Traditionally, the merchant cash advance (MCA) industry originated in New York City, and its law continues to be the law of choice in many MCA agreements. This has led to a lot of litigation because, unlike dozens of other states, New York has a 25% criminal usury limit on business loans. In many disputes, MCA lenders argue that MCA agreements are not loans and are therefore exempt; while professional clients (called “traders”) seeking to evade their obligations, unsurprisingly, argue that these are in fact loans subject to capping.
There are now dozens of first instance decisions and several appeal decisions on this issue. This well-developed MCA case law has resulted in more careful drafting of MCA agreements in recent years, but some recent decisions suggest that MCA litigation is about to get wilder.
MCA agreements are purchases of future receivables, not loans. When properly drafted, MCA agreements should not be subject to a usury cap because an MCA is not structured like a loan. In practice, however, wear and tear caps have fueled much litigation against MCA’s backers, particularly in New York City.
MCA transactions are akin to traditional factoring agreements. The funder buys the future receivables for a predetermined price, and repayment depends on the success of the business. It is important to note that unlike a loan, the business does not have an absolute repayment obligation. A merchant is not required to forgive receivables that it does not receive as a result of a business bankruptcy, and the merchant’s remaining non-debt assets cannot be foreclosed. There is also no interest rate in the MCA agreement that would result in an increase in the gross amount that the company is required to pay if its receivables are delivered over a longer period than initially estimated. These fixed payments are estimates of an agreed percentage of the average daily receivables which can be adjusted at the merchant’s request if the receivables decrease. Initially, the backer of the MCA takes the risk of not being reimbursed in the event of bankruptcy of the company.
Nonetheless, traders often sue MCA lenders who seek to rescind the agreements they maintain as mere “disguised” loans with outright repayment obligations. Traders generally claim that when their daily fixed receivables payment amounts are annualized, they would effectively pay the lender a rate well over 25% per annum. Most of the lawsuits were dismissed at the lower court level because the written agreements prove that the MCAs were not loans. In addition, many courts have found that despite various protections for donors, such as security agreements, personal performance guarantees and admissions of judgment, donors still run the substantial risk of failing. never recoup their investments if the business failed.
This has been especially true for MCA agreements which contain a “reconciliation” provision that allows the company to request, and requires the funder to provide, an adjustment to the company’s daily payments to reflect the decrease in receivables. medium. Such agreements, which reflect the actual ebb and flow of the business and adjust remittances accordingly, are generally not considered loans.
MCA Appeal Decisions. New York, the most important state for MCA, until recently had no guidance from the courts of appeals.
In 2018, the First Department released a terse decision that appeared to give the green light to the MCA deals in New York. See Champion Auto Sales vs. Pearl Beta Financing, 159 AD3d 507, 507 (1st Dep’t 2018) (noting that “[t]The evidence shows that the underlying agreement which led to the judgment by confession was not a usurious transaction. However, the ruling did not provide any detailed framework for determining what provisions of an MCA agreement could convert it from a legal purchase contract to a usurious loan.
Some of these details were provided by the second department in LG Funding v. United Senior Props. from Olathe, 181 AD3d 664, 666 (2d Dep’t 2020), which adopted a three-part test used by some lower courts to determine whether an MCA was a loan: “(1) whether there is a reconciliation provision in the agreement; (2) whether the agreement has a fixed term; and (3) whether there is a remedy if the merchant declares bankruptcy ”. The nature of the reconciliation provision was particularly important to Department 2, which focused on the use of the term “may” in the reconciliation provision, which could give the funder discretion to adjust the terms. remittances to reflect the decrease in receivables.
This has created a significant amount of litigation over whether reconciliation is corporate right (and therefore the agreement is not a loan) or discretionary and illusory (thus creating a loan-like absolute payment obligation. ). When the courts before LG financing largely on the donor side, subsequent decisions closely scrutinized the obligation of reconciliation. Where the LG financing Factors indicate that a deal may be a loan, courts have granted preliminary injunctions in favor of traders or dismissed lenders’ dismissal motions.
Last month, the first department of Davis v. Richmond Capital Group, 2021 NY Slip Op. 03111, 1 (1st Dep’t May 13, 2021), upheld the dismissal of a motion to dismiss, finds that the MCA agreements in question may be loans due to:
the discretionary nature of the reconciliation provisions, the allegations that the defendants refused to authorize the reconciliation, the selection of daily payment rates that did not appear to represent a good faith estimate of the receivables, the provisions for the rejection of a direct debit on two or three occasions without notification of an event of default entitling the defendants to immediate reimbursement of the full amount purchased but not collected, and provisions allowing the defendants to recover the personal guarantee in the event of inability to pay or bankruptcy of the applicant company.
This probably means that after Davis the decision of the first instance court will focus on additional provisions in the MCA agreements beyond the LG financing factors to determine the true nature of the transaction. Further, the ruling suggests that, even if the MCA agreement were valid when it was entered into, a subsequent failure by the funder to provide a reconciliation would not only constitute a violation, but could prove that a funder has. treated his deal as a loan rather than an MCA.
The impact of ‘Davis’ is felt. The past few years have seen a spate of litigation against MCA funders by state and federal investigators alleging usury and violations of other consumer protection laws.
In People of New York State v. Richmond Capital Group, NY Co. Index No. 451368/2020, the New York Attorney General alleges that some funders and their constituents violated the Usury Act because of their pre-contractual conduct: transactions are described as “loans” in sales calls, emails, advertising materials and web pages, which also deal with payment terms, and because they are taken out as loans, by looking at credit scores and bank balances rather than historical claims. The NYAG also alleges that post-contractual conduct grants loans to agreements, including filing admissions of judgment or enforcing personal guarantees in the event of a missed single payment, filing false affidavits, double deducting daily payments, and refusing to grant reconciliations.
On June 2, 2021, Supreme Court Justice Andrew Borrok heard oral argument and dismissed the MCA respondents’ motions to dismiss the NYAG motion. He rejected what he described as their “form over substance” argument, namely that because MCA agreements are not structured as loans, they cannot be usurious. Instead, citing the recent Davis decision, he said the NYAG had sufficiently alleged fraudulent conduct on the part of the donors to overcome any rejection on the basis of documentary evidence arguments by the donors.
The court seems to interpret Davis as allowing it to look not only beyond the four corners of an MCA agreement to determine whether there had been usurious intent at the time of the transaction, but to subsequent fault that could retroactively subject the loans of the MCA agreements to the New York usury criminal law.
The recent Davis This decision will likely result in usury lawsuits against the MCA companies. Donors using legacy agreements drafted when the MCA industry was in its infancy are the target of such litigation, but even regularly updated agreements should be reconsidered in this environment.
However, exposure to litigation – and frankly criminal – cannot be mitigated by just a well-written form. Future litigation and investigations may examine not only the four corners of MCA agreements, but also the pre and post-contractual behavior of funders, vendors, underwriters and independent sales offices, to determine if the product has been successful. been properly presented and the actors acted. in accordance with the terms of the agreements.
In addition, various state legislatures (including New York) have introduced or passed legislation covering MCA agreements. These require some pre-contractual disclosures of the terms of the agreements, including, disconcertingly, an annual percentage rate (APR) and a repayment term. However, the MCAs have neither and would be accused of raping two of the three LG financing factors if they did.
It was time to update the MCA agreements, fully comply with New York law, and train staff in the basics of MCA, but the momentum to do so has not expired. MCA funders should contact experienced MCA lawyers to review their forms and advise them on best practices.
Reprinted with permission from the July 2, 2021 edition of the New York Law Journal © 2021 ALM Media Properties, LLC. All rights reserved.
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