Usury New York

Court Refuses To Enforce Merchant Cash Advance Agreement That Smacks Of Chicanery

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Funder Files Appeal, Seeking To Avoid A Ruling Declaring Its Cash Advance Agreements To Be Usurious Loans And/Or Unenforceable Contracts

This is the fifth in a series of articles taking a hard look at the Merchant Cash Advance industry, its practices, and its ties to Rockland County.

By Rick Tannenbaum

“It appears that Plaintiff has a business of making loans under a variety of aliases to desperate small businesses, bleeding them dry, and then getting personal judgments against their owners,” Acting Supreme Court Justice Keith Cornell wrote in an order denying a local finance company summary judgment against an out-of-state defendant, its owner, and a series of the owner’s affiliate companies including Saint Matthews Primitive Church Cemetery Association, Inc., and Saint Matthews Primitive Baptist Church, Inc.

The case filed last year against Georgia-based Nic’s Painting, LLC, is one of hundreds of cases filed every year in Rockland County Supreme Court by a series of related companies against small, unsophisticated, out-of-state companies, who as part of their effort to secure financing have to agree to be sued in Rockland County Supreme Court, regardless of their location, or their ability to defend themselves from afar.

“This court will not be used as a cudgel to enforce potentially illegal and/or unconscionable loans,” Cornell wrote in denying the plaintiff a judgment against the defendants.

In a series of articles in Rockland County Business Journal, we have endeavored to shed light on the scope of the problem, and the role Rockland County Supreme Court Justices have had in enforcing these arguably usurious and/or unconscionable contracts.

Interest rates become usurious in New York when they exceed 16 percent. They become criminal when the interest rate exceeds 25 percent. Loans made in excess of 16 percent are typically modified or voided by the courts when such cases are litigated. Loans made with interest in excess of 25 percent can be referred for criminal prosecution.

The agreements between the funder and the borrower are complex transactions where a company, desperate for funding, agrees to sell what looks like a portion of its future receivables for a sum certain which is immediately deposited into the business’s account. The receivables are sold at a significant discount to their value. For example, a business may sell $300,000 in future receivables for $180,000 today – obligating it to pay back the full $300,000, plus a bevy of fees, though it only received a fraction of that amount. The business owner personally guarantees the repayment, and gives a security interest in all of the business’s assets as collateral for the loan. Payments are extracted directly from the business’s account, either daily or weekly, on an accelerated basis, that can often represent the business’s entire income, or close to its entire income. The repayment schedule is fast, generally a few months for the entire advance to be repaid.

If found to be loans, many of these agreements would have effective annual interest rates between 65% and 200%.

Until recently, Rockland County Supreme Court Justices have enforced these contracts, based on a series of appellate opinions that found the agreements – on their face – to be “Merchant Cash Advance” agreements and not loans. If the advances are not loans, then they cannot legally be considered usurious. If they are not usurious, then the agreements are enforceable. Hundreds of litigants have had judgments entered against them based on this “usury” loophole.

That is until the New York State Attorney General got involved and starting filing lawsuits against merchant cash advance firms, charging them with fraud and seeking refunds for their victims. Courts then started to take a closer look – not just at the cold contracts – but at how they were being negotiated and administered, the fairness of their terms, and whether the provisions in the agreement that exempted them from usury laws were illusory.

For example, if the agreements include a “reconciliation clause” that enable the business to avoid default and have its payments adjusted downward to reflect a downturn in their businesses, but those clauses cannot be meaningfully exercised, then the Court can reject the exemption and refuse to enforce the agreement. The Court can deem the contract to be a usurious loan, or an unenforceable, unconscionable contract. In Nic’s Painting case, the borrower had only one day to seek reconciliation after a withdrawal was rejected by his bank.

A look behind the contract also may reveal that the repayment terms were never actually based on the business’s receivables, but were based on a timed repayment plan designed to return the loan in a fixed period of time, regardless of the volume of the business’s receivables and regardless of what was written into the contract. This practice formed the basis of some of the fraud allegations brought by the Attorney General and seems prevalent in many of the cases now in Rockland County Supreme Court.

In standard fashion in this case, the funder, Pomona-based MCA Servicing Company, sought summary judgment against the businesses and its guarantors that would enable it to record its judgment and then pursue the company’s and guarantor’s assets in their home state.

Except in this case, Justice Cornell denied the funder the judgment it sought and said the structure and administration of the agreement “smacks of chicanery.”

“Plaintiff allegedly aggressively pursues these out-of-state, unsophisticated businesses, promising an advance on their collections. Plaintiff allegedly then presents them with a form contract that contains onerous repayment terms, hair-trigger events of default, and liquidated damages clauses that result in amounts owed that far exceed the value of the funds extended. While aggressive contract terms are not necessarily illegal, if the transaction is a subterfuge, it cannot be countenanced.”

“This court will not be used as a cudgel to enforce potentially illegal and/or unconscionable loans,” Cornell wrote in denying the plaintiff a judgment against the defendants.

The funder immediately filed an appeal. It also asked to re-argue its case before Justice Cornell while its appeal is pending. If Justice Cornell agrees to hear re-argument, he will likely rule on the case again this summer. An adverse ruling could jeopardize MCA’s business model and render similar and other agreements void and unenforceable.

Rick Tannenbaum writes frequently on legal and land use issues for Rockland County Business Journal. He also edits the Marijuana Monday newsletter, the What’s The Big Deal? column and the Legal Beat.