In October, a US District Court judge ruled that merchant cash advance (MCA) agreements barring small businesses from participating in class-action lawsuits may violate New York’s lending laws. This case highlights the increased scrutiny of merchant cash advances by federal regulators, state lawmakers, and the courts.
The Backdrop
In February, several businesses filed a racketeering lawsuit against a group of MCA providers, including GoFund Advance LLC, Funding 123 LLC, and Merchant Capital LLC. The lawsuit alleges the MCA companies (the defendants) operated a predatory lending enterprise by persuading small businesses (the plaintiffs) to sign one-sided contracts that were usurious with interest rates exceeding 500 percent.
The agreements included a provision whereby the plaintiffs agreed to waive their right to participate in a class-action lawsuit against the plaintiffs. In June, district judge Jed Rakoff denied the defendants’ request to dismiss the case while narrowing plaintiffs’ claims. Judge Rakoff has served as a U.S. district judge for the Southern District of New York since March 1996 and was a leading figure in financial regulation and the judicial response to the 2008 financial crisis.
Rakoff recently ruled that those waivers, and the contracts, may be void if their terms violate state lending laws. A lawyer for the plaintiffs said the ruling was a “plaintiff-friendly” standard. Now that Rakoff has denied the lenders’ attempt to block the defendants from taking collective action, he must still decide whether the claims should be certified as a class action.
A class-action lawsuit is one in which many plaintiffs bring claims for similar injuries or losses. The plaintiffs combine their claims into a single action to recover damages suffered by all members of the class.
Why This Matters
Whether the judge will grant the plaintiffs class-action status remains to be seen. Notably, merchant cash advances are not loans but the purchase and sale of future receivables in exchange for upfront cash. Therefore, MCAs do not fall under New York State consumer lending or usury laws.
Although Judge Rakoff played a lead role in the proposed settlements with Bank of America and Citigroup during the financial crisis, a finding that MCAs violate New York lending laws is uncertain at best. The question comes down to how the contracts were structured.
A typical MCA agreement will include a reconciliation clause that requires the funder to restructure the payment plan if the borrower experiences a business downturn and meet the payment terms. This clause means that the agreement is not a demand for payment and, therefore, not a loan.
In any event, merchant cash advance providers continue to be under the microscope, and these alternative funding products may see greater regulatory scrutiny. In the meantime, if your business is struggling under the terms of an MCA agreement, contact the experienced debt relief specialists at ReconcileMyMCA.com.