Merchant cash advances in the hot seat | Manatt, Phelps & Phillips, LLP

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Could investigative reports on merchant cash advances lead to enforcement action against the companies making these advances, or potential legislation prohibiting certain practices inherent in this industry?

According to reports, New York Attorney General Barbara Underwood has launched an investigation into possible abuses by companies that provide cash advances to merchants 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 borrowing cash advances from tradespeople.

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 more than state usury laws allow lenders to charge. However, these companies allege that they are not subject to state usury caps or state licensing laws arguing that the arrangement with the borrowers is not a loan but an advance of funds on credit card settlement funds to be received in the future. There is a subtle but significant difference between a purchase of future revenue and a loan whose repayment is secured by that revenue. And although lenders’ contracts are all different, contracts that have been drafted with this distinction in mind have been successful in defeating borrowers’ lawsuits.

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

If this practice has been prohibited in consumer contracts since 2014, it is authorized in commercial agreements, and the admission of judgment is a powerful remedy. Bloomberg’s exposure also alleged that some companies that provide cash advances to merchants rely on false documentation, lie about the amount the borrower owed, or initiate a seizure even when the borrower hasn’t missed any. payment.

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

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

The Bloomberg articles also prompted a reaction at the federal level. On December 6, 2018, Senator Sherrod Brown (D-OH), a ranking member of the Senate Banking, Housing, and Urban Affairs Committee, and Senator Marco Rubio (R-FL) introduced legislation called Small Business Lending Fairness. Act. The law 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 is it important

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

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