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Hundreds Of Lawsuits Are Filed Against Out-Of-State Entities, Charged With Defaulting On What Many Consider Usurious Loans
ANALYSIS
Rockland County Supreme Court is a hub for out-of-state Merchant Cash Advance (MCA) providers filing lawsuits against out-of-state defaulters.
Hundreds of cases filed by entities with names like Funding Depot, Funding Futures, Mantis Funding, Lendr Online, The Merchant Marketplace, Swift Funding and variations on the same are filed each month. Many result in default judgments; few are challenged by sometimes desperate borrowers located thousands of miles from Rockland County.
The MCA companies, backed by hedge funds and private equity, provide funding to small businesses around the country under the mantle of purchasing “future” earnings or receivables at substantial discounts. If these contracts were considered traditional loans, they would be unenforceable under New York’s Usury laws, which set an interest rate cap at 16% per year for most individual borrowers. Loans with rates of 25% per year are generally considered criminal, and loan contracts exceeding these rates can render a loan obligation void.
Recently, a federal Bankruptcy Court in the Southern District of New York threw a wrench into the Merchant Cash Advance business model that could affect most existing MCA contracts and their enforceability in New York courts that run afoul of his ruling.
US Bankruptcy Judge David Jones in In Re: Kossoff, determined that the MCA contracts before him (a template for many of the other MCA contracts), though carefully drafted to avoid the appearance of being loans, were in sum and substance loans, and as such subject to New York’s usury laws. Jones’ ruling effectively voided the MCA contracts and recast them as unenforceable usurious loans.
Jones found several shortcomings in the MCA contracts, including one-sided reconciliation clauses that were neither mandatory nor retroactive, a fixed repayment schedule, a lack of meaningful risk-of-loss for the MCA company, and a lack of proximity between the MCA and the future receivables purchased. These failures made the substance of the contract more akin to a loan, than a purchase of future receivables.
Reconciliation is the process where the daily or weekly payment is adjusted to more accurately reflect the amount of receivables available for repayment of the advance. A failure to reconcile, or an illusory reconciliation process, is evidence that the payments were fixed over time as in repayment of a loan, and not related to fluctuating receivables, as a purchase of undefined future receivables.
Rockland County Is The Venue Of Choice For Filing These Lawsuits
RCBJ randomly reviewed dozens of recent filings by MCA companies. A majority of the lawsuits are filed by Texas-based lawyer Michael Scarpati who maintains an address at a shared office at 190 Bowery in Manhattan. Scarpati represents Lendr Online, Mantis Funding, and Merchant Marketplace, entities that file the majority of the hundreds of lawsuits. A handful of other lawyers also represent other MCAs.
The venue in the lawsuits (location of the county where the suit is filed) is generally designated as Rockland County, though Rockland County is the home of neither the MCA (Plaintiff) nor the merchant (defendant), and the contract was not signed in Rockland County. Rockland County has no connection to the transaction. The MCAs often cite an irrelevant New York City court rule in support of venue in Rockland County. Sometimes the contract will designate New York as the state where the parties agreed to have the case heard, other times Illinois or Connecticut are designated. When New York is chosen for jurisdiction, other New York counties are sometimes listed as the chosen venue.
All of the MCA contracts allow for service of process to the out-of-state merchants by certified mail, though no return receipts are provided and no process server is involved.
Many of the MCAs wait out a 30-day window and then seek default judgments from the Clerk of the Court. A fraction of the cases are defended.
Looking randomly at a few filings should give the Rockland County Court Clerk pause about accepting these filings, and strict scrutiny before awarding default judgments.
In a case filed earlier this month by Mantis Funding against Arizona-based Clean The Planet Recycling LLC and its owner Francisco Gilberto Rivas (as guarantor), Mantis paid the defendant $17,100 for $24,460 of future receivables. Clean The Planet was required to pay back $299 per day for 82 days. When it defaulted, Clean the Planet was also charged a $5,000 default fee, a $2,500 Blocked Account Fee, and $199 UCC Lien fee.
The agreement allowed for discretionary reconciliation, but only prospectively, a key failure of the Kossoff case. If considered a loan, the annual interest rate on the 82-day loan would be 288%.
In another case filed by Lendr Online against Virginia-based Predestined Hauling and its owner James Sinclair, Jr., Lendr Online paid the defendant$96,000 for $130,000 in future receivables. Predestined Hauling was required to pay back $2,579.37 per week for 50 weeks. The venue Sinclair agreed to was Nassau County, NY. The case was filed in Rockland County.
The agreement allowed for reconciliation, but only prospectively. If considered a loan, the annual interest rate on the 50-week loan would be 64%.
In a suit filed by Merchant Marketplace Holdings against California-based Purpose Driven Daycare LLC and its owner Vera LaGrone White, Merchant Marketplace paid defendant $18,000 for $31,000 in future receivables. Defendant was required to pay back $387.50 per day for 50 days.
The venue specified in the agreement was Fairfield County, Connecticut. The case was filed in Rockland County. If the contract was considered a loan, the annual interest rate on the 80 day loan would be 546%.
Interest rates like these are commonplace in merchant cash advance contracts. MCA providers are often thought of as “lenders of last resort.”
The high yields on the merchant cash advances reflect the risks of non-payment by the merchants and high rates of default. The returns for investors exceed most anything available in the institutional bond market or in the pooling of mortgage-backed securities.
MCA portfolios are increasingly bundled, securitized, and sold to institutional investors. The massive liquidity driving the industry flows from Wall Street institutional investors, private equity, hedge funds, and specialized debt syndication platforms seeking outsized returns.
There are several bills pending in the New York State legislature to extend criminal and civil usury caps to MCAs, invoice financing, and revenue-based financing. Other measures include a mandate that all MCA providers and originators be licensed directly through the New York Department of Financial Services (DFS), which would give the NY State Attorney General expanded power to police predatory merchant contracts.
The Attorney General has recently filed lawsuits against several predatory lenders with favorable results.
Whether the tide finally turns against the MCAs after the Kossoff opinion remains to be seen.
