The Rise and Risks of Merchant Cash Advance Debt Relief Companies
A SPECIAL REPORT by Tripp Scott's Paul Lopez and Corey Cohen as published in: Law.com | DBR Daily Business Review
Cash is king and business owners know that harsh reality more than most since oftentimes businesses run into cash crunches at certain times of the year. When that happens sometimes traditional lenders such as banks are not an option and businesses need to reach out to merchant cash advance companies (MCAs). As MCAs grow in popularity, there is concern about an increase in companies claiming to negotiate MCA terms on behalf of business owners. While these services may seem appealing, they come with inherent risks that business owners should carefully consider.
Initially, it is important to address “What is a merchant cash advance?” A merchant cash advance is a form of alternative financing where a business owner receives a lump sum of money in exchange for a specified amount of future receivables. Typically, MCA providers assess the amount a business can receive based on its previous few months of bank statements. MCAs are particularly popular among small businesses that may not qualify for traditional loans, such as those in industries where banks are hesitant to lend (e.g., cannabis companies) or those needing quick funds to complete projects (e.g., plumbing, electrical, or HVAC services). Given the competitive MCA market, providers often deliver the initial payment within 24 hours of application completion.
Merchant cash advance companies obtain repayment from business owners by way of daily or weekly payments. The inherent risk that merchant cash advance companies take is that if a small business fails, it does not have any recourse; meaning that it does not have an avenue to recover the initial lump sum payment it injected into the company. Moreover, for a merchant cash advance to be legal and enforceable, filing for bankruptcy cannot serve as an act of default under the applicable agreement between merchant cash advance provider and merchant/business owner.
When a business takes out multiple MCAs, these are considered “stacked,” a red flag indicating potential financial distress. Debt relief companies frequently target business owners facing such challenges, promoting services under labels like "debt consolidation" or "business debt experts." These companies may suggest that business owners can eliminate or reduce their payments to MCA providers. However, without fulfilling certain conditions, engaging these services can create significant legal and financial liabilities.
Engaging a company to consolidate merchant cash advances is generally premised upon one thing: paying the debt-relief company a reduced monthly payment instead of paying the merchant cash advance provider. At bottom, the merchant is breaching its agreement with the MCA with the hopes that the debt consolidation company can work out anew deal for them. In this hypothetical scenario, the debt-consolidation company will likely hold those funds in a pseudo-escrow account, and when that fund reaches a certain amount, it will begin to negotiate with the merchant cash advance provider. Should the merchant cash advance provider engage in negotiations with the debt-consolidation company for an amount less than it was obligated, things generally work out for all parties. However, problems may arise when the merchant cash advance provider does not want to negotiate.
In the aforementioned example where the merchant cash advance provider does not want to negotiate with the debt-relief company, usually the merchant cash advance provider will initiate a lawsuit against the small business owner for breaching their contract. If the small business owner had been making consistent payments to the debt-consolidation company instead of the merchant cash advance provider, but is still cash-strapped, the small business owner is at risk of paying the merchant cash advance provider all the future receivables it was obligated to under the applicable agreement in addition to expending money on the business debt relief company.
To avoid this, the debt-consolidation companies have begun to offer third-party legal services purporting to provide a defense to these small businesses. However, often times these attorneys consistently file boilerplate pleadings and discovery responses that fail to include facts specific to each case, which potentially puts the merchant at risk since boilerplate defenses are usually ineffective. The merchant can then be liable for the full amount of the obligations due within the contract plus attorney’s fees and costs. Not only does this typically include the full amount of future receivables owed by the company, but various default and NSF fees.
In sum, engaging debt relief companies to negotiate MCAs can be fraught with risks. Business owners should exercise caution, consult experienced legal counsel and thoroughly understand the terms of their MCA agreements before pursuing such services. Properly navigating MCA obligations can help businesses avoid costly legal battles and ensure financial stability for the future.
