Maryland Legal Alert for Financial Services

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

In a recent decision that should interest firms that provide financing under a merchant cash advance agreement, the United States Bankruptcy Court for the Northern District of Georgia, applying New York law, held that a finance company was not liable for criminal usury under New York law because its transaction with the debtor was not a loan, but rather a purchase of the debtor’s accounts receivable. Prior to the debtor’s bankruptcy, the finance company purchased $210,000 of the debtor’s accounts receivable for $150,000. The merchant cash advance agreement provided that the finance company could debit the debtor’s account daily in the amount of $1,400 until such time as the Purchased Amount was paid in full. The finance company acknowledged in the agreement that it would bear the loss if the purchased receivables were not collected in full and that a filing of bankruptcy by the debtor would not be a default. However, the agreement also listed several Events of Default, which would trigger a liability for payment of 100% of the Purchased Amount. Among the Events of Default was the debtor’s failure to provide the finance company with 24 hours prior notice that there would be insufficient funds in the debtor’s account for payment of the daily amount, and failure to provide the finance company with all requested documentation and allow for the daily monitoring of the account. The agreement was guaranteed by the debtor’s principal and the debtor granted a lien in the purchased accounts.

After filing a Chapter 11 bankruptcy case, the debtor sued the finance company making a number of claims including a claim 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.  The debtor argued that the merchant cash advance agreement was structured so 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. The court ruled in favor of the finance company on summary judgment finding that the agreement “bears all of the hallmarks of a sale of future receivables and not a loan”. Among the factors considered by the court were that the finance company expressly assumed the risk of collectability of the accounts, the agreement included a provision that allowed the daily 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. The court found that the existence of a guaranty or the granting of a lien on the accounts receivable did not transform the agreement into a loan. In addition, the court found that the Events of Default were narrowly tailored to be consistent with the purchase of the debtor’s receivables as opposed to a loan.

Practice Point: 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.

For additional information, please contact Lawrence D. Coppel.