A Merchant Cash Advance (“MCA”) allows an MCA provider (“buyer) to purchase future credit or debit card sales from the merchant (“seller”). The payback amount depends on the merchant’s sale volume. Merchant Cash Advances differ from loans because the buyer of the future receivables takes on the risk of non-payment. When a Merchant Cash Advance is constructed correctly, it will not be considered a loan and will not be subject to state usury laws. However, while the original intent was to provide small businesses with an alternative to traditional loans, predatory lenders have disguised their usurious loans as MCA’s to circumvent state usury laws and charge interest rates that exceed the maximum allowed.
TRUE SALE OR LOAN?
Courts have widely held that Merchant Cash Advance agreements are not subject to usury laws because the they are a purchase of future receivables as opposed to a secured loan. Determining whether an agreement is a true sale of future receivables or a loan hidden behind the Merchant Cash Advance name is important since that will decide if the agreement is subject to usury laws or not. While the courts have not articulated a precise test or standard for determining whether a transaction structured as a sale of receivables is really a secured obligation, they have identified factors that should be considered.
- Whether the buyer of the future receivables acquires the risk of loss or whether the risk remains with the seller
- Whether the buyer has the opportunity to recover more than just the principal plus interest, such as retaining all collections
- Whether the seller of the receivables continues to collect the receivables and is allowed to co-mingle it with other funds- (if it is a true sale of future receivables then the purchaser usually gets to collect the set percent of receivables)
- Whether or not the maker of the MCA is absolutely entitled to repayment under all circumstances. For a true loan, it is essential to provide for repayment absolutely and at all events or to secure the principals in some way as distinguished from being put in a hazard.
- The MCA agreement must have an indefinite term, evidencing the contingent nature of the repayment plan.
- Whether the purchaser of receivables has any recourse should the merchant declare bankruptcy.
These factors have been commonly used in making the assessment, however other courts have detailed other factors in making the decision. While there is no exact standard to apply, the burden of proof is on the seller of the future receivables to show that the agreement was actually a loan and not and MCA. The factor with the biggest impact on the outcome of the decision is: who assumes the risk in the case that the seller of the future receivable’s defaults. If the MCA company assumes the risk that they will not be repaid and they do not have a legal recourse in the case that the merchant defaults, this will not be considered a loan and therefore will not be subject to usury laws.
“There can be no usury unless the principal sum advanced is repayable absolutely. If it is payable upon some contingency that may not happen, and that really exposes the lender to a hazard of losing the sum advanced, then the reservation of more than legal interest will not render the transaction usurious, in the absence of a showing that the risk assumed was so unsubstantial as to bear no reasonable relation to the amount charged”
In Pearl Capital Rivis Ventures, the court held that an agreement under the name “Merchant Cash Advance” was actually a loan where the “buyer” could not point to a nonrecourse provision which would force the plaintiff to assume the risk of non-payment.
Denominating a loan document by another name does not shield it from a judicial determination that such agreement contemplates a criminally usurious transaction.
Many Merchant Cash Advance agreements include guarantors. While adding a guarantor does not automatically turn a valid MCA into a loan, the obligations of the guarantor must be the same as those of the Merchant. In Platinum, The New York Supreme Court held that they repayment obligations of the Merchant and the guarantor principal owner, were not unconditional and that the only source of repayment, subject to the MCA, was to come from the “deposited receipts from future transactions.” In this case, the court reasoned that this MCA was not to be considered a loan since the obligations of the personal guarantee were no broader than those of the merchant. Similarly, in Colonial Funding the court held that as long as the obligations of the personal guarantee mirror the obligations if the merchant, the MCA will not become a usurious loan. In Colonial Funding, the guarantor was obligated, along with the merchant, to deposit each day’s collected receivables into a designated account. However, the guarantor was not obligated to make up any deficiencies in the amounts deposited out of his pocket, and therefore the agreement was not a loan.
We represented Gencarelli Pizzeria and Restaurant Inc. in a recent dispute with Merchant Cash Advance companies. Here, the Merchant entered into two usurious loan agreements, one of which was disguised as a Merchant Cash Advance so that it could charge an annual interest rate of 117%. John J. Scura III, Esq., determined that the Merchant Cash Advance contained provision which afforded the Merchant Cash Advance companies a recourse in the event of non-payment by the Merchant.
Specifically, because the agreement contained two additional overbroad guaranties that could be enforced in the event of non-payment and set a timeframe in which the loan was to be paid back, John J. Scura III, determined that this was a usurious loan disguised as a Merchant Cash Advance so that it could charge interest rates exceeding rates allowed by the applicable state laws. Ultimately, on October 6, 2020, we settled the case with the loan company and knocked out all of the interest charges on the usurious loan.