Maryland Legal Alert for Financial Services

In This Issue:

MERCHANT CASH ADVANCE HELD TO BE A PURCHASE OF ACCOUNTS RECEIVABLE, NOT A LOAN

FLOOD INSURANCE GUIDANCE

STATE AND FEDERAL LEGISLATORS SEEK TO CURB CONFESSIONS OF JUDGMENT

Merchant Cash Advance Held to Be a Purchase of Accounts Receivable, Not a Loan

A bankruptcy case from the Northern District of Georgia offers useful insight for firms that provide financing under a merchant cash advance agreement. The case arose from a suit by the debtor against a finance company that purchased $210,000 of the debtor’s accounts receivable for $150,000 prior to the bankruptcy filing. The debtor alleged, among other things, that the debtor had no liability to the finance company because the merchant cash advance agreement was a criminally usurious loan under New York law (which governed the merchant cash advance agreement). The debtor argued that the merchant cash advance agreement was structured in such a way that the occurrence of an Event of Default was inevitable, thus creating an obligation to pay 100% of the Purchased Amount as opposed to a contingent payment based on the collectability of the Purchased Amount of the receivables.

The court held that the finance company was not liable for criminal usury because its transaction with the debtor was not a loan, but rather a purchase of the debtor’s accounts receivable. The court reasoned that the agreement “bears all of the hallmarks of a sale of future receivables and not a loan”, including that the finance company expressly assumed the risk of collectability of the accounts, the agreement included a provision that allowed the daily debit amount to be adjusted once a month, the debtor’s filing of bankruptcy was not a default, and the agreement did not contain a fixed term of repayment. Click here to read more about the case and its implications.

Practice Pointer: The Georgia bankruptcy decision highlights the importance for firms that provide merchant cash advance financing to include provisions in their finance agreements that are consistent with a purchase of accounts receivable as opposed to a loan. So long as the agreement does not create a disguised loan, it should be upheld in accordance with its terms.

Contact Lawrence D. Coppel | lcoppel@gfrlaw.com | 410-576-4238

Flood Insurance Guidance

On August 22, 2019, the Board of Governors of the Federal Reserve System (Board) issued guidance concerning flood insurance requirements.  Under applicable federal regulations (12 C.F.R. 208.25), a member bank may not make a real estate loan in a special flood hazard area unless the collateral is covered by flood insurance meeting certain requirements.  Flood insurance may be obtained from certain “mutual aid societies” (associations with members that “share a common religious, charitable, educational, or fraternal bond”) in certain circumstances.  A member bank may accept flood insurance issued by a mutual aid society if the Board has determined that the insurance qualifies as flood insurance under applicable law and the insurance: (1) provides coverage in the required amounts, (2) covers both the lender and the borrower(s) as loss payees, and (3) provides sufficient protection of the related loan (consistent with safety and soundness principles) and the member bank documents its conclusion regarding the sufficiency of protection of the related loan (in writing).  The recent Board guidance notes that Federal Reserve Board staff will provide assistance to member banks in analyzing whether flood insurance issued by a particular mutual aid society will meet the above requirements.  The guidance applies to institutions supervised by the Board with total consolidated assets of $10 billion or less.

Practice Pointer: Banks that routinely make real estate loans in special flood hazard areas should review whether any mutual aid societies exist that may provide flood insurance for collateral in these areas. Banks should seek assistance from Federal Reserve Board staff to analyze whether a particular mutual aid society’s insurance meets Board requirements.

Contact Christopher R. Rahl | crahl@gfrlaw.com | 410-576-4222

State and Federal Legislators Seek to Curb Confessions of Judgment

In response to a series of Bloomberg News articles detailing certain lenders’ use of New York confession of judgment procedures against out-of-state businesses, New York Governor Andrew Cuomo recently signed a bill aimed at curbing confessions of judgment in New York state courts. Confessed judgment provisions allow lenders to obtain judgment expeditiously against obligors upon a default under the applicable credit agreement. Under the act, lenders may not confess judgment against obligors residing outside of New York.

Some federal lawmakers wish to go further and bar the use of confessed judgments entirely. A bipartisan contingent of federal lawmakers have introduced the “Small Business Lending Fairness Act”, which seeks to prohibit the use of confessed judgments for all extensions of credit, regardless if the loan is for a commercial or consumer purpose. The bill has been referred to committee and we will continue to monitor its progress. Click here to read more about the legislation and its implications.

Practice Pointer: We have not yet observed a similar groundswell in Maryland seeking to curb the use of confessed judgments in commercial loan instruments. Thus, unless the Small Business Lending Fairness Act gains traction in Congress and eventually gets signed into law, confessed judgment provisions should remain enforceable under Maryland law for the foreseeable future. However, commercial lenders should be aware of the rising opposition against these provisions among state and federal lawmakers and plan accordingly.

Contact Bryan M. Mull | bmull@gfrlaw.com | 410-576-4227