On December 27, the New Jersey Division of Consumer Affairs (the Division) entered a consent order with Yellowstone Capital LLC (Yellowstone) and several related companies to resolve allegations that, in violation of the New Jersey Consumer Fraud Act, the company engaged in abusive lending practices in connection with Merchant Cash Advances to small business owners (MCAs). Pursuant to the settlement, Yellowstone must forgive all outstanding balances for customers who entered MCAs, which is estimated to be approximately $21.7 million, and pay more than $5.6 million to the Division for purposes that may include, restitution, attorneys’ fees, costs of investigation and litigation and costs of administering restitution, and penalties up to $250,000. The order also imposes additional requirements regarding Yellowstone’s agreements and collections activity discussed below.

As background, MCAs are a form of financing in which the MCA company provides money to a small business up front in exchange for the right to receive a percentage of the company’s future revenue up to a specified aggregate dollar amount. Frequently, MCAs require the merchant to deliver the future revenues through daily payments reflecting actual revenues or an estimate of such revenues, subject to some form of periodic reconciliation process. Unlike a loan, a properly structured MCA contract does not guarantee the issuer regular payments over a fixed, finite term. Instead, a decline in the merchant’s revenues should entitle the merchant to an automatic reduction in payments or a reconciliation which either decreases the merchant’s periodic payments, resulting in the MCA payments continuing over a longer period, or requires the MCA company to provide a refund to the merchant of any excess payments received. The concept is that, at least in most states, properly structured MCA agreements are sales of future receivables, and not loans, and, accordingly, lending and usury laws do not apply to MCA agreements.

As part of the settlement, Yellowstone was required to reform its reconciliation procedures, providing more favorable reconciliation terms to merchants, including allowing merchants more time to request a reconciliation and requiring that reconciliations cover the entire transaction, rather than only the preceding month. Yellowstone was also required to implement new procedures to: (1) inform merchants who are not in default that they may request the more favorable reconciliations; (2) review accounts when merchants default prior to sending the accounts to collection; (3) provide certain notices related to default; (4) not engage in certain collections activities including the use of confessions of judgment and specified uses of UCC notices; and (5) implement certain procedures related to the use of brokers. Yellowstone was also required to reform certain contractual provisions to limit the scope of personal guarantees, decrease or eliminate certain fees, improve disclosures, and remove limited liability clauses, among other changes.

In the complaint, the Division alleged:

• Although Yellowstone’s merchant agreements were presented to consumers as MCA contracts, the merchant agreements included numerous terms and conditions that made them substantially less favorable to consumers than typical MCA contracts.

• Yellowstone’s merchant agreements obligated consumers to pay a fixed amount subject to interest, over a defined period, untethered from the consumers’ receivables, just as the consumers would be obligated to repay a traditional loan, but without the legal protections (such as interest rate caps) afforded to loan borrowers.

• Yellowstone’s MCAs compelled consumers to execute additional documents that not only obligated the small business owners to personally guarantee repayment of the loans, but also made it exceedingly simple for Yellowstone to obtain a consent judgment against and/or to freeze and seize the assets of not only the small business, but the small business owner.

Yellowstone denied all allegations in the consent order. However, this is not the first settlement Yellowstone has entered into regarding allegations of unfair lending. On May 4, 2021, the Federal Trade Commission announced that Yellowstone would pay more than $9.8 million in restitution to settle allegations that it took money from businesses’ bank accounts without permission and deceived them about the amount of financing they would receive, net of inadequately disclosed fees, and other features of its financing products. Specifically, the FTC alleged that Yellowstone continued withdrawing money from businesses’ bank accounts for days after their balance had been satisfied.

This action by the New Jersey Attorney General constitutes a continuation of the office’s policy goal of addressing alleged usurious lending, particularly when such practices are asserted to disproportionately affect New Jersey’s lower-income and minority communities. For example, the New Jersey Bureau of Securities issued a Cease and Desist Order to another MCA company, Complete Business Solutions Group, for violating New Jersey securities law by offering and selling unregistered securities to purportedly raise capital to fund MCAs to small businesses.

Additional state attorneys general have scrutinized the use of MCA companies issuing short-term, high-cost funding for small businesses. Dating back to 2018, the New York Attorney General opened an industrywide investigation into MCA companies, which resulted in a report that a subpoena was sent to Yellowstone and the 2020 lawsuit against New York-based Richmond Capital Group.

We will continue to watch the states attorneys general activity with regard to MCAs and alleged usurious lending, and we will post updates here as they occur.