While perhaps not the world’s oldest profession, the business of borrowing money has been around since there have been those with an excess of capital and those who need it. However, as when satisfying all great needs, there comes a cost. The normal price of borrowing money is interest. The earliest existing law code we have, the Code of Hammurabi [1754 B.C.], sets maximum rates of interest a lender may charge depending on whether the loan was silver or grain based. Christianity has long frowned on charging excess interest as the sin of usury, and States have passed laws prohibiting usurious interest rates. Even Einstein has been credited with noting that “compound interest is the eighth wonder of the world.”
The Issue
So, what if you are a lender who wants to skirt the legal limits on interest? Or, what if you are seeking to borrow money, but the doors for usual lenders such as banks or credit unions are closed to you? In recent years, the ingenuity of man has developed a wonderfully simple scheme: the Merchant Cash Advance (“MCA”).
The MCA is one of the more clever financial feats of financial casuistry ever devised. And more importantly, an MCA is a financing scheme no borrower should contemplate without an assured, steady stream of future income. The simplicity of the MCA is that is does not call itself a loan, and some courts have recognized it as a sale, and not a loan. In an MCA, a borrower agrees to “sell” future receivables from any source for a present influx of cash. In simple terms, in a normal loan of $100 at 10% interest, the borrower would have to pay the lender back $110. In an MCA, the seller agrees to give the buyer far more in future receivables than the amount the seller receives in capital from the buyer. The MCA purports to be a sale, and therefore the lender gains certain priority of payments over other creditors and the transaction is not subject to usury laws.
A properly structured MCA purports to purchase a completely inchoate non-existent intangible. It is not a purchase of the right to future receivables from some source, but the non-existent future receivable itself. This analysis has been cogently criticized as a legal, if not completely illogical impossibility.[1] The basic problems are that MCAs look and act like incredibly high-interest loans. It is only the appellation of “MCA” and not “loan” that makes the difference.
To a borrower in need, MCAs may be wolves in sheep’s clothing. The structure of MCAs results in very little risk to the purchaser and can provide in essence 60% or more interest over 6 months – a clearly usurious rate. Some States have limited the use of MCAs, and the State of Maryland is currently reviewing legislation banning certain MCA transactions. [2]
The Takeaway
When seeking financing, the borrower must be on the lookout to see if the transaction is a loan or an MCA and should consult with an attorney or financial adviser before “selling” their future receivables at great cost. Illogically, the failure to make even one payment can accelerate the non-existent future receivables as immediately due (as is typical in loans). Therefore, when dealing with Merchant Cash Advances, one must keep in mind a twist on an old adage: LET THE SELLER BEWARE!
[1] “A “Sale” of Future Receivables: Disguising a Secured Loan as a Purchase of Hope” L F. Hilson & Stephen L. Sepinuck, 9 Transactional Law 14 (2019)
[2] https://legiscan.com/MD/bill/HB1478/2020
Anderson & Quinn, LLC is a law firm based in Rockville, Maryland, providing individuals, businesses, corporations, and healthcare institutions with the legal and litigation support they need to protect revenues. Philip Wright is an associate of Anderson & Quinn, LLC, 25 Wood Lane, Rockville, MD, 20850. Tel: 301-762-3303.
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