In our February 14, 2022 post, we highlighted certain consequences regarding the treatment of a merchant cash advance (“MCA”) transaction as a “loan” rather than a “true sale” of receivables or future receivables and the implications of such treatment to an MCA provider. Among the takeaways was that a court’s characterization of an MCA transaction as a loan opens an MCA provider up to a host of potential claims by cash advance recipients (“customers”) and their successors (e.g., bankruptcy trustees) that are not otherwise available if the transaction is treated as a true sale.
Recent trends in the case law appear to evidence a developing sympathy for customerswhere the underlying documentation and business practices of the MCA provider allows an opportunity for courts to characterize a transaction as a loan. MCA transactions are designed by MCA providers to achieve certain economic returns in a structure where their risk of loss is minimized. Recent caselaw may, however, motivate MCA providers to rethink transaction terms and structures to best avoid the characterization of such transactions as loans. Borrowers will take some comfort from these cases that, if their transaction has certain indicia of a loan, a court may be inclined to treat it as such, regardless of the label.
Since our last post, at least three reported decisions from the Southern District of New York have analyzed MCA transactions in the context of claims of usury and violations of the Racketeer Influenced Corrupt Organizations Act (“RICO”). The underlying transactions were, for the most part, similar. In each, the MCA provider purported to purchase its customer’s future receivables utilizing documents which stated that the transaction was a “true sale.” Pursuant to the agreements, on a daily basis the MCA provider would withdraw a contractually fixed amount from its customer’s bank account regardless of the amount of daily collections even though the MCA agreements also provided that payments to the MCA provider would be based upon an estimated percentage of daily collections. If there were an insufficient amount of collections on any given day, the ACH withdrawal would be rejected and the customer would be in default.
In each case the customer granted a security interest in its receivables and other non-receivable assets of the customer and there was recourse against certain guarantors. Further, the MCA agreements enumerated events of default typically seen in loan transactions. Economic risk allocation, based upon these contractual provisions alone, clearly points to the customer.
The analyses undertaken by the three SDNY Courts followed similar paths to reach similar outcomes.
a. The Fleetwood Court stated the following: “[v]iewing the [MCA] Agreement as a whole, the Court concludes that it is a loan and not a contract for the purchase of future receivables”. Having come to that conclusion, the Court then analyzed claims of usury and RICO, both of which require as a predicate for liability that the underlying transaction require repayment of a debt (i.e., a loan).
b. The Haymount Court described the core claim in the complaint as one where the defendants were liable under RICO, for operating “an enterprise that loans money to small businesses at criminally usurious interest rates and then uses various improper tactics to collect on those loans.” After a lengthy analysis of loan vs. true sale factors, Judge Rakoff concluded that that the plaintiff had adequately pled that the MCA agreements at issue functioned as loans. “Because the transactions should be treated as loans, at least at this juncture, and because defendants do not dispute that the implied interest rates on these transactions far exceed 50% per annum (twice the New York State criminal usury rate), the Court holds that the Complaint has adequately pled that the debts created by the MCA agreements that the defendants issue are unenforceable, “unlawful debts” under the RICO statute.”
c. The Lateral Court also analyzed RICO allegations based upon underlying claims of usury. There too, for purposes of ruling on the defendants’ motion to dismiss, the court stated: “[o]n balance, the Complaint pleads sufficient facts to show that the transactions reflected in the Merchant Agreements are loans subject to usury laws.” It allowed the RICO and usury claims to proceed.
In each case, the Court took the trouble to calculate the interest rate embedded in the transaction and in each case the result would breach applicable usury laws in most states: Fleetwood – 278.5%; Haymount – in excess of 50%; Lateral – multiple agreement with interest ranging from 100% to 300%. Further, in at least one of the cases, the MCA provider never advanced the full amount contractually promised to the customer, yet continued to withdraw the fixed daily amount from the customer’s bank account as if the full amount promised had been advanced. The fact that collections had slowed was a risk to borne by the customer and not the MCA provider (as would be the case in a true sale).
The Courts also seemed to be influenced by the business behavior of some of the MCA providers. For example, the Fleetwood Court outlined several facts that influenced its decision. At one point in its relationship with the MCA provider, Fleetwood requested a pause in the ACH withdrawal of the fixed daily to reflect a slowdown in collections, to which a collection agent responded “UNFORTUNATELY … WE DO NOT OFFER ‘BREAKS’. DOING THAT WOULD PUT YOU IN AUTOMATIC DEFAULT,” and [the MCA provider] continued to debit amounts from the Fleetwood Account,” and reconciliations were never performed to address the excessive ACH withdrawals. Further, the MCA provider made no attempt to dispute similar statements in affidavits from other customers submitted to the New York Attorney General. One customer, after advising of a seasonal slowdown in collections, requested a reduction in the daily payments and was told by the MCA provider, “We will take everything from you…. We are from New York…. Don’t mess with us.” Another customer requested a one-week adjustment of its payment obligations because it was awaiting payment on receivables from its clients. The same MCA provider responded: “I don’t care about your problems,” and “I’ll default you before you can get out of the bathroom.” While not dispositive, bad behavior does not help an MCA provider that may already be facing an uphill battle.
What is dispositive, however, is with whom, after examination and analysis of all of the documents, business dealings between the parties, and the economics of the transaction, the ultimate economic risk lies. If the scales tilt toward the customer, characterization as a loan is the more likely outcome. If risk allocation scales tilt toward the MCA provider, the transaction will stand a better chance of being characterized as a purchase.
The Fleetwood Court summarized the risk analysis as follows:
“The ultimate question…relates to whether the transaction involves a transfer of risk. Where the putative “lender and not the [putative] borrower bears the risk of non-performance by the account debtor” and “the borrower’s debt is extinguished” by the transaction, then “the lender’s risk with regard to the performance of the accounts is direct,” and the transaction is properly characterized as the purchase of accounts receivable. (citation omitted). By contrast, the transaction is properly characterized as a loan where “the lender holds only a security interest [and] the lender’s risk is derivative or secondary, that is, the borrower remains liable for the debt and bears the risk of non-payment by the account debtor, while the lender only bears the risk that the account debtor’s non-payment will leave the borrower unable to satisfy the loan.” (citation omitted).
These recent decisions are a signal that Courts are taking notice of certain MCA providers’ behavior and are providing guideposts for aggrieved customers. They are also a signal to the MCA providers that the Courts in the SDNY are willing to find their MCA arrangements are loans if the parties’ agreements are not properly allocating economic risk and if an MCA provider’s behavior is not commercially reasonable and consistent with its contractual obligations, thereby opening a path to usury and RICO claims against the MCA provider as well as disadvantageous and potentially costly treatment in the bankruptcy of the customer.
 Recent legislative action also appears to be oriented toward customer protection. Several states, most notably California and New York, have adopted consumer style disclosure requirements for commercial finance transactions meeting certain thresholds and which are offered to customers by commercial finance lenders that are not otherwise exempt. In both California and New York, the disclosure requirements are applicable to non-exempt MCA providers, factors and other providers of financing regardless of whether the non-exempt transaction is a loan or a true sale. California’s disclosure requirements take effect on December 9, 2022 and New York’s requirements take effect at the time the New York Department of Financial Services finalizes implementing regulations.
 Fleetwood Services, LLC v. Ram Capital Funding, LLC, et al, 20-cv-5120 (LJL), 2022 WL 1998207 (June 6, 2022 SDNY) (“Fleetwood”); Haymount Urgent Care PC, et al. v. GoFund Advance, LLC, et al., 22-cv-1245 (JSR), 2022 WL 2297768 (June 27,2022 SDNY) (“Haymount”); Lateral Recovery LLC, et al. v. Queen Funding, LLC, et al., 21 Civ. 9607 (LGS), 2022 WL 2829913 (July 20, 2022 SDNY) (“Lateral”). These cases are in various procedural postures. Fleetwood was a decision on the plaintiff’s summary judgment motion; Haymount and Lateral were rulings on motions to dismiss filed by the defendants in each case.
 The MCA agreements also contain a reconciliation provision designed to address over or under payments based upon actual collections and the contractual percentage. These reconciliations provisions provide the MCA provider with multiple opportunities to avoid making the calculation. In each of the cases cited above, failure to make such calculations formed part of the plaintiffs’ claims.
 Fleetwood at *14.
 Haymount at *4.
 Id. at 8.
 Lateral at *6.
 Fleetwood at *5.
 Fleetwood at 10.