When are Merchant Cash Advances Disguised Loans?

Merchant case advances (MCAs”) are often funding sources of last resort for distressed businesses.

What is a MCA?

A true MCA is a sale of future receivables. The buyer or funder provides cash up front to the seller/borrower equal to a discounted value of the receivables being sold.

How is the buyer repaid?

The repayment is usually deducted as a percentage of the company’s daily or weekly credit or debit card sales until the full amount of the receivables sold is paid.

What are the advantages of MCAs?

MCAs do not necessarily require collateral, are not contingent on a favorable credit history, and can quickly result in the availability of working capital.

What are the disadvantages of MCAs?

MCAs are generally more expensive than traditional loans. The effective annual percentage rate (APR) may greatly exceed the legal limits for conventional loans and could be as much as 200% over the repayment term depending on the amount of the cash advance and lender. Many businesses are unable to service this debt without falling into deeper debt and ultimately failing.

The transactional documents and terms of the MCA are more complicated than a traditional loan and far more confusing. Less scrupulous lenders might disguise a usurious loan as an MCA for the purpose of skirting laws prohibiting loan sharking.

When is an MCA a disguised loan?

Each state and federal circuit may consider different factors in determining when an MCA is a disguised loan.

Under Principis Cap., LLC v. I Do, Inc., 160 N.Y.S.3d 325, 326-327 (2d Dept. 2022), New York courts usually weigh three factors in making that determination: “(1) whether there is a reconciliation provision in the agreement; (2) whether the agreement has a finite term; and (3) whether there is any recourse should the merchant declare bankruptcy.”

June 8, 2023, the United States Second Circuit Court of Appeals issued a summary order in Fleetwood Services LLC v. Richmond Capital Group LLC, 22-1885-cv on June 8, 2023, which adopted the view of the New York state courts and affirmed a district court judgment in favor of a MCA seller, i.e. the merchant, against its funder.

In Florida, MCAs are not subject to Florida’s usury law, unless a court concludes it is a disguised loan, according to a January 6, 2021 order of the Florida Third District Court of Appeal (Appellate Court) entered in Craton Entertainment, LLC, et al., v Merchant Capital Group, LLC, et al.. A copy of the order can be found here.

Merchant Capital Group, LLC dba Greenbox Capital sued Craton in December 2016 over a default in a Purchase and Sale of Future Receivables transaction. In turn, Craton responded with various defenses and counterclaims that asserted the underlying transaction was really an unenforceable usurious loan.  The Circuit Court for Miami-Dade County sided with Greenbox in August 2019. The defendants appealed.

The short Appellate Court order stated only the following in affirming the MCA at issue:

Affirmed. See Saralegui v. Sacher, Zelman, Van Sant Paul, Beily, Hartman & Waldman, P.A., 19 So. 3d 1048, 1051 (Fla. 3d DCA 2009) (reasoning that transaction is not indicative of a loan where repayment obligation is not absolute, but rather contingent or dependent upon the success of the underlying venture); Oregrund Ltd. P’ship v. Sheive, 873 So. 2d 451, 456 (Fla. 5th DCA 2004) (observing that “transactions in which a portion of the investment is at speculative risk” are “excluded from the usury statutes”); Hurley v. Slingerland, 461 So. 2d 282, 284 (Fla. 4th DCA 1985) (holding that where “a portion of appellee’s investment was at risk . . . the transaction was not usurious”); Diversified Enters., Inc. v. West, 141 So. 2d 27, 30 (Fla. 2d DCA 1962) (“When the principal sum lent or any part of it is placed in hazard, the lender may lawfully require, in return for the risk, as large a sum as may be reasonable, provided it is done in good faith.”).

What is the Commercial Finance Disclosure Law?

Several states began adopting the Commercial Finance Disclosure Law (CDFL) in 2022. California and Utah were among the first adopters.

New York and Florida followed suit in 2023. New York’s CDFL is applicable to transactions entered into six (6) months after the enactment. Florida’s CFDL is applicable to “Commercial Financing Transactions” consummated on or after January 1, 2024 that are $500,000 or less and originated by a covered “Provider”.

Prior to the consummation of a covered transaction, the Florida CFDL (and most state versions), codified at Florida Statutes Chapter 559, Sections 559.961, et seq., requires disclosure in writing of:

(i) the total amount of funds provided to the business;

(ii) the total amount of funds disbursed to the business, if different from the amount provided;

(iii) the total amount that the business must pay to the provider;

(iv) the total dollar cost of the terms of the commercial financing transaction, calculated as the difference between the amount that the business must pay to the provider and the total amount of funds provided to the business;

(v) the manner, frequency, and amount of each payment, or if payment amounts may vary, the manner and frequency of payments and an estimate of the amount of the first payment; and

(vi) a statement of whether there are costs or discounts associated with prepayment with reference to provisions in the agreement.

“Commercial Financing Transactions” are defined to included, but not limited to, a commercial loan (meaning, a closed-end loan to a business, whether secured or unsecured) and an accounts receivable purchase transaction (including “commercial financing facility” that contemplates a provider purchasing multiple accounts receivable from a recipient over a period of time), such a MCA.

The Florida Attorney General is given exclusive authority to enforce the CFDL subject to statutory penalty provisions [FL Stats. § 559.9615(1)(a), (c)]. The CFDL does not create a private right of action for alleged violations.

Violations of the law give rise to civil penalties. For each first time violation, the statutory penalty is $500 (maximum aggregate penalty of $20,000). For each repeat violation, the statutory penalty is $1,000 (maximum aggregate penalty of $50,000).

A violation of the Florida CFDL does not render a covered commercial financing transaction void and unenforceable, as would be the case for a criminally usurious loan. [FL Stats. § 559.9615(2)(c).]

David’s Dicta: MCAs are often fundings source of last resort by a desperate merchant. Given the varying terms and risk involved for the merchant, it is critical that the terms and transactional documents be reviewed carefully with qualified counsel so that the merchant understands the expectations during repayment, the consequences of a default to both the merchant and any guarantors, and whether the proposed MCA is really a disguised usurious loan.

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