What happens if I default on a merchant cash advance?

If you default on a merchant cash advance (MCA), the funder has a few options. They may demand payment for the claimed remaining balance, pursue you personally under a guarantee, send notices to customers or payment processors, or file a lawsuit. The speed and methods used will depend on the specific MCA agreement, the facts of the situation, and the laws that apply. None of these actions are automatic, and there is no fixed schedule.

If you are starting to wonder if you can handle the payments going forward, gather up your contracts, look at your revenue, and review your payments. Sales slowing down, a failed withdrawal attempt and getting a funder’s claim of default are all different and require their own questions to be answered. If you have been handed papers about a lawsuit, judgment or account restraint, you will need to have a lawyer review them promptly. Don’t just wait to get new financing or work out a deal to make payments.

Default is just a fancy name for an alleged failure to do something that the agreement says you need to do. The funder might say that you missed some payments, that they couldn’t withdraw from the right bank account, or that you didn’t send in the business records on time. There is no universal grace period for default, and what the agreement says really matters. Some agreements have a period to give notice or a chance to cure things, others don’t. A drop in sales does not, by itself, mean that you are in default. Many MCA agreements will handle lower receipts through a reconciliation provision that re-calculates the repayment. Check the agreement. Even if you get a default notice, it does not prove every fee or amount demanded is correct. Keep any notices sent to you so they can be reviewed with other facts to get the right answer.

What often happens is that the funder will try to withdraw money for a payment, and that will fail or be returned. They may then bombard you with calls, texts and emails. Some funders will add a bunch of contract fees. After a while, they may declare that you are in default, demand that you pay the claimed balance, and reach out to anyone who agreed to be a personal guarantor. That is a good time to double-check how payments already made have credited the balance and how any fees were added.

If you get a UCC notice, read it. Your funder may be telling your customers or payment processors to pay it directly, claiming rights to receivables under the MCA agreement. Some of these recipients may hold funds until the situation is sorted out. Also, a UCC-1 filing lasts five years unless continued in the last six months. The UCC-1 is only a public filing giving notice of a claimed interest, but on its own it does not give the right to collect your receivables. The right to do that depends on the agreement, assignments and the laws of a particular state. So when you get the notice, make sure to keep a copy, note which funds are being held, and keep what you tell your customers accurate.

A funder may sue the business, and often the guarantor. When you get those papers, save all of them, note the date, and how you were served. Have a lawyer look at them as soon as you can to find the deadline to respond and any defenses you may have. Trying to talk payments, by itself, does not extend the time to respond. If you miss the deadline, a default judgment may be entered.

If you signed a confession of judgment when you got the funding, that might give the funder the option to skip a normal lawsuit and get a judgment against you, without you first having the chance to challenge it. Whether that is allowed or how it is done will depend on where you are, and in some places it may be limited or not allowed.

In New York, a 2019 law change means that a confession of judgment can only be filed in the county where the signer lived or their business had a place of business. That means confession of judgment may no longer be usable in New York against out-of-state businesses. To be valid, a confession must also be filed within three years of signing.

Once a judgment is entered, the funder may try to enforce it, and the methods will depend on the law where you are. For instance, in New York a restraining notice served on your bank account can freeze up to twice the judgment amount, for up to a year or until the judgment is paid or vacated. A frozen account generally follows a judgment or other legal process. But, a UCC notice can also make a processor hold funds. So, figure out which document is the cause of the hold. Whether a judgment can be vacated depends on the court rules, why you did not respond, and when you act. Keep everything you get and work with your lawyer to make the right decision.

If the business is in trouble, some of your financing may also come back to you if you signed a personal guarantee. Before you worry about that, find the agreement, figure out who signed it and what triggers the personal liability. Guarantees vary a lot, so read yours. A demand on a guarantor and a judgment are very different stages.

The funder may have a problem if the MCA is actually a loan. When a New York court looks at one, it asks if it is really a loan. It does that by looking at three factors:

• if the reconciliation provision really works;
• if there is a fixed end date; and
• if the funder can collect if the business goes bankrupt.

If a New York court says it is really a loan, knowingly charging over 25% a year is criminal usury, a felony. In New York, a corporation or LLC can raise criminal usury as a defense if sued by a funder, but cannot bring it as a counterclaim. And a missing or disputed reconciliation clause does not by itself settle enforceability, so it’s best to ask a lawyer to check this.

If you already have court papers in hand, those go first. Take the time to save every notice, email, text and note the date you got it. Find the agreement, any amendments, the UCC notices and any personal guarantees you signed. Match up every debit or bank withdrawal to what the contract says. Circle the days with duplicate debits or ones that got returned. List every merchant cash advance you got, when each started, the amount, and the claimed balance now. It may feel like you need to hide, but before you do anything big like switch your bank accounts, block withdrawals, or redirect your receivables to a new merchant account, it is best to get advice on whether that is right for your situation. Shutting down one merchant account won’t solve the problem, and signing new financing or settlements under pressure are generally bad ideas, so read the new contract before you ink your name.

You have several options for dealing with an MCA:

• restructuring can change the amount or timing of payments;
• settlement can resolve claims against you and should cover releases and guarantees;
• consolidation is new financing, so compare the total cost and check that each MCA is actually paid off.

Any forgiven debt is generally considered taxable income. There are exceptions to being taxed for canceled debt. If you filed a bankruptcy case, then the canceled debt is excluded. Outside of bankruptcy, the cancelation of debt is excluded if you are insolvent, but it is only excluded up to the amount you were insolvent.

Filing a bankruptcy case does automatically stop the collection of debts, including judgments, enforcement of a lien, lawsuits, and the collection of old debts. Before you shut the business down, or before you file for bankruptcy, consider talking to a bankruptcy lawyer. There is no waiting period until you have talked out everything, so if you are starting to doubt you can meet the business obligations, talking to counsel early means being ready before you need to act. What you file also matters: a Chapter 7 is generally a liquidation, a Chapter 11 reorganizes a business, and a Chapter 13 is only for eligible individuals. It is also important to note that even if a business files for bankruptcy, that may not end the owner’s obligation under a personal guarantee, so get advice to make the right move.