On June 10, 2020, the Federal Trade Commission and the  New York Office of the Attorney General filed actions against two merchant cash advance (MCA) companies – RCG Advances and Ram Capital Funding – and individuals associated with both companies in the Southern District of New York and the Supreme Court of the State of New York County of New York. Both the FTC and New York AG assert several claims against the defendants related to the marketing, offering, and collecting of MCA. These lawsuits pose a particularly threatening challenge to the MCA industry, and provide insight into the types of claims state and federal regulators will bring against MCA companies in the future. That being said, the allegations are just that: allegations. We have not yet seen a response by the MCA companies that are defendants in this matter, and as with most litigation, the record can be more nuanced than is suggested by the initial legal complaint. Moreover, as identified below, there are open issues of pure law that may serve as fodder for future motion practice.

Marketing

The primary allegations by the FTC concerning marketing relate to misleading claims. For instance, the FTC alleges that although the defendants’ websites state that the MCA requires “no personal guaranty of collateral from business owners,” the contracts actually contain a “personal guaranty” provision. Also, the FTC alleges that defendants “buried” fees in the contracts “without any language alerting consumers that [the fees] are withdrawn upfront.” Relatedly, the FTC claims that the defendants provide consumers with “less than the total amount promised by withholding various fees ranging from several hundreds to tens of thousands of dollars prior to disbursement.”

Collection Practices

The FTC specifically targets the defendants’ alleged use of confessions of judgment. In a nutshell, a confession of judgment is a document signed by the MCA customer in which the customer accepts liability in the event that the advance is not repaid. This document allows an MCA company to obtain a judgment against the MCA customer without the need for trial or other traditional legal process. Under recent New York legislation, confessions of judgment executed by individuals living outside of New York after August 30, 2019, are unenforceable. According to the FTC, the use of confessions of judgment conflicts with the defendants’ contracts that “provide that Defendants will not hold consumers in breach if payments are remitted more slowly.” Notably, it is unclear whether the FTC’s allegations related to confessions of judgment relate at all to New York’s new law limiting the practice. Moreover, the FTC’s complaint does not state whether these confessions of judgment were executed before or after August 30, 2019, or whether they were executed by non-New York MCA customers. Finally, the FTC also claims that defendants made threatening calls to consumers related to repayment of the advances.

Recharacterization

Along with similar claims and allegations advanced by the FTC, the New York AG contends that defendants “disguise each loan as a ‘Purchase and Sale of Future Receivables,’ but in reality, . . . the transactions a[re] loans.” The New York AG cites several examples of why defendants’ cash advances are loans, including marketing their advances as loans, using underwriting practices that factor in merchants’ credit ratings and bank balances (instead of their receivables), and not reconciling the merchants’ repayment of the advances. According to the New York AG, since the merchant cash advances are actually loans, they violate New York’s civil and criminal usury laws.

Takeaways

Although the FTC’s and New York AG’s complaints do not foreclose the future of merchant cash advances as a viable financial product, the complaints do provide a glimpse into what merchant cash advance companies should expect in a regulated future for the industry. This is not necessarily a problem for an industry that has been largely unregulated. In particular, the New York AG’s complaint related to recharacterization of merchant cash advances as loans provides significant guidance for not only the drafting of the MCA agreement, but also the underwriting and marketing of the MCA. For those in the industry, it is now clear that both state and federal regulatory authorities have taken interest in MCAs and will file actions against perceived bad actors. As such, MCA companies should evaluate their agreements, marketing materials, underwriting processes, and collection techniques to avoid future enforcement actions. Additionally, MCA companies should consider creating or improving existing compliance programs in order to mitigate risk in anticipation of a more-regulated future.