Some businesses in Connecticut have received summonses for civil action filed by the funders of merchant cash advances. If you were caught up in one, you may be able to raise defenses that get you off the hook, and even collect treble damages and attorneys’ fees. But only some merchant cash advances are eligible for those defenses.
Most merchant cash advance cases seem to end with the business being in default or settling. If you were going to do that, why not raise defenses? Failing to do so wastes leverage.
Connecticut lately seems to have been hot for merchant cash advance funders, and some funders have now written their contracts to say their agreement shall be governed by the law of the State of Connecticut.
In some cases, the contracts also require or allow the suit to be filed in Connecticut state courts.
It is practically amazing how many cases the funders have filed in the Connecticut state courts - hundreds now - so be warned.
A Portion of the Business’s Future Revenue
A merchant cash advance is where the funder, called the buyer, purchases a portion of the business’s future revenue, up to a fixed amount.
A contract typically controls the deal. The buyer usually agrees to pay the seller the purchase price in one lump sum.
After funding, the buyer agrees to debit the seller’s bank account daily or weekly, for an amount that is sometimes a percentage of what the business took in before.
The debits continue until the contracted amount is received, and that amount can be far more than the purchase price.
The Strong Prejudgment Remedy
Why Connecticut? One reason may be the strong prejudgment remedy the state gives a contract creditor. This is just a guess.
Your daily debits may be more than half of the average amount your business took in in the past, and even though your sales decrease, the debits may remain fixed until the goal is reached.
Say the funder takes a whole day’s, even a whole week’s, revenue from your business and wants more. At some point the funder sues, and when the seller has no lawyer, the funder may get a judgment entered and the funder can collect the whole claimed balance.
Until recently, if the contract had a waiver provision, the funder could freeze the seller’s accounts, with no hearing or order.
The State of Connecticut passed an act (Public Act 23-201) ending this, and new disclosure requirements are in effect. Covered agreements and contracts signed on and after July 1, 2024 cannot waive the hearing and notice.
Since most sellers sued apparently do not get an attorney, the effect of Connecticut’s new law is hard to predict.
Disguised Usurious Loans
A complex contract, a naive merchant, and an opportunist funder. Merchant cash advance contracts can be tricky, and funders may use complicated structures to exploit unwary merchants and commit unauthorized, illegal acts, and the funders might get away with it, at least in the short term.
If the merchant cash advance has certain terms or the merchant cash advance funder acted a certain way afterwards, it may be a loan covered by lending laws.
Unlike a true advance, some merchant cash advance contracts may be usurious loans. Connecticut courts do not enforce a usurious loan.
You may be able to raise the defense of usury when you are sued by the lender. Connecticut law bars collection of usurious loans, whether of principal or interest.
In some cases, a funder which collects on a usurious loan that is dressed up like an MCA may owe you treble damages and attorneys’ fees.
Usury is a defense that the courts in this State apparently have not fully ruled on as of this date. No treble damage or attorney’s fee claim was yet raised here, it seems.
In the past, funders often chose New York law and New York courts. In those cases, courts in New York, including federal courts in the Second Circuit, found that certain MCAs could be disguised usurious loans.
And, then, the Second Circuit also held those funders who did that may have violated federal law.
That question of whether an MCA is a loan or not may matter a lot, because if it is a usurious loan, the borrower may have a federal law claim for treble damages and legal fees, even aside from state defenses like usury.
The courts in this State may look beyond the form of the deal to see whether the premium the funder charges was for the use of money or to shift risk. If money, usury laws can apply.
There are various questions that a court in this State would probably take up in deciding whether the funder disguised a loan with the MCA.
- Can the daily payments be reconciled in the future to correspond to the seller’s revenue?
- Is there an express ending date to the deal?
- Can the funder come after the seller even if the seller declares bankruptcy?
- Do the payments estimate income fairly and honestly?
- Did the funder buy particular accounts receivable? Who has the obligation to collect?
- When a default happens, does the contract demand all the remaining money be paid at once?
New York courts led the way. In time, if the seller argues the right facts and law, Connecticut courts may well decide certain merchant cash advances are usurious loans too.
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