Merchant Cash Advances on the Hot Seat

Financial Services Law

Could investigative reporting into merchant cash advances lead to enforcement action against companies that make these advances, or to potential legislation to ban certain practices inherent in this industry?

According to news reports, New York Attorney General Barbara Underwood has launched an investigation into possible abuses by companies that make merchant cash advances, and has already issued at least one subpoena. In addition, a bipartisan effort has led to the introduction of a bill at the federal level that would ban the practice of “confession of judgment,” a favorite remedy of lenders seeking recourse against borrows of merchant cash advances.

What happened

Over the past few months, Bloomberg News has published several articles about the merchant cash advance industry. Merchant cash advances typically involve high fees, often in excess of what state usury laws permit lenders to charge. However, these companies allege that they are not subject to state usury caps or state licensing laws by arguing that the arrangement with borrowers is not a loan but a cash advance against credit card settlement monies to be received in the future. There is a subtle but significant difference between a purchase of future receipts and a loan the repayment of which is secured by those receipts. And while the contracts of the lenders are all different, contracts that were drafted with this distinction in mind have been successful in defeating court claims by borrowers.

Another critical element of merchant cash advances is that companies making them often require borrowers to sign a “confession of judgment.” This means that the borrower forfeits the right to defend itself in court, making it easier for the lender to collect the debt and seize assets from the borrower. 

While this practice has been banned in consumer contracts since 2014, it is permitted in commercial agreements, and confession of judgment is a powerful remedy. The Bloomberg expose also alleged that some companies making merchant cash advances rely on forged documents, lie about the amount owed by the borrower or initiate a seizure even where the borrower has not missed any payments.

Not all merchant cash advances are made in New York or to New York borrowers. However, New York has become the preferred venue for these contracts due to the ease of obtaining a confession of judgment in New York courts. Bloomberg reports that since 2012, merchant cash advance lenders have obtained more than 25,000 judgments in New York against businesses, worth an estimated $1.5 billion. Many of these judgments have been obtained in a handful of courts in upstate New York. With the spotlight on merchant cash advances, these practices may be stopped. According to Bloomberg, Underwood’s office subpoenaed one of the largest merchant cash advance companies in the country and inquiries into other lenders will likely follow.

“It’s reprehensible to defraud, deceive and harass small-business owners through predatory debt collection practices and the abuse of our court system,” she told Bloomberg in a statement. “If a company is engaging in fraudulent and deceptive conduct, we want to know.” New York legislators reportedly also are reviewing New York laws that allow predatory lending practices. 

The Bloomberg articles have gotten a reaction on the federal level as well. On December 6, 2018, Sen. Sherrod Brown (D-OH), ranking member of the Senate Committee on Banking, Housing and Urban Affairs, and Sen. Marco Rubio (R-FL) introduced legislation called the Small Business Lending Fairness Act. The act would protect small businesses by extending to small-business borrowers the Federal Trade Commission’s ban on confession of judgment in consumer loan agreements.

Why it matters

The recent publicity has drawn attention to a segment of the financial services industry that previously had remained in the shadows. Although for many years merchant cash advances have fallen between the cracks of existing laws and have escaped regulatory oversight—despite practices that are deemed by borrowers to be unfair, deceptive and usurious—the New York AG’s investigation and potential New York and federal legislation could reverse that trend.