Three years ago New York outlawed a contested practice in which small businesses that took funds from a local group of cash advance companies waived their legal right to defend themselves.
When borrowers defaulted, the lawsuits were clogging the courts, as both Bloomberg and The City reported at the time. Yet the outcomes were essentially predetermined because of the waivers. The state’s judiciary urged the Legislature and governor to end these contract terms, known as confessions of judgment, for out-of-state companies. New York passed a bill into law.
That might have been the end of the story.
But as the worst of the pandemic ebbed in 2021, state courts began filling up once again with cash advance companies seeking judgments against small businesses. The businesses were struggling to cover operating expenses as federal pandemic programs dried up and labor shortages and supply-chain challenges mounted. As a result, businesses evidently turned to cash advances—and then ran into trouble with them.
Now, two years after the confession of judgment ban brought attention to predatory practices in the industry, merchant cash advance companies have devised new methods for finding clients and recouping advances and they are clogging the courts once again.
“It’s like whack-a-mole,” said Shane Heskin, a partner at the Philadelphia office of White and Williams, who has argued several recent New York cases on behalf of businesses that have taken out merchant cash advances, known as MCAs. “There are so many bad actors, and there is not enough police power to regulate these things,” he said. The resurgence of one such actor, Jonathan Braun, was documented earlier this year by Bloomberg’s Businessweek.
A merchant cash advance is, at its core, a simple financial product, akin to certain kinds of accounts receivable financing, like factoring. A small business sells a specified quantity of its future receipts to the cash advance firm at a large premium. For example, a construction firm in need of cash to pay suppliers before its clients pay their bills might pay back more than $100,000 in daily or weekly automatic deductions for an advance of $70,000. This—crucially—is not a loan. But if you play out the math as if it were a loan, interest rates can be in the triple digits.
That’s where businesses often get into trouble, because the MCA firms usually start taking receipts almost immediately.
If something goes wrong, cash advance firms turn to the courts with perfected formulas for going after the companies’ bank accounts. Because of New York’s ban on confession of judgment clauses, the small businesses no longer waive their rights to a trial. But lawsuits are still frequently served without sufficient notice or with extremely tight deadlines, said Leslie Tayne, a Melville, Long Island, attorney. Tayne said she represents so many small-business clients in MCA cases that she has given up her other practice areas in the past year to focus solely on the issue.
“It’s exploded,” she said. “For the last year, it’s all I do every day.”
Although it’s hard to quantify the total number of cases or the rate of growth, the cases have flooded all districts of the state Supreme Court. While the MCA firms are usually in the city, the small businesses that contract with them hail from around the U.S.
For a while in 2020 and 2021, around $1 trillion in government relief programs kept small businesses relatively flush. As late as April of this year, the share of small businesses with at least three months of cash on hand was near its pandemic high, according to information collected by the since-discontinued Census Bureau Small Business Pulse Survey.
But as life got back to normal, access to traditional funding became more difficult for companies with fewer than 500 employees. The share of firms seeking traditional financing fell from 43% in 2019 to 36% in 2021, and they were more often looking for money for operating expenses rather than expansion, according to the Federal Reserve’s Small Business Credit Survey 2022 Report on Employer Firms. Moreover, the share of applicants who received all the traditional funding they sought fell from 51% in 2019 to 30% in 2021, the survey found.
“It’s a perfect storm,” Tayne said.
Tayne said her clients represent a wide range of industries: trucking, construction and landscapers, as well as farmers, retailers, restaurants, house cleaners, dentists and technology services. While some businesses—and their cash advances—are quite small, others have many millions of dollars in revenue.
The owner of a construction business in the New York metropolitan area said that he turned to cash advances around the time that business took off. Rapid growth in new-home building and renovations from a hot housing market led to cash flow problems for the owner—who wished to stay anonymous out of concern that information about his finances could affect his ability to sign clients or make things worse with his MCA relationship. He said he has about 20 employees and annual revenue of about $5 million.
Several larger customers were stretching out their bills over a longer period at the same time that he took on five new construction projects that required a substantial cash outlay upfront.
Because he needed money fast, a traditional line of credit did not suffice and government loan products like the Small Business Administration’s 7a were too slow to apply for. As the owner of a fairly new business, he did not feel confident in being approved for a conventional bank loan, he said.
Supply-chain issues have made businesses particularly cash-hungry, said Heskin, the White and Williams partner. For example, a builder could end up in a bind because lumber prices soar after fixed contracts are signed with a client. Or a trucker might be awaiting payment because a delivery doesn’t arrive from overseas for months after it was expected.
Once repayments aren’t made, things get ugly.
In the case of the builder, the company who had gave him the advance put out liens against him and the business. Because the MCA firm has access to a company’s checking account, it could see his checking account and contacted his business and homeowner clients for payments. His receivables and online accounts such as PayPal and Venmo were frozen, he said. Next came threatening letters to his home.
The process of selling—and upselling—the advances is also rife with ill intent, Tayne said.
Brokers pitch funds to desperate companies, and their commissions just add to the pile of fees to be repaid. Their sales lines sometimes include untruths, such as the idea that MCAs will help a business build its credit and lead to successful future loan applications, which is not the case.
After a successful advance, the companies will frequently pitch another exchange, she said.
The local builder, for example, said he was successful in making all the payments on the first couple of advances. “But once you have a good track record,” he said, “they give you more. It’s a revolving door of money.” He added that once he was about 60% paid down on one advance, companies approached him again to inquire if he wanted taccess to more money.
A city business, a jeweler on West 47th Street, was sold three successive advances totalling nearly $1 million in two months, according to a complaint by Fox Capital Group, which sold the advance.
Frequent MCA companies in the state court system include Liberty Funding Solutions, Reliance Financial, Quicksilver Capital and Last Chance Funding Group. The companies sometimes dissolve and form again, attorneys say,
“It’s very profitable,” Tayne said.
It’s when a small business empties its checking account or cuts off before full repayment that the MCA firms begin to tack on fees. Then the MCA firms head to the courts.
They file lawsuits quick and fast—“like a machine,” Tayne said. “They’re prepared to file on that exact day, and we file answers often on the day it’s due.” Defendants often do not even get notice or have time to find an attorney. The MCA firms get the judgments they need to freeze bank accounts or put liens on a defendant’s assets.
Even with the confession of judgment ban, New York has a fairly favorable law that makes it easy to bring cases to court, said Julia Heald, an attorney at the Federal Trade Commission’s Division of Financial Practices, Bureau of Consumer Protection.
“The original intent is that it is a quick and easy way to resolve payment of an undisputed amount,” Heald explained.
In addition to a handful of private lawyers, both the New York attorney general and the Federal Trade Commission have brought and won several cases against the MCA companies this year. In general, the government goes after the worst actors, Heald said.
Although it might not win whack-a-mole, one solid legal strategy appears to have emerged: If lawyers can show that the MCA is functioning as a loan, then the company selling the cash becomes subject to a great deal more federal and state regulation, Heskin said.
Three recent decisions in federal court in New York’s Southern District found exactly that, with judges ruling that several infamous companies, such as Financial District-based Richmond Capital Group were deceiving and threatening small businesses. Those follow an April 2021 decision in the same court in favor of the FTC against Jersey City, New Jersey-based Yellowstone Capital, which had to pay nearly $10 million in total to more than 7,700 small businesses. So far, 587 New York-based businesses have received $778,512 in refunds from the case, according to the FTC’s tracker.
The bottom line in legal terms, Heald said, is that MCAs’ place in the financial system is to provide funds in exchange for taking on the risk that a business could fail rather than getting a guarantee that it can help itself to steady future payments regardless of the business’s health.
“If the MCA provider was truly purchasing a share of the future income, which would rise and fall as business did, there is something in it for the business too,” she said.
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