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The default notice: what the funder can do now, what it is hoping you do, and how to answer it

Small business owners have two primary ways of raising capital: taking on investors, or taking out loans. There are benefits and drawbacks to both, and which approach is better (or which one is even available) will depend on several factors. Merchant cash advances (MCAs) provide a third option - they can often serve as a bridge for businesses in need of immediate cash flow.

An MCA is a form of business financing that is based on a business's projected revenues from sales or other income-generating activities. When a business needs to raise cash in the short-term and conventional financing isn't available (or the business doesn't want to take out a loan for other reasons), entering into a merchant cash advance agreement allows the business to raise the capital it needs while also imposing an obligation to pay for that capital through its future earnings.

When executed properly, merchant cash advances allow businesses to avoid using existing assets as collateral for a loan. They also allow business owners to avoid providing personal guarantees to secure the debt that comes with more-traditional financing arrangements. However, business owners will need to personally guarantee MCAs in some cases, and the difference between an MCA and a conventional loan isn't as stark as some lenders might lead business owners to believe.

The Risks of MCAs

When MCAs go wrong, they can go very wrong. This can put businesses and their owners in very challenging circumstances that they need to do everything they can to overcome.

If you have a potential dispute with your MCA lender, prompt intervention can ensure that you do not unnecessarily (and potentially unjustifiably) pay more than you owe. Depending on the circumstances, it may be possible to resolve your company's situation while you maintain full rights to the revenues and cash that your business generates on an ongoing basis.

MCA lenders do usually pursue litigation. With all that these lenders stand to gain in the event of a default, litigation is well worth the costs involved. Even so, the most-reasonable approach for the lender may be to avoid going to court. Oftentimes, MCAs go awry not because business owners have intentionally sought to mislead their MCA lenders, but because business owners made the wrong decisions for the wrong reasons at the wrong time. Under these circumstances, MCA lenders will often decide that it is in their best interests to avoid litigation—so long as they are confident that they are not going to face similar issues again.

MCA Stacking

MCA stacking can be a recipe for disaster. Merchant cash advances are repaid through businesses' ongoing revenues. If a company is using one MCA to pay off another, this means that the company's owner (or someone else in a position of control) is allocating future revenues to multiple MCAs in excess of the company's projected receipts. Not only is this an unethical and potentially fraudulent practice, but it will inevitably result in financial challenges for all parties involved.

MCA stacking can take multiple different forms, and representing businesses and their owners in these cases means determining the most-appropriate path forward under the specific facts and circumstances at hand. Depending on the nature of the challenges, this could mean anything from negotiating with one or more lenders to avoid litigation, to defending in state or federal court.

Alleged Breaches of Merchant Cash Advance Agreements

Merchant cash advance agreements are notoriously complicated contracts. There are several reasons for this; but, for businesses, these reasons do not matter. Businesses and their owners need to ensure that they fully understand what they are signing, and they need to have a clear plan for repayment that aligns with the terms of the agreement. Otherwise, even without engaging in MCA stacking or any other intentional or reckless practices, business owners can find themselves facing allegations of breach of contract from their MCA lender.

Breaches of MCAs have the potential to put businesses (and business owners) at risk for far more than the principal amount they originally received, and MCA lenders will often seek default interest, attorneys' fees, and costs on top of repayment. Defending against these allegations often means focusing on facilitating an out-of-court resolution. In some cases, this means denying liability and focusing on the terms of the agreement in question, while in others, this may mean raising defenses such as that the MCA in question was actually a conventional loan, that the company was fraudulently induced into the MCA agreement, or that the company was otherwise unlawfully targeted.

While MCAs are based on businesses' projected revenues, it is often very difficult to determine whether a merchant cash advance is actually a merchant cash advance. A lawyer can review your company's MCA and determine whether it is an MCA or a conventional loan agreement in disguise. If the agreement is a disguised conventional loan agreement, this may provide grounds for avoiding further financial obligations to the lender.

Accusations of Fraud, Theft, or Embezzlement

In addition to facing liability in civil litigation, business owners who mismanage their company's MCAs or take unauthorized steps to raise cash can also face allegations of criminal wrongdoing - from fraud, theft, and embezzlement to PPP loan fraud and other forms of white-collar crime. These allegations can lead to investigations involving federal authorities, ranging from the Federal Bureau of Investigation (FBI) and Internal Revenue Service (IRS) to the U.S. Department of Justice (DOJ). Fraud, theft, and embezzlement are subject to significant statutory fines and terms of incarceration, and convictions for multiple charges can potentially lead to substantial financial liability and years (or decades) of imprisonment.

Liens, Judgment Debts, and Other Claims

Another risk associated with entering into a merchant cash advance agreement is having to deal with liens, judgment debts, and other types of financial obligations that can have long-term consequences for a business's operations and growth prospects - struggling under the weight of exorbitant debt for the remainder of the company's life cycle.

Options for Getting Out of an MCA Agreement

What can you do if your business has run into trouble with a merchant cash advance agreement? The short answer is that it depends. Your business could potentially have several options: asserting that the agreement in question is not a merchant cash advance agreement, but rather a conventional loan agreement; raising a breach of contract defense on the part of the MCA lender (if the lender hasn't fulfilled its obligations under the agreement); raising other defenses, such as fraudulent inducement, based on the circumstances involved; executing an out-of-court settlement; or defending against the lender's allegations in state or federal court.

Merchant cash advance agreements are not valid and enforceable in all circumstances. There are several issues that can render an MCA unenforceable, from deceptive marketing practices and misrepresentations of terms to efforts to create unconscionable repayment terms. There are also specific state-law rules that can render MCA agreements unenforceable in some cases.

If your business cannot afford to repay its MCA lender, protecting yourself and your business will require a prompt, proactive, and strategic approach. Speak with a lawyer promptly, and avoid making any mistakes that could result in civil liability or criminal charges. An experienced attorney will be able to evaluate your (and your company's) circumstances and advise you regarding your next steps.