Are Merchant Cash Advances Legal?
Our lawyers here at the Business Debt Law Group are often asked a simple and straightforward question regarding merchant cash advances (MCAs). Are merchant cash advances legal?
YES. Merchant cash advances are, in fact, legal.
As of the latter half of 2023, there has been no attempt by the United States Federal Government to regulate the multi-billion-dollar MCA lending industry. Likewise, most state legislatures have chosen not to tackle the subject of merchant cash advances yet.
MCAs Are Legal, But What Protections Do Borrowers Have?
While MCAs are not against the law and are recognized as a legitimate type of alternative financing that many businesses utilize to acquire quick capital, the legality of MCAs can be impacted by various factors.
- Jurisdiction: Laws and regulations concerning lending and financial transactions vary from state to state. What is considered lawful in one jurisdiction could be considered unlawful in another.
- Unethical Lenders: In certain situations, predatory or unethical practices by merchant cash advance companies may be deemed unfair and intended to take advantage of the borrower.
- Consumer Protection Laws: A limited number of jurisdictions use consumer protection laws that encompass small businesses to protect MCA borrowers.
- Usury Laws: Usury laws, which set limits on effective interest rates that a lender can charge, may apply to certain MCA agreements.
The stage at which an MCA might be considered illegally usurious varies from jurisdiction to jurisdiction, but one factor to consider is the “Effective Interest Rate.”
An MCA agreement will not contain language regarding a traditional interest rate.
However, calculating the “Effective Interest Rate,” considering all costs, fees, and charges associated with the advance, as well as the total repayment amount, may lead to a conclusion that the subject MCA is illegally usurious. This is especially true if the effective rate is excessive.
Where Does MCA Regulation Exist?
Several states have implemented regulations that specifically address MCAs and other high-risk lending products.
These merchant cash advance regulations are often targeted toward lender transparency, disclosure, and preventing abusive lending or collection practices.
Merchant cash advances are not like traditional bank loans. Instead, an MCA provider gives a business owner an advance against their future revenue. In effect, they buy your receivables, like future credit card sales. Because they’re distinct, little regulation exists.
Some states, like New York, have outlawed the practice of lenders using what is referred to as “Confessions of Judgment” (COJ) to secure court judgments against out-of-state delinquent borrowers.
However, New York does still permit the use of Confessions of Judgment if the business is domiciled in the state of New York.
The states of Texas, Utah, and Pennsylvania still permit the use of COJs with limited restrictions.
Surprisingly, Utah does not even have laws on the books limiting interest rates. Permitted there is a written contract between the lender and the borrower. Utah does not recognize Usury.
California, for example, allows alternative finance companies like MCAs to operate lawfully, but they must be licensed by the state. The California Financing Law requires all lenders, including MCA providers, to follow specific disclosure and transparency requirements.
New Jersey has established regulations concerning the conduct of merchant cash advance lenders. As you will see from other articles on this website, the conduct of an MCA lender is as critical, if not more critical, than the contractual agreement language itself.
The contractual agreement may have all the required provisions to protect an MCA lender, including a reconciliation clause, no moratorium on the debtor filing for bankruptcy, and language acknowledging that the repayment obligation is conditional and not absolute.
However, if the lender engages in conduct that demonstrates they didn’t adequately facilitate a reconciliation process or if their collection activities treat the repayment terms as being absolute, the court may find that the MCA has violated the law.
The New Jersey Attorney General has sued certain lenders regarding their conduct, imposing millions of dollars in fines while completely wiping out tens of millions in MCA debt.
Illinois has implemented what is referred to as the Merchant Cash Advance Reform Act. The law provides small business borrowers with additional protection and transparency.
Colorado has enacted regulations that mandate transparency and require disclosure in MCA transactions. Lenders shall provide clear information regarding the financing terms, including the total repayment amount and annual percentage rate.
So again, to provide a simple answer to a straightforward question: are MCAs legal? Without question, they are.
But that is not the end of the story.
In the states of New York and New Jersey, there have been legal actions brought by state Attorneys General and certain regulatory agencies to reign in the conduct of MCA lenders. Consent Orders have been reached, and court decisions rendered declaring certain lender activity as being unlawful.
Many courts throughout the country have found that in certain circumstances, the MCA lender’s conduct and servicing practices made it behave more like a loan and, therefore, was illegally usurious and unenforceable.
What to Do Before Taking on a Merchant Cash Advance
If you’re considering a merchant cash advance for your business, it is critical to comprehensively understand the terms of any potential funding.
You should seek to understand all the associated costs and fees and do your very best to calculate the “Effective Interest Rate” of the advance. You may find that the true factor rate is well in excess of 50, 100, 150, or even 200 percent.
Of course, if you need qualified and experienced legal assistance to better understand the terms of your MCA agreement, including your Effective Interest Rate, the experienced merchant cash advance lawyers at Business Debt Law Group are here to help.
Further, as laws and regulations often change, it’s a good idea to consult with legal experts or regulatory authorities in your jurisdiction to ensure your lender is compliant with local laws.