By Andrew T. Hayner
Jaffe, Raitt, Heuer & Weiss P.C
With traditional lending institutions, such as banks and credit unions, still cautious about lending, especially to startups and emerging businesses, merchant cash advance (MCA) providers have helped to fill the void in providing much needed capital to businesses. Further, the MCA industry has proven ideal for many ISOs seeking a value-added service their competitors may not offer that can also serve as a new source of revenue.
However, due to an increase in participants, the MCA industry may soon become a target of government agencies that incorrectly equate the MCA industry with the highly regulated consumer cash advance industry. Therefore, legal issues and uncertainties are swirling around the MCA industry.
This article discusses the top five legal issues an MCA business should reflect upon when entering into an MCA arrangement with a merchant.
By far the most important legal concern for any MCA provider is structuring the transaction as a true sale rather than a loan. Most states require commercial lenders to obtain a license in the state where the party receiving the funds is located. Obtaining such licenses can be a costly process. However, failure to obtain the required licenses may make the MCA business liable for civil and criminal penalties. For example, the failure to obtain a lending license in Delaware is punishable by monetary fines and/or imprisonment of up to three months.
Even with a lending license, limits exist on the amount of interest the lender can charge. If such limits are exceeded, harsh penalties can be imposed, such as in North Dakota where a violation of its usury law is a penalty of 25 percent plus the principal of the loan. By structuring a transaction as a sale, rather than as a loan, the MCA business may avoid the need to apply for the commercial lending licenses and the usury laws may be inapplicable.
Due to the relative newness of the industry, few legal cases address MCA-related issues. However, the majority of recent litigation concerning the industry has come out of California. The most prominent of these cases is Richard B. Clark, et al. v. AdvanceMe, Inc. In the lawsuit, filed in 2008, plaintiffs alleged MCAs are "not purchases of future credit card receivables, as claimed by Defendant, but rather disguised loans with interest rates that violate California's usury laws and California Business & Professions Code Section 17200."
In 2011, the parties to that case reached a settlement in which AdvanceMe Inc., a leading MCA business, admitted to no wrongdoing, agreed to a settlement payment of $23.4 million, and forfeited the right to pursue further payments from the plaintiff merchants. The heightened litigation in California compared with the amount of related litigation in the rest of the states should make MCA businesses especially cautious when conducting business in California.
With the increased interest in the MCA industry and the entry of new participants, MCA providers have to find ways to differentiate themselves from the competition. Obviously, pricing is a major form of differentiation. Another not so obvious form is the length of the merchant contract.
If given the choice between a four-page merchant contract and a 16-page contract offering slightly better payment terms, it would not be surprising for the merchant to choose the four-page contract since it would cut down on the merchant's time (or legal fees) reviewing the contract. Merchants often prefer to spend their time and resources on matters other than reviewing contracts. MCA businesses must find the right balance between being legally protected without having the merchant contract's length cause an impediment to the business' success.
As previously mentioned, states can and do impose harsh penalties on businesses that offer commercial loans without lender licenses or that charge usurious interest rates. However, few states address the issue of what constitutes a true sale as opposed to a loan in the MCA context.
Therefore, it is important that you, as an MCA provider, adhere to the best practices shared in this article so that if a court decides a case in a manner that is harmful to the MCA industry as a whole, your business will be less vulnerable. By adhering to best practices, you may increase the odds state attorneys general will view your MCA business as a "tough out," one they will not pursue, favoring instead the "low hanging fruit," which is the MCA businesses that do not adhere to the industry's best practices.
The primary goal for an MCA business should be to obtain renewals, not to squeeze the merchant for every last dollar. Merchants that renew are the best customers because they have a proven track record of paying off their MCAs, and they are generally satisfied customers as evidenced by their repeat patronage.
You may wonder why I included the subject of customer loyalty in an article about legal issues; clearly, it addresses a business issue. However, there is substantial overlap between legal and business issues. For instance, from a legal perspective, customer satisfaction is important because a satisfied customer is less likely to pursue a legal action than an unsatisfied customer. Due to the limited amount of precedent cases and guidance concerning the legality of the MCA industry, it is best to avoid highly litigious customers.
Awareness of these legal issues can help guide strategy and decision making for an ISO's successful entry into the MCA industry. By taking the time to understand these issues, discussing concerns with knowledgeable legal counsel, and designing the right approach for your business, your ISO may be able to find an additional revenue source in this burgeoning industry.
The information I've just provided is for education and information purposes only, not to give legal advice and not to promise any particular outcome in any given set of circumstances. Before making a decision or taking any action related to providing MCA, please consult an experienced payments industry attorney who has MCA expertise.
Andrew T. Hayner, Esq. is an attorney with Jaffe, Raitt, Heuer & Weiss P.C. He practices in the areas of electronic payments, emerging and growth businesses and corporate law. For more information about the topics discussed in this article, please contact Andrew at (248) 727-1633 or via email at firstname.lastname@example.org. Andrew blogs at www.electronicpaymentslaw.com.
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