You know those little payday loans, where a relatively small amount of money is given to a consumer who needs to get through to payday, and that person pays back the money from the next paycheck? Well, there’s a version for businesses, called a merchant cash advance, or MCA. A relatively small amount of money is given to a small business, and that business has to repay the money from daily withdrawals from the business checking account. Again, like a payday loan, it’s relatively easy to obtain. But once you get it, it’s a death sentence for a business. Because MCA loans come with a very steep interest rate. 50%, 100% or 300%. And nobody survives on that kind of interest rate. So what happens to that business? Whether it ends up in Chapter 7 or, like the company below, in Chapter 11, the first thing that comes up in the case is this: Did the MCA provide a loan, or did it purchase the future receivables of the business? Some courts (In re R&J Pizza Corp., Bankr. E.D.N.Y. 2020) have looked at this situation and protected MCA lenders. A 2021 decision from a bankruptcy court in Montana, however, found that the advance was a loan, not a sale, and therefore violated usury law.
Merchant Cash Advance Deals with CapCall
Before it filed, Shoot the Moon consisted of 19 different companies that owned and ran 16 restaurants in Montana, Idaho and Washington. To make ends meet, the companies agreed to 18 merchant cash advance deals with CapCall, LLC. All of this was recorded in the usual form merchant agreements with confessions of judgment, personal guarantees from the owners, and UCC-1 filings. In return for immediate cash to cover expenses, CapCall was to receive a share of each restaurant’s sales, paid to them by fixed daily withdrawals (ACH debits) until the debt was satisfied. Most of the money went through the account of Shoot the Moon Grizzly, LLC, a company that wasn’t part of the deal and didn’t even run a restaurant.
On October 20, 2015, all the businesses merged into Shoot the Moon, LLC, which filed for bankruptcy the next day. It was a Chapter 11 case, but the bankruptcy trustee, Jeremiah J. Foster, sold nearly all of the assets of the business. CapCall claimed that it owned certain customer credit card payments that were processed before bankruptcy but were paid into the debtor’s bank accounts after bankruptcy. The trustee had already used some of it, and the remaining $228,449.93 was held in a segregated account. CapCall sued for a declaratory judgment that it was the owner of the funds. The trustee sued back, claiming the transactions were loans not sales, seeking a judgment under Montana’s usury law, and avoidance and recovery of preferential transfers and attorney’s fees.
Is an MCA a loan? The answer depends on the state law, where the court looks at several factors including:
- whether the seller is liable for amounts not paid,
- whether the seller is managing collections,
- whether the buyer can change the payment terms
- and how the parties documented the relationship and handled the process.
In the end, the key question is who bears the risk of loss. If the seller bears the risk of loss, the arrangement is a loan.
The court decided that these were loans. The paperwork gave CapCall a claim to the company’s tax refunds, patents, trademarks, goods, inventory, equipment and fixtures. The forms listed as collateral “all assets” of the company, whether it had them now or in the future. That kind of lien doesn’t fit with buying specific invoices, and it’s strong evidence of a loan. And the form called the business a ‘debtor’ not a ‘seller.’ On top of all that, the owner signed an ‘absolute, primary and continuing guaranty of payment and performance’ and signed an ‘affidavit of confession of judgment‘ for the amount, with interest at 16% per year.
The parties’ conduct pointed the same way. Their emails said “loan” and “balance.” Shoot the Moon’s owner said the deal was like a promissory note. The payments were just commingled with the other business funds in an account owned by an unrelated company, and CapCall knew this. The agreements were repeatedly rolled or stacked. Money from a later advance paid off the earlier one, which is how refinancing works, not sale. CapCall’s witness said it never tried to collect using all those additional rights, but no contract provision disappears just because CapCall never enforced it, the court said. The agreements said repeatedly that the advances were not loans, but a plain ipse dixit statement like that has no weight.
Montana’s Usury Law
Under the Ninth Circuit’s choice-of-law analysis, the Court decided that Montana’s usury law should apply, despite CapCall’s arguments that New York law, which does not contain a similar usury statute, should govern, and held CapCall liable for $1,216,685. The Court also found transfers to CapCall during the 90 days prior to the bankruptcy could be avoided, and, after adjusting for double-counting against the usury award, entered a preference judgment against CapCall of $1,129,071. Because CapCall neither owned the receivables nor had an enforceable security interest in them, its rights to the credit card receipts failed, and the trustee was awarded the funds. CapCall’s proof of claim was disallowed pending repayment of the preference judgment, and the trustee was awarded attorney fees of $424,756.58 under Montana’s reciprocal fee statute.
The ruling was appealed to the U.S. District Court for the District of Montana. It’s too soon to say whether the decision will hold up or whether other courts will follow it. But the ruling changes the balance of power between MCA lenders and their bankruptcy opponents.
So what does this mean for an owner whose business took an MCA and is now headed for bankruptcy? The agreement may call the receivables a “purchase.” That label is not the end of the story. The blanket lien, the guaranty and the confession of judgment the lender wrote in to protect itself are exactly what led the court in Shoot the Moon to treat the deal as a loan.
