Structure of the Merchant Cash Advance

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Structure of the Merchant Cash Advance

Since the early 1990s, Merchant cash advance (“MCA”) companies have provided working capital to small to mid-size retailers and businesses through a specialized form of factoring.

  1. The merchant cash advance company purchases receipts generated from a merchant’s future sales.
  2. The merchant authorizes the merchant cash advance company to receive a certain percentage of its future daily sales receipts, or a fixed daily amount estimated to equal this percentage.
  3. The merchant either authorizes their own credit card processor to send the agreed percentage of daily sales receipts directly to the merchant cash advance company or the merchant authorizes the merchant cash advance company to ACH the agreed amount from the merchant’s checking account.
  4. These amounts are generally transferred each day until the merchant cash advance company has received all of the future receipts it has purchased.

Application of Usury Law

Application of the law of usury to a sales transaction like a merchant cash advance is not easy for the following reasons:

  • Usury focuses on the interest rate, and MCAs don’t quote an interest rate and don’t have a specified term from which to compute interest.  Also – many states don’t have caps or they exempt most common loan transactions from usury laws.
  • It is impossible to determine at the point of contracting whether cash advance contract with no set legal payback terms is usurious. The only manner in which to determine that is upon completion of the transaction and collection time line.
  • The maximum interest rate for unsecured commercial loans vary from state to state and so do the penalties associated with such violations. In some states, if usury laws are violated, the Court will order the excess interest paid to be returned to the borrower. Other states may have to return all the interest charged. In New York, the entire transaction is unenforceable if usury laws have been broken.

Avoiding usury claims – MCA companies create the appearance of conditionality

In a Merchant Cash Advance transaction, the creditor’s payments are directly linked to and contingent upon the receiver’s business income.  In a loan, there is an unconditional right to repayment regardless of the state of the recipient’s business or financial affairs.

To be usurious, and subject to state usury laws, the arrangement has to be considered a loan. Common law generally recognizes that to become a loan transaction subject to a state usury law or licensing requirement, the advance must be unconditionally repayable. If the obligation to repay is conditional, and the conditions are not illusory, then the transaction generally is not a loan. There are no known state law exceptions to this common law rule.

To make sure the repayments are/look conditional, the MCA lenders must make certain that the merchant borrower does not unconditionally agree to “repay” the advances. Here are the terms of the loan agreement that courts acknowledge as evidence of a purchase of receivables rather than a loan:

  • The merchant is only selling its future receipts to the extent they are available.  So, if cash receipts drop due to adverse business conditions (loss of site, disasters or similar material adverse change), the merchant cash advance company suffers the loss.
  • Bankruptcy isn’t a breach of contract or element of default
  • The merchant generally agrees not to engage in fraud or other practices that would intentionally deny the merchant cash advance company its purchased receivables.
  • The owner of the merchant business guarantees that the business will not breach any covenants in the merchant cash advance agreement, but the owner is not an unconditional guarantor of repayment.
  • The merchant’s obligation to deliver the future receivables is conditioned upon the continuance of the merchant’s business.

Recent case law supporting the finding of a loan in a merchant cash advance

QFC, LLC v Iron Centurian, LLC 2017 WL 2989222, 2017 N.Y. Slip Op. 31438(U) (N.Y. Sup. Ct. July 5, 2017)

  • QFC – “Denominating a loan document by another name, as in this case, by calling it a Merchant Agreement, and including in it verbiage of [the funder’s] purported purchase of accounts receivable that is unsupported by actual [business] receivables dedicated to repayment, does not shield it from the judicial determination that it contemplates a criminally usurious transaction, which is void ab initio as a matter of law.”

Merch. Funding Servs., LLC v. Volunteer Pharmacy Inc. 55 Misc. 3d 316 (N.Y. Sup. Ct. 2016)

  • Volunteer – The possibility of a debtor filing for bankruptcy or insolvency is not a risk or hazard which avoids usury.

Pearl Capital Rivis Ventures, LLC v. RDN Const., Inc., 54 Misc. 3d 470 (N.Y. Sup. Ct. 2016)

  • Pearl Capital – “[T]he real purpose of the Agreement was for plaintiff to lend money to defendants at the usurious interest rate set forth therein, and that defendant agreed to borrow the money based on the same usurious terms dictated by plaintiff”
    21

Recent cases supporting MCAs as receivable purchases

Yellowstone Capital v. Central USA Wireless

  • “The only ‘proof’ that Defendants submit in support of their usury claim are self-serving misconstructions of cherry-picked provisions of the merchant agreement, and an outright disregard for contrary provisions contained in that document,”
  • “The Court determines, in light of the history of these litigated matters and known binding precedent, Plaintiff is entitled to recover reasonable attorneys’ fees and costs incurred in defending the Motion [..],”
  • Specifically stated that the finding in Volunteer Pharmacy was an outlier and not applicable to other counties in NY.

Ibis Capital Group, LLC, v. David Fletcher

  • Whether the agreement contains a reconciliation clause. If not, it may be considered a loan.
  • Whether the agreement has finite term. If the term is indefinite, then it “is consistent with the contingent nature of each and every collection of future sales proceeds under the contract.” This is because the company’s “collection of sales proceeds is contingent upon lender’s actually generating sales and those sales actually resulting in the collection of revenue.”
  • Whether the company has a recourse if the merchant declares bankruptcy.

Colonial Funding v Epazz

  • The court focused on the reconciliation clause noting that “Defendants’ argument that the actual daily payments ensure that TVT will be paid the full receipts purchased amounts within approximately 61 to 180 business days . . . is contradicted by the reconciliation provisions which provide that if the daily payments are greater than 15% of Epazz’s daily receipts, TVT must credit the difference to Epazz, thus limiting Epazz’s obligation to 15% of daily receipts.”
  • The court further noted that “[n]o allegation is made that TVT ever denied Epazz’s request to reconcile the daily payments.”

Structure of the Merchant Cash Advance

Structure of the Merchant Cash Advance

Since the early 1990s, Merchant cash advance (“MCA”) companies have provided working capital to small to mid-size retailers and businesses through a specialized form of factoring.

  1. The merchant cash advance company purchases receipts generated from a merchant’s future sales.
  2. The merchant authorizes the merchant cash advance company to receive a certain percentage of its future daily sales receipts, or a fixed daily amount estimated to equal this percentage.
  3. The merchant either authorizes their own credit card processor to send the agreed percentage of daily sales receipts directly to the merchant cash advance company or the merchant authorizes the merchant cash advance company to ACH the agreed amount from the merchant’s checking account.
  4. These amounts are generally transferred each day until the merchant cash advance company has received all of the future receipts it has purchased.

Application of Usury Law

Application of the law of usury to a sales transaction like a merchant cash advance is not easy for the following reasons:

  • Usury focuses on the interest rate, and MCAs don’t quote an interest rate and don’t have a specified term from which to compute interest.  Also – many states don’t have caps or they exempt most common loan transactions from usury laws.
  • It is impossible to determine at the point of contracting whether cash advance contract with no set legal payback terms is usurious. The only manner in which to determine that is upon completion of the transaction and collection time line.
  • The maximum interest rate for unsecured commercial loans vary from state to state and so do the penalties associated with such violations. In some states, if usury laws are violated, the Court will order the excess interest paid to be returned to the borrower. Other states may have to return all the interest charged. In New York, the entire transaction is unenforceable if usury laws have been broken.

Avoiding usury claims – MCA companies create the appearance of conditionality

In a Merchant Cash Advance transaction, the creditor’s payments are directly linked to and contingent upon the receiver’s business income.  In a loan, there is an unconditional right to repayment regardless of the state of the recipient’s business or financial affairs.

To be usurious, and subject to state usury laws, the arrangement has to be considered a loan. Common law generally recognizes that to become a loan transaction subject to a state usury law or licensing requirement, the advance must be unconditionally repayable. If the obligation to repay is conditional, and the conditions are not illusory, then the transaction generally is not a loan. There are no known state law exceptions to this common law rule.

To make sure the repayments are/look conditional, the MCA lenders must make certain that the merchant borrower does not unconditionally agree to “repay” the advances. Here are the terms of the loan agreement that courts acknowledge as evidence of a purchase of receivables rather than a loan:

  • The merchant is only selling its future receipts to the extent they are available.  So, if cash receipts drop due to adverse business conditions (loss of site, disasters or similar material adverse change), the merchant cash advance company suffers the loss.
  • Bankruptcy isn’t a breach of contract or element of default
  • The merchant generally agrees not to engage in fraud or other practices that would intentionally deny the merchant cash advance company its purchased receivables.
  • The owner of the merchant business guarantees that the business will not breach any covenants in the merchant cash advance agreement, but the owner is not an unconditional guarantor of repayment.
  • The merchant’s obligation to deliver the future receivables is conditioned upon the continuance of the merchant’s business.

Recent case law supporting the finding of a loan in a merchant cash advance

QFC, LLC v Iron Centurian, LLC 2017 WL 2989222, 2017 N.Y. Slip Op. 31438(U) (N.Y. Sup. Ct. July 5, 2017)

  • QFC – “Denominating a loan document by another name, as in this case, by calling it a Merchant Agreement, and including in it verbiage of [the funder’s] purported purchase of accounts receivable that is unsupported by actual [business] receivables dedicated to repayment, does not shield it from the judicial determination that it contemplates a criminally usurious transaction, which is void ab initio as a matter of law.”

Merch. Funding Servs., LLC v. Volunteer Pharmacy Inc. 55 Misc. 3d 316 (N.Y. Sup. Ct. 2016)

  • Volunteer – The possibility of a debtor filing for bankruptcy or insolvency is not a risk or hazard which avoids usury.

Pearl Capital Rivis Ventures, LLC v. RDN Const., Inc., 54 Misc. 3d 470 (N.Y. Sup. Ct. 2016)

  • Pearl Capital – “[T]he real purpose of the Agreement was for plaintiff to lend money to defendants at the usurious interest rate set forth therein, and that defendant agreed to borrow the money based on the same usurious terms dictated by plaintiff”
    21

Recent cases supporting MCAs as receivable purchases

Yellowstone Capital v. Central USA Wireless

  • “The only ‘proof’ that Defendants submit in support of their usury claim are self-serving misconstructions of cherry-picked provisions of the merchant agreement, and an outright disregard for contrary provisions contained in that document,”
  • “The Court determines, in light of the history of these litigated matters and known binding precedent, Plaintiff is entitled to recover reasonable attorneys’ fees and costs incurred in defending the Motion [..],”
  • Specifically stated that the finding in Volunteer Pharmacy was an outlier and not applicable to other counties in NY.

Ibis Capital Group, LLC, v. David Fletcher

  • Whether the agreement contains a reconciliation clause. If not, it may be considered a loan.
  • Whether the agreement has finite term. If the term is indefinite, then it “is consistent with the contingent nature of each and every collection of future sales proceeds under the contract.” This is because the company’s “collection of sales proceeds is contingent upon lender’s actually generating sales and those sales actually resulting in the collection of revenue.”
  • Whether the company has a recourse if the merchant declares bankruptcy.

Colonial Funding v Epazz

  • The court focused on the reconciliation clause noting that “Defendants’ argument that the actual daily payments ensure that TVT will be paid the full receipts purchased amounts within approximately 61 to 180 business days . . . is contradicted by the reconciliation provisions which provide that if the daily payments are greater than 15% of Epazz’s daily receipts, TVT must credit the difference to Epazz, thus limiting Epazz’s obligation to 15% of daily receipts.”
  • The court further noted that “[n]o allegation is made that TVT ever denied Epazz’s request to reconcile the daily payments.”
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