Does Merchant Cash Advance Regulation Exist?
If your business has ever needed a cash injection to operate in the short term or possibly to expand, you may have encountered merchant cash advances as a method of financing. While considering this option, you may have asked yourself what the difference is between alternative financing and traditional loans or questioned whether it affects credit scores the same way.
You may even have gone as far in your research to wonder what sort of regulations exist for merchant cash advances to protect the borrower.
Unfortunately, very few protections, if any, exist for business owners who are struggling to pay merchant cash advances.
In this article, we will look at the current state of merchant cash advance regulation and recent trends in a few states toward possibly reigning in the merchant cash advance industry.
Merchant Cash Advance Regulation
So are merchant cash advances legal? in short yes they are. This is because merchant cash advances are not considered loans, there really is not any true regulation associated with them.
Merchant cash advance companies do not need to follow state usury laws, which limit how much interest companies can charge on certain loans or credit cards.
There are no laws that limit how much a merchant cash advance company can charge in its “purchase of future receivables.” The one type of regulation these companies do fall under is from the Uniform Commercial Code, also known as the UCC.
The UCC code helps regulate business transactions in a uniform way for businesses that borrow money, lease equipment, and sell goods in multiple states. However, the Uniform Commercial Code does not regulate costs and fees charged by lenders who purchase receivables.
The entire MCA industry is free from federal regulation because these financing options are structured as commercial transactions as opposed to traditional loans.
This allows MCA lenders a great deal of latitude to operate sometimes, in less than ethical ways, to circumvent regulations and laws that traditional lenders must follow.
Legal Concepts and Areas of Law That May Apply
It is extremely important to recognize that case law and legislative regulation can change.
If you are currently concerned with your merchant cash advance debt or you may be considering a new merchant cash advance, you should consult with qualified and experienced legal counsel or a qualified and knowledgeable financial advisor first.
The areas of law that will likely develop further related to merchant cash advances are:
Usury Laws: Most jurisdictions in the United States have some sort of usury laws on their books. Usury laws set a cap on the interest rates that can be charged by a lender. Merchant Cash Advance lenders commonly attempt to use a factor rate as opposed to an interest rate to calculate the costs and fees of your loan/advance. As noted throughout this website, reconciliation rights and a conditional obligation of repayment are key.
Licensing and Registration: Jurisdiction-dependent (like California noted above). Regulators may require MCA lenders to be licensed as alternative financing providers. These measures are designed to make certain that lenders maintain minimal standards to operate lawfully.
Truth in Lending Act (TILA): TILA mandates disclosure of key terms and costs of credit to borrowers. Whether MCAs fall under TILA laws can depend on the MCA contractual agreement itself as well as the conduct of the lender and their representatives.
Small Business Regulations: While greatly limited at this time, certain jurisdictions have created targeted regulations to protect small business owners from predatory lending. These regulations could create additional disclosure, servicing, and collection requirements for MCA lenders.
Disclosure Requirements: Again, while very limited at this time, a small percentage of jurisdictions in the United States are moving towards requiring MCA lenders to disclose clear terms concerning merchant cash advance fees and repayment structure/obligations.
New York Is the Primary Litigation Battleground
In the absence of government oversight or regulation, many merchant borrowers have looked to the courts for relief.
A majority of MCA contracts require New York law as the choice of law for any dispute.
As a result, the subject of merchant cash advance agreements and whether they constitute loans or, rather, a lawful sale of future receivables has been considered by numerous New York courts.
Those cases examine not only the contractual agreements but also the conduct of the lenders during the application process and the collection process.
Recent decisions evaluating whether merchant cash advance agreements are lawful sales of future receivables or unlawful usurious loans cite certain factors to determine if the transaction (and the lender conduct) liens towards an unconditional obligation of repayment or, rather, a conditional/contingent repayment obligation.
An unconditional/non-contingent obligation to repay is effectively a loan.
Consider an unconditional payment obligation, like a mortgage, that the borrower is legally obligated to repay, no matter the borrower’s circumstances.
On the other hand, a contingent obligation to repay means that if a borrower goes out of business, the remaining debt does not need to be repaid. It is contractually tied to future receivables.
Likewise, if a borrower’s revenues or receivables are reduced, the borrower’s contingent repayment obligation should be reduced accordingly.
FTC and NY Attorney General Target Merchant Cash Advance Companies
In 2020, the Federal Trade Commission and the New York Office of the Attorney General filed actions against two merchant cash advance companies – RCG Advances and Ram Capital Funding in the Southern District of New York and the Supreme Court of the State of New York County of New York, respectively.
The critical elements of those cases examine the following.
Marketing
The primary allegations by the FTC concerning marketing relate to misleading claims.
The FTC alleged that although the defendants’ websites stated that the MCA requires no personal guarantee from business owners, the contracts actually contain a personal guarantee provision.
A personal guarantee is an unconditional/non-contingent obligation to repay.
Collection Practices
According to the FTC, the use of confessions of judgment conflicts with the defendants’ contracts that “provide that Defendants will not hold consumers in breach if payments are remitted more slowly.”
Finally, the FTC also claims that defendants made threatening calls to consumers related to repayment of the advances.
Recharacterization
Along with similar claims and allegations advanced by the FTC, the New York Attorney General pleaded that defendant merchant cash advance lenders “disguise each loan as a ‘Purchase and Sale of Future Receivables,’ but in reality, … the transactions are loans.”
The New York Attorney General cited several examples of why defendants’ cash advances are loans.
This includes the marketing of their advances as loans, using underwriting practices that factor in merchants’ credit ratings and bank balances (instead of their receivables), and not reconciling the merchants’ repayment of the advances. In sum, reconciliation is critical.
The MCA Industry Was Attacked in California
The merchant cash advance industry faced a series of class-action lawsuits in California.
Some of the cases settled once the plaintiffs were able to show that the documentation for these transactions used loan terminology or that the owners had signed broad repayment guarantees.
Because California law does not limit interest rates for most loans of $2,500 or more made by a licensed entity, merchant cash advance companies began obtaining California Finance Lenders Law, “CFLL,” licenses.
Once a merchant cash advance company has a CFLL license, even if the transactions are re-characterized as loans, the transactions are not usurious under state law.
Many lenders added language to their contracts to include: Buyer (lender) and seller (business owner) acknowledge and agree that seller going bankrupt or going out of business, in and of itself, does not constitute a breach of agreement. Thereby affirming that a merchant cash advance borrower has only a conditional obligation to repay.
Florida Court Affirms That Merchant Cash Advance Not Subject to State Usury Statute
In 2021, an appeals court in Florida ruled that a merchant cash advance purchase and sale of future receivables was not a “disguised loan” and, consequently, was not governed by Florida’s criminal usury statute.
While a few states have fairly well-developed case law distinguishing loans from a purchase and sale of receivables, Florida did not have much prior legal authority regarding the issue.
In Craton Entertainment, LLC v. Merchant Capital Group, LLC, Florida’s 3rd DCA delivered an opinion ruling that an MCA purchase and sale agreement was not a loan.
The Plaintiff, Craton, had argued that the agreement contained the elements of a loan. For example, the plaintiff cited the lender’s practice of performing a business credit check. Also, the existence of the personal guarantee signed by the business owner, as well as the lack of language in the MCA agreement regarding the conditional nature of repayment and, specifically, forgiveness and voiding clauses.
The Defendant, Merchant Capital, argued that the parties knowingly entered into a buy-sell agreement as evidenced by the clear language in the contract.
The court found that there were conditional repayment elements in the agreement, with Merchant Capital’s ability to obtain any funds from Craton being expressly conditioned on the borrower company being able to earn revenue.
The court also found that the business owner’s personal guarantee did not unconditionally guarantee repayment, but instead, the business owner had guaranteed the business’ performance under the agreement only.
NJ Attorney General Reaches Settlement With MCA Company After Alleged Unfair and Deceptive Practices
In December of 2022, the New Jersey Division of Consumer Affairs entered into a consent order with Yellowstone Capital LLC and a number of affiliated entities to address allegations arising from violations of the New Jersey Consumer Fraud Act.
The consent order states that Yellowstone engaged in abusive lending practices with small business owners.
As per the settlement agreement, Yellowstone was required to reform its reconciliation procedures by providing more reasonable and fair reconciliation terms to merchants, including permitting merchant borrowers more time to request a reconciliation and requiring that reconciliations cover the “entire” transaction and are not limited to the preceding month, only.
Yellowstone was also required to develop and deploy new procedures to:
- Inform merchants not in default that they may request more favorable reconciliations;
- Review accounts when merchants default before sending the accounts to collection;
- Provide certain notices related to default.
As per the consent order, Yellowstone was also required to revise contractual provisions in order to limit the scope of personal guarantees and to improve disclosures.
Second Circuit Rules to Bring RICO Case Law in Line With New York State MCA Decisions
The United States 2nd Circuit Court of Appeal issued an order in Fleetwood Services LLC vs. Richmond Capital Group, which upheld a district court judgment in favor of a borrower against an MCA lender.
The court affirmed the lower court’s decision that the subject MCA was actually an illegal usurious loan and upheld the award of damages to the plaintiff under the plaintiff’s civil (RICO claim.
The Second Circuit expressly adopted the three-part test regularly applied by the New York state courts in analyzing whether an MCA agreement is actually a purchase of future receivables or a regulated loan.
Those factors are:
- Is there a reconciliation provision in the agreement?
- Did the agreement have a finite term period?
- Is there any lender recourse if the borrower merchant files bankruptcy?
In this instance, the court found that the subject MCA agreement failed part 1 and part 3 of the test.
The reconciliation clause stating that any adjustment of daily payment was in the lender’s “sole discretion” did not afford the borrower a right to reconciliation as required, and the subject agreement permitted lender recourse against the personal guarantors if the merchant declared bankruptcy.
Is Merchant Cash Advance Regulation on Its Way?
As alternative lending becomes more popular in the years to come, MCAs and other online and non-bank lenders will be under greater scrutiny.
Merchant cash advance companies are beginning to be examined much more critically by state and federal governments. In the near future, it seems likely that some type of government regulation will be required to oversee the online and alternative lending industry.
If merchant cash advance regulation happens in the future, it will likely be to require rate disclosures, rate limitations, and other measures to prevent predatory lending.
Work With an Expert to Solve Your Merchant Cash Advance Debt
Is your business struggling with repaying a merchant cash advance?
If you are at risk of defaulting or have already defaulted, then you should strongly consider consulting with a qualified attorney experienced with defending MCA lawsuits.
Laws vary from jurisdiction to jurisdiction and keep evolving. You need a qualified legal professional to advise you not only regarding defending a legal action filed against you but also your rights under the MCA agreement and the protection of your personal and business assets.
Contact the experienced team at Business Debt Law Group to see how we can help you.