Merchant Cash Advance Agreements - Legitimate Purchase of Future Receivables or Disguised Loan?
The relevant factors in determining whether a so-called Merchant Cash Advance (“MCA”) or Purchase of Future Receivables agreement is actually a disguised loan are well-settled under New York law. Where the agreement contains no provisions for forgiveness or modification of the agreement - such as viable and enforceable reconciliation provisions in the event that the funding companies could not collect the daily amounts required - New York courts are more likely to find that the agreement is actually a loan. See e.g. Funding Metrics, LLC v NRO Boston, LLC, 2019 N.Y. Slip Op 32651[U], *5 (Westchester Co. 2019); P & HR Solutions LLC v RAM Capital Funding, LLC, 2019 N.Y. Misc. LEXIS 5992 (New York Co. 2019). As the Erie County Supreme Court stated in McNider Mar., LLC v. Yellowstone Capital, LLC, 2019 Misc. LEXIS 6165, 2019 NY Slip Op 33418[U] (Erie Co. 2019):
Focusing on the reconciliation provision in a given merchant agreement is appropriate because it often determines the risk to the funding company. If the funding company truly is collecting a specified percentage of accounts receivable, then the funding company bears the risk of a downturn in the merchant's business. The specified percentage typically is replaced by a fixed payment (as it was here), but if that payment is reconciled when accounts receivable drop below the merchant's original estimation, then it may take the merchant far longer to repay the amount advanced than the funding company had anticipated.
McNider Marine at *10-11.
Whether the agreement is recognized as a loan or purchase of receivables is not merely an academic exercise - it is often the determining factor in a Court’s decision regarding the enforceability of the agreement. This is because, in practice, when defined as loan repayments, the future receivable payments often violate New York’s criminal usury law, which defines interest rates greater than 25% per year as criminal usury. Loans requiring repayment at criminally usurious rates are unenforceable. Since these agreements also tend to involve a personal guaranty and/or confession of judgment by the owners of the company receiving the funding, this determination can have significant impacts on the personal finances of business owners involved in such funding.
Of course, the funding companies are well aware of this case law. As result, the agreements - which are generally drafted by the funding companies - almost always contain provisions designed to at least give the appearance of a reconciliation provision. However, statements such as “THIS IS NOT A LOAN” do not necessarily carry the day in New York courts. If you are faced with a default on an MCA Agreement or a funding company has commenced collection efforts against you for default, it is important to have your agreement reviewed by an attorney to determine whether it is enforceable under New York law.