Our previous article discussed the predictability of usury-related litigation involving Merchant Cash Advance (MCA) agreements with New York law choice clauses in New York, although we postulated that things were going to get (a little) crazier. But New York is not the only forum in which MCA customers (known as âmerchantsâ) claim usury rights.
Despite New York’s choice of law and place provisions, MCA backers are often forced to defend the legality of their New York MCA agreements when domesticating judgments or suing traders in sisterly states. , or when they file claims in bankruptcy courts where debtor merchants are located. Sometimes these procedures do not go well for funders, but they provide useful lessons for securing MCA contracts.
New York business generally favors MCA backers, unless the contract is poorly drafted.In our opinion, at least 49 New York rulings have concluded that the MCA agreements are purchases of future receivables, not loans, and therefore not subject to New York usury laws. An MCA is the purchase of a company’s receivables and, rather than having an absolute right to recover the purchase price, the lender takes the risk that the merchant’s business will fail. This is true even when the funder takes security for the performance of the MCA contract by the merchant, such as admissions of judgment, security and personal guarantees.
When the New York courts ruled that the MCA agreements were loans disguised as MCA, it was usually because the chords failed the three-factor test in LG Funding v. United Senior Props. from Olathe, 181 AD3d 664, 666 (2d Dep’t 2020) (“(1) if there is a reconciliation provision in the agreement; (2) if the agreement has a fixed term; and (3) s’ there is a remedy if the merchant declares bankruptcy. â).
For example, Advanced Services Group v. Acadian Props. Austin, 2021 NY Miscellaneous. LEXIS 1138, * 13-17 (Kings Co. Sup. Ct. March 12, 2021), allowed a merchant’s counterclaim for summary judgment dismissing an MCA recovery action for having failed the first and third LG financing The factors. The reconciliation provision of the agreement, intended to allow the merchant to request that its fixed daily payments more accurately estimate a specified percentage of its reduced receivables, provided simply that the funder “may … in its sole discretion” grant a reconciliation. Because the reconciliation was discretionary, the court ruled that âthe funder’s right to repayment was absolute, rather than conditional, and therefore indicative of a loan, in lawâ.
In addition, the agreement provided that the admission of judgment and the personal guarantee could be enforced immediately after a bankruptcy filing, stating:incorrectly for a true MCA deal – that a trader’s bankruptcy was itself a violation. The court ruled that in this situation, the agreement’s usury savings clause (which would have reduced the interest rate to the highest rate under applicable law) violated public order.
Some out-of-state cases punish MCA backers with poorly drafted contracts. While courts in New York have provided a good indication of what to look for when analyzing MCA agreements, MCA disputes can be more delicate when they arise out of state or in court. of bankruptcy. To be sure, some out-of-state courts conscientiously apply New York City’s choice clauses and reject usury claims when raised by out-of-state traders. See, for example, AKF v. Upcountry Serv. by Sharon, 2020 Connecticut Super. LEXIS 221, at * 7-9 (Conn. Super. Ct. February 5, 2020) (rejecting the trader’s usury defense); Gecker v. LG Funding (In re Hill), 589 BR 614, 621-23 (Bankr. ND Ill. 2018) (rejecting the adversarial procedure to recover the alleged fraudulent transfers to the MCA funder and reject the claims of the funder). However, litigation is not always rosy for funders in foreign forums, despite New York’s choice of law provisions.
In Cap Call v. Foster (In re Shoot the Moon), 2020 Bank LEXIS 3157, * 9-17 (Bankr. Mo. November 6, 2020), which denied summary judgment to a lender seeking a declaration of its rights to funds in some of the merchant’s accounts, the court did found no material difference between Montana law, where the debtor was located, and New York law, and Montana law applied.
Striking a blow to the lender, the court ruled that the “collective effect” of some of the protections ensuring the merchant’s compliance with the agreement created “a distribution of risk whereby [the funder] is protected by much more than the mere value of the receivables he allegedly purchased âand was probably a loan. These protections included a security interest in all of the merchant’s assets (not just the receivables sold), a security interest and a guarantee for both “Payment and execution â, an admission of judgment, an assignment of lease on the merchant’s building and the obligation to provide bank statements within five days.
It did not help that the correspondence showed that the funder itself referred to MCA transactions as “loans” with “conditions” and that the bank statements showed that the remittances were from mixed accounts rather than from deposits of funds. claims of the merchant.
Then there are the contrasting decisions rendered simultaneously by the same judge-commissioner in the GMI Group bankruptcy, both decided under New York law. In GMI Group. v. Reliable fast cash, 2019 Banque LEXIS 2494, at * 20-33 (Bankr. ND Ga. August 9, 2019), the court issued a summary judgment dismissing the merchant’s adversarial proceedings to quash the MCA agreement.
In addition to deciding that the agreement was not a loan under a LG financing-like the analysis, the court rejected the merchant’s argument that a provision requiring that the amount of the daily rebate be maintained in the merchant’s account transforms the agreement into a loan, since the provision exempted the trader of a default if he gave sufficient notice to the funder that he had a low balance due to a downturn in business and cooperated in providing financial information to the funder.
On the other hand, in GMI Group. v. Unique financing floors., 606 BR 467, 487-88 (Bankr. ND Ga. August 9, 2019), the court concluded that another MCA agreement was a loan because a provision “[r]requiring the debtor to have twice the daily amount in his accounts each day during the term of the agreement guarantees the debtor’s default (and in turn, repayment of the amount purchased).
The court also ruled that the reconciliation provision, which limited the merchant’s right to a reconciliation to once per month, improperly prevented a merchant from obtaining a second reconciliation during a single month of continuous operational downturn.
Finally, the court was hampered by the lack of clarity in the agreement as to when the new daily payment amount would go into effect and whether the merchant would be in breach if he paid less than the previously effective daily amount while the reconciliation request was pending.
In Saturn financing c. NRO Bos., 2017 Mass. Great. LEXIS 3, at * 4 (February 21, 2017), the court refused to enforce a New York judgment by confession against a Massachusetts merchant and guarantor after he was domesticated in Massachusetts, finding that the agreement under Underlying was a loan that violated Massachusetts Usury and Consumer Protection statutes.
Notably, however, the funder apparently did not substantially oppose the trader’s request for release, and the court’s conclusion was based solely on the numbers on the front of the document, rather than a deep dive into its substantial structuring.
Finally, in a first case of MCA, Essex Partners Ltd. vs. Merch. Cash and capital, 2011 US Dist. LEXIS 172116, * 7-18 (CD Cal. August 1, 2011), the court determined that California law should apply, in the absence of any material difference between California law and New York law. The court ruled that even when the agreement called for payment to be made by the merchant’s credit card processor for a percentage of the plaintiffs’ daily credit card receivables â an amount apparently truer sale because it correlates directly to the ebb and flow of merchant receivables and does not require manual reconciliation by the lender – the protections offered by the MCA agreement make it a usurious loan under California law.
Repair your contracts already. It doesn’t matter if the Cap call, GMI Group, NRO Boston and Essex Partners the courts were right on every point – and if we could step in and appeal, we certainly have some points to make – they are a stark reminder to MCA funders that their deals will not always be judged by courts bound by the law. LG financing previous. These out of state cases provide teachable points to ensure that MCA agreements are structured in such a way as to avoid even the perception that they may be loans. If even one court views a particular agreement as a loan, then overall it seems a good idea to revise contracts to address those concerns before another court – even one in New York – grabs the same issues. .
Many of the provisions that these courts considered to be indicative of loans are identical to some we saw in the old MCA forms still used by some lenders. With the MCA’s case law constantly evolving – and in some cases defined by courts outside the state – and regulation on the horizon, MCA funders need to vigilantly and constantly review their agreements.
Jacob H. Nemon is associated and Jeffrey S. Boxer is a partner in the litigation department of Carter Ledyard & Milburn. They regularly represent MCA’s funders in disputed usury disputes and advise them on compliance.