MCA Contracts and State Usury Limits: When the Advance Is a Loan

The contract speaks in factor rates and the statute speaks in interest, and nearly everything that matters in an MCA usury case turns on the distance between the two.

Usury law fixes the most a lender may charge for the use of money, and the ceilings vary by state. In New York, civil usury caps most transactions at 16% per annum, while criminal usury sits at 25% per annum. A loan that crosses the criminal line is not enforceable in part or on reformed terms. It is void. The law regards the agreement as though it had never been formed, and the obligation to repay dissolves with it. A voidable contract, which a court might still enforce on the right facts, belongs to a different category altogether. Void admits no argument.

The industry has offered the same defense for a decade: usury law cannot reach the transaction, the argument runs, because nothing was lent and a purchase of future receivables is a sale. Courts have grown less patient with the label. Where the reconciliation right proves illusory, where the guarantee returns every loss to the merchant, where collection proceeds on a fixed daily schedule whether or not the receivables exist, the advance is recharacterized as a loan, and the effective rate of interest must be computed. The computation is the part of the file the funder least wants read aloud.

Calculating the Effective Rate

A $50,000 advance at a factor rate of 1.40 obligates the business to return $70,000. Read as a price, that suggests 40%, which is expensive though perhaps survivable for a short product. The factor rate was, if we are being exact, never an interest rate at all; it is a multiplier, and a multiplier carries no information about time.

Time is the quantity the daily draft consumes. Over a six-month term collected through daily ACH withdrawals, principal and profit travel back to the funder every business day, and the funder holds the use of that returned capital for the remainder of the term. By the midpoint you have surrendered much of the principal. The total owed has not moved. Early return earns the business nothing, because the full repayment figure was fixed on the day of signing.

Computed under standard APR methodology, the same arithmetic that truth in lending rules require for loans, the transaction leaves 40% far behind. Depending on the term and the draft schedule, the effective annual percentage rate may reach 150%, may reach 200%, and in some agreements, when the mathematics is honest, it passes 300%. What the contract calls itself carries no weight in that computation; the cash flows are the only record consulted.

Rates of that order exceed the usury ceiling in every state that maintains one. In New York the excess over the criminal threshold can reach a factor of six or more, and against most civil thresholds the margin runs wider. There are exceptions in a few jurisdictions, though in practice they tend to confirm the pattern. Whether the legislatures that wrote these caps had a product collected by daily debit anywhere in mind is a question worth sitting with. The arithmetic, in any event, is not close.