What Happens if You Default on a Merchant Cash Advance?
E.J. Simonsen | Jan 26, 2022
Merchant cash advances are an all-too-common debt trap for businesses. Unfortunately, most businesses don't know how deep the water is until it's too late. Merchant cash advance providers seem like they're offering a lifeline–until you miss a payment.
If you've heard horror stories of business's accounts being frozen or men like Gino showing up unannounced, it's important to know that you have rights. Here's what happens if you default on a merchant cash advance, and what you can do about it:
- How Does an MCA Work?
- What Happens if Your Business Misses MCA Payments?
- What Happens After A Business Defaults on an MCA
- If the MCA Lender has a Confession of Judgment, Cognovit Note, or Agreed Judgment
- If the MCA Lender does not have a Confession of Judgment, Cognovit Note, or Agreed Judgment
- What Happens After a Judgment is Filed Against Your Business by an MCA Lender?
- My Business Missed a Payment on an MCA — Who Can Help?
What Happens if You Default on an MCA?
If you're just looking for the simple answer: when a business defaults on an MCA, the business is immediately vulnerable to the MCA lender. The first missed payment invokes the lender's right to pursue you and your business. We'll get into all of the specifics in the article below, but in most cases, when a business defaults on an MCA, the contract states that the MCA lender can immediately begin to:
- File a collection lawsuit
- Freeze your business's bank accounts
- Seize property, vehicles, or assets
- Divert income to them with a UCC lien
- Contact your customers
- Come after your personal finances and assets
- and more.
The consequences of defaulting on an MCA are significant for any business. We'll walk through the detailed procedure below, so you have all the information you need to make the best decision for your business. First, let's start with a clearer understanding of how MCAs work.
How Does an MCA Work?
To understand what happens when a business defaults on a merchant cash advance, it's important to understand how merchant cash advances, also commonly called MCAs or cash advance loans, work.
First and foremost, MCAs claim not to be loans in an attempt to avoid interest rate caps. MCA lenders appear to offer a unique, secured, asset-based type of funding, similar to receivables factoring. In fact, most contracts read as if the MCA lender is purchasing a certain dollar amount of receivables. But, instead of purchasing specific receivables, the MCA lender advances money in exchange for a "claim" against your future income. In other words, you are borrowing money against your current income and money you hope to collect.
So, how does the MCA funding work?
Essentially, you pledge everything in exchange for near instant funding - your future income, your assets, and a personal guarantee. This makes an MCA a unique type of funding that's risky yet easy to obtain. After funding, you immediately start daily or weekly payments until the cash infusion plus a significant premium is paid off — usually over 2-8 months. If your business "re-ups" before paying off the first one - a very common practice - it's likely you'll have paid back the original debt many times over.
MCA payments are calculated as a percentage of your sales, but as with any borrowed funds, there is a borrowing cost. Unfortunately, most business owners don’t realize the interest rate cap in Texas is 18% APR, while the average merchant cash advance rate often exceeds 250% APR.
While MCA lenders would like you to believe that their intentions and operations are as legitimate as any traditional lender, the truth is that MCA lenders do not operate like traditional, regulated lenders. MCA are quick to fund, and just as quick to employ heavy-handed collection methods.
What if Your Business Misses MCA Payments?
If you're worried about making payments, always consult your lender before you default. While most MCA lenders have a reputation for being unhelpful, it's important to at least try. They want their principal back, along with a choice premium, and talking to them before you miss a payment might help you get a short forbearance and avoid defaulting. Also, MCA contracts contain specific instructions for this type of communication, and request for .
If you do fear missing a payment, here are a few things to keep in mind:
Don't Borrow More Money
Many MCA lenders, when they see a business struggling to make payments, will offer an additional MCA or something called a reverse consolidation.
Both are attempts to get you to divulge your most recent customer or income list and borrow more money, which will only make your situation worse. Remember the Rule of Holes, "First rule, when you're in a hole, stop digging!"
Taking out an additional MCA or signing up for a reverse consolidation will only increase your business debt, expose your most recent customers, and worsen your business's overall financial situation.
Do Invoke Reconciliation
If you've talked to your MCA lender, and they won't voluntarily work with you, you may be able to invoke reconciliation. Since your MCA payment is based on your business's revenue, if weekly or monthly revenue drops, it's unlikely your business will be able to make the planned payments calculated at the previous, higher revenue rate. For this reason, most MCA contracts include a reconciliation or re-adjustment clause.
This isn’t done out of kindness; it’s done to protect merchant cash advance lenders from being considered illegal or usurious loans. This clause typically states that if your business's revenue changes, your MCA lender may have the obligation to adjust or reduce your daily or weekly payment to ensure you're still paying an accurate portion of your receivables.
If You Miss a Payment, You Are In Default
If you've already missed a payment on your MCA, your business is technically in default. Missing any payment breaches (or breaks) the contract you've signed, at least according to the lender. When you default, it invokes the lender's right to pursue you and your business. That includes the right to leverage a UCC lien, so they can contact customers, lock merchant accounts, as well as sue you and your business.
In most cases, MCA lenders require that business owners sign a personal guarantee to get the merchant cash advance. If you had to sign any type of personal guarantee, you may be personally liable for that business debt. This means your personal finances and assets (which can include your savings, your property, any investment accounts, and more) are at risk. Which is one more reason that having a qualified attorney with experience dealing with merchant cash advance lenders, and who practices law in your business's state, is important to defending your rights.
If your business defaults on an MCA, the collection process swiftly begins.
What Happens After A Business Defaults on an MCA?
Defaulting on an MCA is particularly scary for most businesses since MCA lenders act quickly. They are often quick to tell borrowers that they will sue for fraud, seize property, send in-person collectors or property inspectors, file a collection lawsuit, file a confession of judgment, use UCC liens, or other legal collection efforts.
1 If The MCA Lender Has a Confession of Judgment, cognovit note, or agreed judgment
If your MCA lender has a Confession of Judgment (CoJ), Cognovit Note, or Agreed Judgment (AJ), they are likely to move quickly against you. "Wait!" you say, "I heard CoJs are illegal." WRONG! CoJs are just now more limited in their use.
While MCA lenders are prohibited from filing a CoJ in New York against a non-New York business. They can use Cognovit Notes, an Agreed Judgment, file a normal collection lawsuit, or file a CoJ in another state. Both Cognovit Notes and Agreed Judgments can be used to quickly seize bank accounts and other assets. Let's take a look at what these documents are, and what they mean for your business.
Understanding the Confession of Judgment, cognovit note, or Agreed Judgment
A few years ago, nearly all MCA lenders required — but rarely told you upfront — an affidavit and a corresponding Confession of Judgment (COJ), typically buried in the pile of papers you are required to sign when entering into an MCA agreement.
Confession of Judgment
Once signed, a Confession of Judgment waives many of your business’s legal rights to defense if the MCA is defaulted on. It allows the MCA lender to avoid a traditional and lengthy legal proceeding where they must prove to the court that you defaulted and how much you owe. Instead, you give them the power to notify a court that you “confessed” or agreed to a judgment. Worse, a CoJ can be filed, stamped, processed, and served on a bank or other institution to seize business and personal assets even before a first-class USPS letter notifies the business owner of filed CoJ.
An Agreed Judgment is like a Confession of Judgment, except that it requires active consent.
Why would a business owner agree to a judgment? In our experience, many business owners are unaware of their consent.
How could you be unaware you consented? Sadly, the easiest trap is during a modification or settlement.
The MCA lenders know that pushing a CoJ into the paperwork at this stage will send up red flags. So, instead you voluntarily AGREE that the amount stated on the "modification" or settlement is owed in full, by the business and you personally, in exchange for them generously modifying the payment terms.
Cognovit Notes are promissory notes whereby the borrower gives permission, or in other words consents or agrees, that the lender may obtain a CoJ or AJ without notification if they default.
Who would agree to such a thing?
Nearly every business owner, because they are unaware.
How could they be unaware?
- First, they don't know such agreements exist as they are outlawed in most states - per personal or consumer loans - NOT business.
- Second, lenders who use such agreements know that borrowers don't read the fine print, even the bold safety warnings, especially if signing on a mobile device with the expectation or need for money to arrive in 48-72 hours.
The upside is that traditional MCAs do not use cognovit notes because that would make the advance a loan. The downside is that the companies who use cognovit notes lend and operate like MCAs, yet tout themselves as "real lenders" are not MCA companies.
With a signed Confession of Judgment, Agreed Judgment, or Cognovit Note, creditors and lenders can often obtain the right to freeze your business and personal bank account in a matter of days.
2 If the MCA Lender does NOT have a Confession of Judgment
Even if your MCA lender does not have a Confession of Judgment, they can still move against your business in a matter of weeks, and sometimes even just days - especially using UCC liens.
Many MCA lenders leverage their access to your primary business bank account to build a database of your clients, vendors, other bank accounts, and other eCommerce accounts (Merchant Account, PayPal, Venmo, Cash App, etc.). They will file UCC liens against you and your business if they have not already. With UCC liens in hand, they contact their most popular merchant account or digital payment processors in hopes of freezing and then seizing these funds. Next, they contact your largest customers, vendors, or those with whom you do business or routinely receive income or inventory to freeze and seize those assets.
Can an MCA Lender Freeze My Bank Account Without a Confession of Judgment?
Fortunately, they cannot immediately freeze your bank account without a judgment (CoJ or AJ). The MCA lender must file a lawsuit against you, usually a breach of contract claim for missed payments. According to the law, they are supposed to send you a summons or a notice of the lawsuit. Then, depending on the jurisdiction where that lawsuit is filed, you have a certain number of days in which you must file a formal legal pleading in defense of that breach of contract lawsuit.
For example, in the state of New York, you have 30 days from receiving a summons or notice to respond and just 20 days to respond if your suit was served by hand. That deadline differs by jurisdiction, so it is important to pay close attention to where the suit is filed.
What's worse is that there are many unscrupulous lenders who will say they mailed you a summons letter, and use the date that the letter was mailed as the first day of your allotted response time.
If you have not filed a response by the deadline required by the jurisdiction of your suit, the MCA lender will likely obtain a default judgment against you, which means you will no longer have the opportunity to defend that lawsuit in that court.
What Happens After a Judgment is Filed Against Your Business by an MCA Lender?
Once a judgment is filed, your MCA lender will start working to collect your outstanding debt through any means possible. This can include, but isn't limited to:
- Freezing your bank account
- Calling you
- Emailing you
- Contacting your customers
- Harassing you on social media
And more. As we mentioned earlier in the post, there are many accounts of unscrupulous MCA lenders sending people like Gino directly to the place of business, unannounced, to attempt to collect money through scare tactics and threats. This is why it's so important for your business to seek support as soon as you recognize that you may be unable to support your MCA payments.
Once an MCA lender files a judgment, it can be very difficult to keep your business and your assets without legal support.
My Business Missed a Payment on an MCA — Who Can Help Me?
At The Lane Law Firm, we like to make it very clear to any business owner that merchant cash advances are rarely a good solution. That said, if your business has already taken an MCA and missed a payment, it's important to know that qualified help is available. A qualified merchant cash advance attorney in your state can help you resolve or restructure business debts, so you can get away from predatory and harassing creditors and do your best to get your business back on track.
No matter where your business is in the MCA process, or where your business is located, it's always best to seek a local MCA attorney who is familiar with and experienced in your area. Every state has its own unique laws around lending and merchant cash advances — finding an attorney in your state is essential to finding quality representation. If you're looking for merchant cash advance representation in Texas, The Lane Law Firm has you covered. We're here to talk whenever you need us. Set up your free consultation today, and let's get you out of this merchant cash advance.