Our previous article discussed the predictability of usury litigation involving Merchant Cash Advance (MCA) agreements with choice of law clauses in New York, even though we had assumed that things were going to get (a bit) crazier. But New York is not the only forum in which MCA customers (referred to as “merchants”) assert usury claims.
Despite New York’s choice of law and venue provisions, MCA funders are often forced to defend the legality of their New York MCA agreements when domesticating judgments or being sued by merchants in Sister States, or when making claims in the bankruptcy courts where the debtor merchants are. . Sometimes these procedures don’t go well for funders, but they provide instructive lessons for securing MCA contracts.
New York cases generally favor MCA backers, unless the contract is poorly drafted.By our count, at least 49 New York decisions have found MCA agreements to be purchases of future receivables, not loans, and therefore not subject to New York’s 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 funder assumes the risk that the trader’s business fails. This is true even when the funder takes security for the merchant’s performance of the MCA agreement, such as admissions of judgment, sureties, and personal guarantees.
When the New York courts found that the MCA agreements were loans disguised as MCA, it was usually because the agreements failed the three-factor test LG Funding v. United Senior Props. of Olathe181 AD3d 664, 666 (2d Dep’t 2020) (“(1) if there is a reconciliation clause in the agreement; (2) if the agreement has a fixed term; and (3) if there is recourse if the merchant declares bankruptcy.”).
For example, Advanced services. Group c. Acadian Props. Austin, 2021 NY Various. LEXIS 1138, *13-17 (Kings Co. Sup. Ct. Mar. 12, 2021), granted a merchant’s counterclaim for summary judgment dismissing an MCA recovery action for failing at first and third LG Financing The factors. The matching provision in the agreement – intended to allow the merchant to request that its fixed daily payments more accurately assess a specified percentage of its diminished claims, on the simple condition that the funder “may…in its sole discretion” grant reconciliation. Since the reconciliation was discretionary, the court ruled that “the lender’s right to repayment was absolute, rather than conditional, and is therefore indicative of a loan, in law.”
In addition, the agreement provided that the confession of judgment and personal guarantee could be enforced immediately upon filing for bankruptcy, stating:unduly for a true MCA agreement – that a merchant bankruptcy was in itself a violation. The court held that in this situation, the usury savings clause of the agreement (which would have reduced the interest rate to the highest rate under applicable law) violated public policy.
Some out-of-state cases punish MCA funders with poorly drafted contracts. Although the New York courts have provided a good indication of what they are looking for when analyzing MCA agreements, MCA litigation can be trickier when out of state or in bankruptcy courts. . Certainly, some out-of-state courts dutifully enforce New York’s choice of law clauses and dismiss usury claims when raised by out-of-state merchants. See, for example, AKF vs. Upcountry Servs. by Sharon, 2020 Conn. Great. LEXIS 221, at *7-9 (Conn. Super. Ct. Feb. 5, 2020) (dismissing merchant usury defense); Gecker v. LG Funding (In re Hill), 589 BR 614, 621-23 (Bankr. ND Ill. 2018) (dismissing adversarial proceedings to recover alleged fraudulent transfers to MCA funder and dismissing funder’s claims). However, litigation isn’t 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 Banker. LEXIS 3157, *9-17 (Bankr. Mo. Nov. 6, 2020), which denied summary judgment to a moneylender seeking a declaration of his rights to funds in some of the merchant’s accounts, the court found only no material difference between results Montana law, where debtor was located, and New York law, and Montana law applied.
In a swipe at the funder, the court ruled that the “collective effect” of some of the protections ensuring merchants’ compliance with the agreement created “an allocation of risk whereby [the funder] is backed by much more than just the value of the receivables he supposedly purchased” and was likely 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”, a confession of judgment, an assignment of lease on the merchant’s building and an obligation to provide bank statements within five days.
It didn’t help that the correspondence showed that the funder itself referred to MCA transactions as “loans” with “conditions”, and that bank statements showed the remittances came from mixed accounts instead. as trader receivables deposits.
Next come the contrasting decisions handed down simultaneously by the same judge-commissioner in GMI Group bankruptcy, both decided under New York law. In GMI Grp. v. Fast and reliable cash, 2019 Banker. LEXIS 2494, at *20-33 (Bankr. ND Ga. Aug. 9, 2019), the court entered summary judgment dismissing the merchant’s adversarial proceeding seeking to void the MCA agreement.
In addition to ruling that the agreement was not a loan under a LG Financing-similar to the analysis, the court rejected the merchant’s argument that a provision requiring the amount of the daily rebate to be maintained in the merchant’s account converts the agreement into a loan, since the provision exempted the merchant from default if he gave sufficient notice to the funder that he had a low balance due to a downturn in business and cooperated by providing financial information to the funder.
On the other hand, in GMI Grp. v. Unique funding floors.606 BR 467, 487-88 (Bankr. ND Ga. Aug. 9, 2019), the court found that a different MCA agreement was a loan because a provision”[r]requiring the debtor to have twice the daily amount in their accounts each day during the term of the agreement secures the debtor’s default (and in turn, repayment of the purchased amount).
The court also ruled that the reconciliation provision, which limited a merchant’s right to reconcile to once a month, wrongly prevented a merchant from obtaining a second reconciliation during a single month of operational downturn. continued.
Finally, the court was bothered by the lack of clarity in the agreement as to when the new daily payment amount would come into effect and whether the merchant would be in breach if they paid less than the previously effective daily amount while the reconciliation request was pending.
In Saturn Funding v. NRO Bos., mass 2017. Great. LEXIS 3, at *4 (February 21, 2017), the court declined to enforce a New York judgment by admission 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 laws.
Notably, however, the funder apparently did not oppose the merchant’s cancellation request on the merits, and the court’s conclusion was based solely on the figures on the front of the document, rather than on an in-depth analysis. of its basic structure.
Finally, in a first MCA case, Essex Partners Ltd. vs. Merch. Cash and capital, 2011 US Dist. LEXIS 172116, *7-18 (CD Cal. Aug. 1, 2011), the court determined that California law should apply, in the absence of material difference between California law and New York law. The court held that even when the agreement stipulated that payment was to be made by the merchant’s credit card processor of a percentage of the plaintiffs’ daily credit card receivables—an amount apparently truer sale as it directly correlates to the ebb and flow of merchant receivables and does not require manual reconciliation by the funder – the protections afforded by the MCA Agreement made it a loan shark under California law.
Repair your contracts already. Regardless of the fact that the ceiling appeal, GMI Group, NRO Boston and Essex Partners the courts were right on all counts – and if we could step in and appeal, we certainly have some arguments to make – they are a stark reminder to MCA funders that their deals will not always be judged by courts bound by the LG Financing previous. These out-of-state cases provide teaching points to ensure MCA agreements are structured to avoid even the perception that they may be loans. If even one court sees a particular agreement as a loan, then overall it seems like a good idea to revise the contracts to address those concerns before another court, even in New York, takes up the same Questions.
Many of the provisions these courts have found to be indicia of loans are identical to some we have seen in older MCA forms still used by some lenders. With ever-changing MCA case law – and in some cases defined by out-of-state courts – and regulation on the horizon, MCA funders must review their agreements vigilantly and constantly.
Jacob H. Nemon is associated and Boxer Jeffrey S. is a partner in the litigation department of Carter Ledyard & Milburn. They regularly represent MCA funders in contested usury litigation and advise them on compliance.