What happens if my business defaults on a merchant cash advance?

Merchant cash advances look like a lifeline, but far too often they turn into a trap. For a lot of owners, they see the trap once it’s already sprung.

We’ve all heard the stories about bad lenders. The accounts that suddenly disappeared overnight, the enforcers who introduce themselves in person (“Hi, I’m Gino. Nice to meet you.”). All a good reason to avoid them if you can, but you have legal rights if you find yourself in the trap. Default is nothing more than a legal fact, and this article explains it for you.

As surprising as it sounds, missing one payment can be enough for default. You missed one payment, now what? There are several steps a lender can take:

• They can sue you to collect.
• They can freeze your business bank accounts.
• They can seize property, vehicles or other assets.
• They can use a UCC lien to redirect your revenue to them.
• They can contact your customers and make you look bad.
• They can even go after your personal money and property (more on that later).

And that’s not all.

Merchant cash advances also work differently from standard debt, and that leaves a lot of owners without options, unsure if they even know how to ask for help.

How the Loan Works

To understand what default looks like, and how to handle it, you have to understand how the loan works. Officially they call it a merchant cash advance, but most owners and lenders call them MCAs or cash advance loans.

Merchant cash advances aren’t quite what they seem. These contracts read like they’re buying an amount of receivables, factoring basically. But the real catch is that MCAs usually operate above state interest rate caps. This happens because technically the lender isn’t loaning you money, they’re buying a guaranteed payment stream. It’s a loophole. But read the details. You’re borrowing against future income. Really it’s a loan, just worded carefully.

MCAs hook a lot of owners. They move fast, and when you need cash, they can look like the only option. Your future income, plus the assets of the business is pledged, often with a personal guarantee to back it up. Repayment starts right away, and those payments are typically daily or weekly. They provide needed cash for overpriced terms, generally 2-8 months, with a hefty premium on top. A common practice among cash advance lenders is to get owners to re-up. This works out well for the lender, since it can mean you repay the original amount many times over. Yeah, it’s easy to get, but you better really need it.

Tying payments to sales makes repayment look easy. It’ll just be some fraction of sales. So how bad can it be? But you’re still paying a premium to borrow, and costs often top an eye watering 250% APR. By comparison Texas caps interest at 18% APR. Owners rarely realize what they’re signing up for until it’s too late.

Cash advance lenders like to present themselves as friendly and legitimate, but they’re not regulated like the banks are. It looks simple until the emails from the lender stop coming and the phone calls start. They don’t hesitate to go after revenue streams and personal assets if the opportunity presents itself.

If you know you’re going to miss a payment, call the lender. They’re only people too. See what options they can give you. Also the contract tells you how to communicate this; the contract can be a good ally. Most MCA lenders won’t be helpful, but it’s smart to try anyway.

The worst thing you can do when you’re in this position is panic. Read the contract you signed, and take a realistic look at what you can do.

Lenders love to pile on debt when they sense weakness. And they’re good at it. They often pitch a second MCA or a reverse consolidation.

Up front they’re talking about saving your business; once they have your income figures and updated customer list, you’re back on the hook. A lot of owners in this situation make matters worse by signing for more funds from the original lender. It’s a bad bet, but it looks like the only option at the time. Rule of Holes: When you find yourself in a hole, stop digging.

More MCAs, more debt, more problems. And the reverse consolidation is no better. This hands over your newest customers, along with their contact information. Now you’re more in debt, with a bigger balance and a less secure income stream.

The contract is there for a reason. Read the fine print. MCAs are tied to your revenue stream. Readjusted payments? Few owners know this little secret, but a lot of contracts come with a reconciliation clause. Ask the lender about your reconciliation options if your revenue stream is contracting.

Don’t mistake the clause for kindness; it’s a way for a lender to avoid getting charged for an illegal, usurious loan. Still, it can work for you as well. Your merchant lender, the one that convinced you this contract was a great idea, may be able to change the payments based on new revenue. Lenders rarely mention reconciliation out of the blue, but after reading the contract, they may well have to.

The First Missed Payment Puts You in Default

Most cash advance contracts see any missed payment as a default. That’s the start. Check the definition section of your contract. Once you’re there, a lot of lenders take full advantage of the powers default gives them. At this point the lender can file against its UCC lien, contact your customers, lock your merchant accounts and take you to court. None of this feels good.

Just when it feels like you’ve given it all away, the personal guarantee shows up. Most MCA lenders get you to sign one, and sometimes owners don’t even realize it. Your personal guarantee can make you personally liable for the contract terms, meaning that your money, your home, your cars are all legally open to the lender. You need a lawyer in your state.

And if the contract is in default, things can change overnight.

Default is scary, and the lender can make it all kinds of scary. It feels like one missed payment turns into lawyers, collections calls, even inspectors. Owners love to think of default as a game, that somehow it’s all a bluff. Lenders think differently. The system doesn’t dawdle.

Confession of Judgments

With a CoJ, or a cognovit note, the lender can move right to collections or even seize assets to satisfy the balance. You may have heard they’re banned. They are not illegal, just less powerful now.

New York famously refused to allow CoJs against out-of-state businesses a few years back, but MCA lenders are adaptable. It takes more work now, but cash advance lenders are very, very good at finding the loopholes. As a response the lenders now try to leverage cognovit notes, agreed judgments, usual collections processes, ordinary state judgements or CoJs filed out of state. CoJs, agreed judgments and cognovit notes are technically different, but they have a lot of legal power in common. Make no mistake, they’re dangerous.

Confession of judgments used to be really common. And, guess what, owners nearly never read them. The affidavit of confession was a way to put owners on a legal hook, and most did not realize they had signed up to play.

A signed CoJ takes away a lot of your best defenses. With a signed CoJ, a lender has a wide range of legal powers. It doesn’t have to prove you missed a payment in full court or even the full amount owed. The lender serves your bank, and by the time you see a notification, your accounts may already be frozen. A CoJ or a cognovit note changes the business plan very quickly.

An agreed judgment looks a lot like a CoJ, but it needs your consent.

How can you agree to a judgment without knowing it? The trap is usually around a contract update, settlement or modification of the loan. During the back-and-forth during contract modifications, it’s not unusual to agree to an overall view of a new contract. And in the flurry of pages, an agreed judgment can show up. Boom.

This one tends to look like an offer to help. Think of agreed judgments like a legal choke point. The owner agrees they owe the full amount of the debt, both personally and through the business. In order to improve the repayment terms, it sometimes gets signed without the owner fully thinking it through. Read it closely and consult a lawyer if you’re not sure.

A cognovit note is a promissory note. It’s essentially you admitting you owe the debt in advance, as a condition of the agreement. In practice, it feels like a CoJ, since you’re not notified until after the court action.

Who would agree to a judgment against the business, against themselves, without knowing it?

The most common answer is, “I didn’t know I was signing it.” Owners tend to skim over it before signing and not realize what they agreed to.

How does it happen?

They assume it’s illegal, and its kind of surprising it’s not. Most states do have bans on cognovits, but a lot only ban them on consumer loans, not business loans.

Nobody reads every contract they sign, and lenders know it. Lenders prefer owners who need the money now, often within 48 to 72 hours. Needing money that fast, owners don’t give it their full attention before signing, and usually have to sign on a phone or computer.

Most traditional cash advance lenders don’t use cognovit notes. That’s because officially, using the note would classify the advance as a loan. Some lenders call themselves real lenders, instead of merchant cash advance lenders. Nothing stops them from going the extra legal mile to protect the loan, even while acting just like MCAs.

A CoJ or an agreed judgment gives a lender the power to freeze your accounts, often within days, personal ones included. If you have any non-trivial amount of funds in the business account, freezing it can damage your business overnight.

Just because you didn’t sign a confession of judgment doesn’t mean it’s over. Owners mistakenly think that as long as they didn’t sign the CoJ, the business is protected. Lenders can move quickly. Often a few weeks, sometimes within days. After that point they pull the UCC lien that a lot of owners forget about.

Your bank account is a treasure trove of useful information. Merchant advance lenders love to call their deals “business partners.” But they map out your financial web. From there it’s a matter of time until they freeze, seize or redirect income and assets. UCC liens are powerful. With it on file, the lender has the power to redirect revenue coming to the business to the balance. Merchant accounts and payment processors (PayPal, Venmo, Cash App) can be frozen. Once your revenue has been locked down, your customers get a visit from the lender.

If you don’t have a CoJ, or any of the other unpleasant agreements, you may have time. Owners often panic about seizures without realizing that most lenders don’t have that power right away. Getting hit with a lawsuit is never fun, but you do have a window to answer it. The lender generally has to file a lawsuit (usually a breach of contract action) and give you the summons. Exactly how long you have to answer a summons varies based on state laws.

Most breach of contract actions require that you answer within a set timeframe (in New York, 30 or 20 days depending on service). If served in person, it’s 20. Never ignore a summons.