What debt relief options do I have for personally guaranteed merchant cash advances?

If you own a small business that’s having a tough time, you’re not alone. Cash flow is tight, and making the monthly bills is hard. Small businesses often find it hard to get loans from traditional banks. The merchant cash advance has provided an alternative for many, but when business slows, owners may struggle to repay the cash advance they took to support their company. This post discusses debt relief options for those who have personally guaranteed a merchant cash advance.

With a Merchant Cash Advance

With a merchant cash advance, the funder gives you cash up front in exchange for the right to some of your business’s future sales or receivables. The funder will then file a UCC lien on your business’s assets, including your bank accounts. They then take payments directly out of your bank account every day or week. Most often, the owner also personally guarantees the merchant cash advance, so they may also be required to pay back the amount if the business fails to. Sometimes a confession of judgment also happens as part of the process, which means the lender can skip suing you to try to enforce the contract.

Another problem with MCAs is that they’re very expensive. Very expensive. And the owner will sometimes take out a new MCA to pay off an older one, and can be trapped in a vicious circle. About 20 to 30 percent of MCA customers default. As for the payments, they’ll take a set percentage of your daily sales or a withdrawal based on estimated monthly sales. Either way, the cash flow is drained by the funder. Also, often the payments can eat up all the receivables and income, making it very hard to keep the business afloat.

Often MCA funders will argue that the cash advance is not a loan at all, but an investment or a purchase of receivables. But this is largely a strategic decision, made so that after you default it removes many of the defenses a borrower would have when facing a loan. MCA funders include:

• BFS Capital
• Bizfi
• Can Capital
• CapAssist
• Capify
• Colonial Funding Network
• Core Business Finance
• EBF Partners
• FB Funding
• Fundera
• Funding Circle USA
• Fundzio
• IBIS Capital Group
• Kabbage
• Lending Club
• LG Funding
• Merchant Capital Partners
• Merchant Cash & Capital
• ML Factors Funding
• Next Level Funding
• OnDeck
• Platinum Rapid Funding Group
• RapidAdvance
• Retail Capital, which does business as Credibly
• Swift Capital
• Yellowstone Capital

Merchant cash advances can be fraudulent loans in disguise. New York Attorney General Letitia James filed suit on March 5, 2024 against Yellowstone Capital, Delta Bridge Funding and several individuals, claiming high-interest loans were being marketed as “merchant cash advances.” The AG is seeking at least $1.4 billion dollars that the defendants wrongfully took from small businesses in interest and fraudulent fees, plus a court order to stop the illegal practices.

A Personal Guarantee

A personal guarantee, or guaranty, is when a signer becomes personally liable for whatever the business can’t pay. Small businesses often get loans with a personal guarantee because the lender is taking on more of a risk with the small business. This is extra protection for the lender. After default the lender may be able to sue the guarantor and go after their personal assets.

Another issue is the “confession of judgment,” or COJ, mentioned above. With a COJ, the lender is able to put a judgment on the public record without ever suing you. You have already agreed that you owe them, so they bypass court and go straight to enforcement. New York amended CPLR 3218 to bar COJs against out-of-state defendants. COJs in merchant cash advances have become less common since then, but some unscrupulous lenders are still using them.

The UCC lien gives the lender legal rights to the collateral securing the loan, so they can take or seize the collateral if you default.

Sued by an MCA Lender

Once you get sued by an MCA lender, your options include settling the debt, fighting the lawsuit in state court, and filing bankruptcy.

In some cases, you may be able to settle your merchant cash advance by paying less than you owe. Usually the cash advance must be in default before you can negotiate a deal to pay less than the balance. The funder may ask to see financial documents that support a claim of hardship. A one time payment is often preferred over a payment plan by the lender, but if you don’t have the full discounted amount, a payment plan may be an option.

If it is not possible to settle the MCA, you can fight the default in state court. A seasoned debt attorney can review the language of the agreement you signed and craft a defense. Whether you can raise the validity of the agreement will depend on the facts and circumstances of your cash advance. Generally it is easier to challenge a deal that is structured as a loan, and harder to challenge a deal that is structured as a purchase of future receivables. New York courts generally use a three-factor test.

In New York, the three factors that generally determine whether a loan is a loan or “something else” are: (1) Whether there is a reconciliation provision (2) Whether the term is finite or limited (3) Whether the funder has recourse if the merchant files for bankruptcy. This test is based on the Second Department Appellate Division’s 2022 decision in Principis Capital v. I Do, 201 A.D.3d 752.

But because merchant cash advance lenders have gotten smarter in writing contracts that avoid court decisions like these, fighting the lawsuit will not always work out in your favor. Often it will just delay the inevitable judgment coming down the pipeline anyway.

There are two types of bankruptcy that can help you. The first is Chapter 7 liquidation, which could be filed by the business or the owner personally, often when the business is closing. The type of Chapter 7 that you should probably file is the personal one. With your Chapter 7, you can stop all the collections against you, including the merchant cash advance lawsuits. With a personal bankruptcy, you’ll probably also be able to discharge your personal liability under any guaranteed merchant cash advances that you got. After a personal bankruptcy, you can rebuild your credit and possibly even start a new business or two. Chapter 7 bankruptcies filed by your business are another option, if you are shutting down. A corporate Chapter 7 will stop the suits against your company. But Chapter 7 for your business will not stop the merchant cash advance lawsuits against you, since the personal guarantee is not discharged in that type of bankruptcy. Filing a Chapter 7 bankruptcy for your business is not always necessary.

Option number two for the business owner: Subchapter V of Chapter 11 is a better fit for the business owner who wants to keep the business and needs to get out of debt to keep going, if the business has value or can be viable with help. Subchapter V restructures the debts to make the business survive. It’s a streamlined version of Chapter 11, for smaller cases, not as expensive as Chapter 11 but more expensive than a Chapter 7. There is no guarantee that the business will stay open. More than half the cases do not get plans confirmed, and fewer than that complete their plans.