Desperate businesses that turned to merchant cash advance companies for rescue found their lifeline shackled to high interest rates, hidden fees and long-term debt, several lawsuits claim.
Offering quick financing that isn’t technically a loan, merchant cash companies structure the deals as money up front in return for a portion of an enterprise’s future accounts receivable. By claiming the funds aren’t loans, the cash advance companies avoid usury restrictions even though annual percentage rates of interest can amount to 400%.
“They’re predatory,” said Frank H. Falkner, who specializes in bankruptcy at the Dilks Law Firm of Little Rock and has counseled clients who dealt with MCAs, as the financing companies are known.
When struggling companies grab on, “it’s not really a lifeline,” Falkner said. “It’s like throwing an anchor to somebody instead of a life raft.”
Attorneys Tim Hutchinson of the RMP LLP law firm in Fayetteville and Matthew Bishop of Fayetteville have filed lawsuits seeking class-action status against several companies that provide MCAs. The suits accuse the companies of improper practices.
The MCAs are “not regulated by any federal or state body,” Hutchinson told Arkansas Business, adding that the amounts the companies charge and the collection efforts they employ are abusive. “That’s what the impetus is behind these lawsuits.”
If Hutchinson’s suits prevail, he said, MCAs doing business in the state will be required to register with the Arkansas Securities Department. And it happens that the department has also noticed the MCA industry.
“While our enforcement staff cannot comment on any matters that may be under open investigation, the Department urges Arkansans to exercise extreme caution before entering into any type of MCA arrangement,” Commissioner Eric P. Munson said in a statement to Arkansas Business.
Munson said MCAs are complex financial arrangements with substantial obligations and risks. The advances fall into a gray area of law, not specifically defined as securities under the Arkansas Securities Act or any other state statute.
The Federal Trade Commission also has filed enforcement actions alleging that several large merchant cash advance providers have used unfair and misleading business practices, he said.
The companies that offer cash advances to merchants have used aggressive collection methods, including filing “confessions of judgment” against debtors in New York without their knowledge. The attorneys then added thousands of dollars in fees to the balances owed.
By the time the client finds out about the judgment, the client has to hire a New York lawyer to fight it, Bishop said. “You already don’t have enough money to pay this anyway, so it’s, effectively, what good does it do?” New York legislators closed the loophole that allowed the judgment practice in August 2019.
Stephen Denis, executive director at the Small Business Finance Association, which represents companies that offer MCAs, defended the industry’s practices.
“It just provides the business with a lot more flexibility in terms of how they approach financing,” he said.
The SBFA worked with New York legislators to ban the confessions of judgment, Denis said. And the association is working with the Federal Trade Commission so it knows “the good and bad practices” of MCAs.
Denis said merchant cash advance companies buy a business’s future accounts receivable, an arrangement that could appeal to seasonal businesses.
He said it’s “misleading” to apply an APR metric to the arrangements because if a business does well, it will fulfill its obligation quicker. If it struggles, paying off the obligation may take two years.
“Businesses … they operate differently than your average consumer,” Denis said. “For the most part, businesses are sophisticated operators, and they know the financing they need. And they understand the terms and obligation.”
He said the MCA segment is growing, although he didn’t have any estimates on how much funding the MCAs provide. He said small businesses have been “largely ignored by the traditional banking industry” and therefore seek out alternative funding options.
“Business owners, when they’re looking for financing, you know, sometimes cost isn’t the most important thing to them,” Denis said. Still, he said, the companies he serves are trying to become more transparent about the pricing.
“But like any industry, there’s some bad actors out there,” Denis said. “And they aren’t as transparent” about financial terms as they should be.
Letha’s Pies Cases
Bishop, the Fayetteville attorney, said the merchant cash advance providers started appearing in Arkansas around 2011. The sales pitch to small businesses involves offering to supply operating cash within a day or two of applying for the money.
“They kind of took off as a lot of states started shutting down payday lenders,” he said.
Merchant cash advance companies promote their services to “unsophisticated, Arkansas small businesses facing an immediate need for cash flow,” according to the lawsuit Bishop and Hutchinson filed on behalf of Letha’s Pies of West Fork (Washington County).
Around August 2016, Letha’s Pies was facing what it believed to be a temporary cash-flow shortage and began using MCA services. In July 2019, the bakery filed suit against three MCA companies in Washington County Circuit Court.
One was against Principis Capital LLC of Jersey City, New Jersey. Principis Capital’s voicemail box was full, so no message seeking comment could be left with the company. The case was later transferred to U.S. District Court, where it was then sent to arbitration in October 2019. In July, the parties resolved their disputes and told the arbitrator that the case should be closed, which it was.
Letha’s Pies also filed similar lawsuits seeking class-action status against EBF Partners LLC of New York, which does business as Everest Business Funding, and Funding Metrics LLC of Bensalem, Pennsylvania, which does business as Quick Fix Capital.
Funding Metrics has denied Letha’s Pies’ allegations in its court filings. It asked that the case be dismissed and its attorneys be awarded fees. The case is pending.
EBF denied the allegations in its filings. It asked that the case be dismissed and sent to arbitration. Circuit Judge Beth Bryan denied the request in October 2019, and EBF has appealed her decision to the Arkansas Court of Appeals, where it is pending.
Need for Cash
Founded in 1990, Letha’s Pies makes frozen fried pies for resale to restaurants. The bakery is owned by Timothy and Rhonda Glenn.
Principis Capital offered to buy Letha’s Pies’ future accounts receivable, according to the lawsuit. The transaction called for Principis to pay $76,400 immediately in exchange for $103,900 worth of future receivables.
But no specific accounts receivable were ever marked for assignment from Letha’s Pies to Principis, the suit said. Instead, “the smaller print” said Principis would receive a percentage of the bakery’s gross funds received, the suit said. Letha’s complaint argued that the arrangement was similar to a preferred stock interest or preferred bond, both of which are securities under Arkansas law, the suit said.
But the suit said that companies offering MCAs didn’t have securities licenses, weren’t registered with the Arkansas Securities Department and weren’t associated with registered broker dealers in the state. The suit said the companies weren’t allowed to market the MCA products in the state, yet they did.
Financing Arrangement
In exchange for the money, Principis would withdraw about $285 from Letha’s accounts every business day until the $103,900 was repaid. But under the terms of the MCA, the daily amount Principis could withdraw could rise or fall depending on the bakery’s sales.
But at $285 a day, the funding would be repaid in 72 weeks, resulting in an APR of about 28%, the suit said.
The agreement gave Principis a security interest in all of the bakery’s assets, and personal guarantees of the owners. In addition, Principis received power of attorney, which it used when Letha’s Pies saw sales slip and it couldn’t make the daily $285 payment. When Principis determined that Letha’s had defaulted, Principis took about $20,000 from Timothy Glenn’s adult son’s bank account, according to the lawsuit.
The son “was obviously shocked,” Hutchinson said. But Principis maintained that it could take the money from the son’s account because Timothy Glenn was a signatory on the account when the son opened it years ago, the suit said.
“And they did it without notice,” Hutchinson said. “They didn’t provide notice to Letha’s Pies. They didn’t provide notice to the son. This is the type of collection efforts that we’re talking about.”
The bakery used about five of the MCAs “at one point or another, but Letha’s Pies was able to actually pay them all off and get out from under it,” Hutchinson said.
Collection Methods
Other businesses have other MCA collection nightmare stories.
Falkner, the bankruptcy attorney, said that the merchant cash companies “in general” are very aggressive when it comes to collecting money.
“When people stop paying, they take extraordinary collection efforts,” he said. He said the debt collectors will drive by the debtor’s home and business and take photos.
“And they’ll call you back and tell you that they’re going to take all that stuff from you,” Falkner said.
Before New York shut it down last year, the “confession of judgment” tactic involved filing an affidavit and little else. The MCA providers were then able to get judgments and seize assets from borrowers while making it difficult for the borrower to challenge the judgment.
The legislative protection came too late for Michael and Kathy Rose of Hot Springs, who owned Healthcare Medical & Respiratory Care Inc. of Hot Springs.
Michael Rose said the company needed money after Medicare and Medicaid cut reimbursement rates to durable medical equipment companies by more than half in about 2016. He turned to EBF Partners LLC, the New York company that Letha’s Pies used, and received about $50,000 in financing, he told Arkansas Business last week.
Rose said he didn’t remember how he heard about the company, but he was drawn to the offer because the company couldn’t access financing through conventional sources.
“They could get you the money quickly,” he said of EBF Partners, and Healthcare Medical was in dire need.
It wasn’t long before Healthcare Medical defaulted on the payments, which were more than $5,000 a month. On Dec. 19, 2016, an attorney for EBF Partners filed a confession of judgment in New York against Healthcare Medical, listing $41,690 as the amount owed, plus $220 in interest from Dec. 1, 2016, and attorney fees of an eye-popping $10,422.
The three-page judgment filing doesn’t say what legal work was done to generate the fees for attorney Christopher Murray of Mineola, New York, since it appeared no depositions or discovery was done in the case. Murray didn’t return a call for comment.
Rose said he didn’t know about the judgment until EBF was taking money out of his bank account.
The Roses filed for personal bankruptcy and EBF “got nothing,” Rose said.
Falkner, who did not represent the Roses in bankruptcy, said the MCAs get personal guarantees from the owners and when the business becomes insolvent, the owner follows by filing for personal Chapter 7 bankruptcy. If the debtor receives a discharge in bankruptcy, it wipes out the personal liability from the MCA provider.
“So the merchant cash advance people are left with a judgment against a defunct company with no assets,” Falkner said.
Sign up for Daily E-news
