to settle for less than the full amount owed. A first consultation is free and confidential.
