What Happens if I Default on a Merchant Cash Advance?

As a small business owner, sometimes you need extra business funding to keep operating smoothly. Merchant cash advances (MCAs) have become a popular source of fast business financing. Unlike typical bank loans, MCAs are typically repaid with future sales from credit card sales.

Unfortunately, they don’t have the same benefits and protections as a traditional small business loan. The high fees and tricky contracts associated with MCAs can threaten your business and finances if you aren’t careful. If you’re in danger of defaulting on a merchant cash advance, knowing how that could impact your business is important.

Read on to find out what happens if you default on an MCA, how to avoid it, and what to do if you’re already behind on payments.

How Merchant Cash Advances Work

Merchant cash advances provide businesses with a way to obtain immediate capital by selling a portion of their future sales at a discount to the lender. This type of funding is often used by businesses that need quick access to cash and have a high volume of credit card transactions or consistent sales revenue streams. It’s important to note that MCAs are not loans; they are advances based on the business’s future sales.

Here’s how they work: A business applies for an MCA, providing the funder with sales records and other required documentation. The MCA funder then evaluates the business’s sales history and cash flow to determine eligibility and the advance amount. If approved, the business receives a lump sum payment.

Repayment of an MCA is tied to the business’s sales volume, with the lender taking a percentage of daily or weekly sales. This percentage is known as the “holdback” rate. The frequency and amount of payments can fluctuate based on the volume of the business’s sales, meaning repayment is faster during periods of high sales and slower during periods of low sales. Additionally, instead of interest rates, MCAs use factor rates to calculate the cost of the advance. Factor rates are expressed as decimal figures rather than percentages, typically ranging from 1.1 to 1.5. The factor rate determines the total amount the business must repay.

Why Merchant Cash Advances Are Different

With other types of small business debt, it’s possible to work something out before the MCA funder files a lawsuit. However, merchant cash advances work a bit differently.

Many contracts from MCA providers include what’s called a confession of judgment. When you sign a contract that includes this clause, you’re effectively signing away your rights to defend yourself if there’s a breach of contract and the funder files a lawsuit to collect.

In other words, the funder can simply file the lawsuit and get a judgment to start seizing your business assets through UCC liens or other methods to recoup its money.

In many cases, merchant cash advance companies also require a personal guarantee. If your business can’t repay the debt, you can pay it back with your personal assets. So if the funder files a lawsuit, it could also impact your personal finances, not just your business.

Here’s an example

A restaurant needs to renovate its kitchen urgently and decides to take a merchant cash advance to cover the cost. The lender approves an advance of $50,000 for the restaurant with a factor rate of 1.3.

• Advance Received: $50,000
• Factor Rate: 1.3
• Total Repayment Amount: $50,000 * 1.3 = $65,000

The agreement specifies that the lender will take 10% of the restaurant’s daily credit card sales until the $65,000 is fully repaid. If the restaurant averages $2,000 in daily credit card sales, the daily repayment amount would be $200 (10% of daily sales), and it would take approximately 325 days to repay the advance if sales remained consistent. However, the actual duration could vary with fluctuations in the restaurant’s sales.

Merchant cash advances offer a flexible financing option for businesses, especially those with strong sales but less favorable credit profiles. However, due to their high costs compared to traditional loans, businesses should be cautious about taking on this kind of financing.

Defaulting on a Merchant Cash Advance: What Happens Next?

If a borrower misses one or more MCA payments, the borrower is considered in default on their MCA agreement. Defaulting on a merchant cash advance is usually considered a breach of contract.

If you default on a merchant cash advance, there are several potential negative consequences:

1. Heightened collection efforts: MCA providers may aggressively pursue collection efforts to recover the owed amount. This can include hiring collection agencies or taking legal action to enforce the repayment.
2. Legal action: If the MCA provider decides to take legal action and wins, they may obtain a judgment against the business (and possibly the business owner, if there was a personal guarantee). This can lead to bank account levies or seizure of assets to satisfy the debt.
3. Personal financial risk: Many MCA agreements include a personal guarantee. This means that the business owner could be personally liable for the debt if the business defaults. This can put the owner’s personal assets, including savings and property, at risk.
4. Credit score impact: While MCAs don’t always report to credit bureaus (since they’re not traditional loans), defaulting can still impact the business owner’s personal credit score and the business’s creditworthiness, especially if a court judgment is obtained against the business. This can make it more challenging to secure financing in the future.
5. Reputation damage: Legal battles and financial struggles can harm a business’s reputation with customers, suppliers, and potential partners. This reputational damage can have long-term effects on the business’s viability and growth prospects.
6. Renegotiation challenges: While some MCA providers might be willing to renegotiate the terms of repayment in cases of financial difficulty, not all are flexible. Defaulting can limit a business’s ability to negotiate favorable terms, leading to more stringent repayment conditions that further strain the business’s finances.

What Is an MCA Lawsuit?

When an MCA company decides to sue a customer, they must first send a court summons and complaint notice. This will explain why you’re being sued and include the deadline for responding with a formal legal pleading. The exact timeline for responding depends on where you’re located. In New York, for example, you have 20 days if it was physically handed to you. You’d have 30 days if it was sent by some other means (like U.S. mail).

It’s crucial that you respond to the lawsuit before the deadline. The MCA company can obtain a default judgment against you if you don’t. That means you can no longer challenge or defend yourself against the lawsuit.

Unfortunately, some MCA contracts contain a “confession of judgment” clause (also known as an “agreed judgment”). This allows the MCA company to avoid going through the normal lawsuit process. They can obtain a judgment against you without notifying you or allowing you to defend yourself in court. They can then move quickly to seize business assets, freeze accounts, etc., in days.

Additionally, you may have been required to sign a personal guarantee when securing the MCA. This means that you are personally liable for the business debt. So your own assets and money could be at risk in a lawsuit.

Steps You Can Take to Defend Yourself

While a confession of judgment doesn’t give you many options, it’s not ironclad. In some states, you may be able to fight it if you can prove any of the following:

• The confession of judgment doesn’t comply with state law or local rules.
• The confession of judgment is inaccurate regarding parties involved and the amount owed.
• Your MCA breach of contract doesn’t meet the stipulations to trigger the confession of judgment.
• The funder was negligent in clarifying what the confession of judgment meant when you signed the contract.

If you have reason to believe that any of these are true, you may be able to request that the court vacate the confession of judgment. If you’re facing legal issues with MCAs, it’s a good idea to enlist the help of an attorney who can help you make the right moves.

Tips to Avoid Defaulting on a Merchant Cash Advance

As you can see, defaulting on an MCA can seriously affect your business and finances. Not only are there the legal consequences listed above, but you can also damage your credit score and potentially put your personal assets at risk. If you’re in danger of falling behind on MCA payments, it’s important to avoid defaulting. Below are a few steps you can try taking.

Look for Ways to Cut Costs

Since MCA payments are based on your receivables, they can take a big bite out of your cash flow. One way to make some more wiggle room is by cutting costs internally. Try hiring freelancers or contractors to save money on labor, or renting expensive equipment instead of buying it. You can also try renegotiating your terms with vendors or suppliers to lower costs.

Try to Restructure the Debt

When you’re in danger of falling behind on your MCA payments, it’s a good idea to contact the MCA company ASAP. These companies are notoriously unhelpful, but they may be able to restructure your deal if it means they’ll continue getting paid. For example, you might be able to negotiate a short forbearance period to give your finances some breathing room. 

MCA contracts also contain a provision known as reconciliation or readjustment. If your business income falls, you probably won’t be able to make payments according to the original terms. So the MCA company must restructure the payments in a way that’s more affordable, or else they’d be considered a usurus (illegal) lender. 

Consider Debt Consolidation

If you want to get out of your MCA contract, you could consolidate the debt. This involves taking out an installment loan and using the proceeds to pay off the MCA. Instead of having a portion of your sales deducted daily, you’ll be responsible for making one fixed, monthly payment over several years. The interest rate will likely be much lower, too. That’s especially true if you have good credit, which is required for a more traditional business loan. Overall, the repayment terms of a term loan are more favorable compared to an MCA.

Attempt to Settle the Debt

Settling MCA debt typically involves negotiating with the lender to agree on a lump sum payment that is less than the total amount owed. It’s a good idea to work with a debt settlement attorney who has experience working with MCA companies if you go this route. They can negotiate on your behalf and help navigate the complexities of the settlement process.

Get a Business Credit Card

If MCA debt has left you with slim margins and little cash flow, a business credit card could help. With a business card, you can charge important expenses when you don’t have the cash on hand, and then pay off the balance when there’s more money in the bank. Keep in mind that it’s important to stay on top of payments and avoid letting the balance growth. Otherwise, your credit card debt will only compound the issues you’re experiencing due to MCA debt.

Hire a Debt Relief Lawyer for Help

Whether you’re worried about falling behind on MCA payments, defaulting on a merchant cash advance, or maybe even facing a lawsuit, hiring an MCA debt settlement attorney is important. Tayne Law firm has been working with clients to resolve MCA and other business and consumer debts for over two decades. We can examine your situation and devise a plan that helps keep your business running while getting debt collectors and ruthless MCA collectors off your back.

For example, our attorneys are skilled at negotiating business debt settlements, which could result in you paying less than what you owe. We have relationships with merchant cash advance companies and their legal teams and understand the legal process that can impact your business. Focusing on your business should be your priority. Having a team that can navigate the challenging world of MCA legal debt resolution may make the difference in your business’s survival and, ultimately, thriving. The stress alone in dealing with MCA debt and business challenges can be debilitating — let us handle it for you and get you the best resolution possible for your business.

We offer a free phone consultation to get to know your business and its challenges. We will discuss what types of services we can provide, including a strategy that makes sense to help you resolve your MCA debt. Don’t let your MCA debt problems get out of hand. Call us today toll-free at (866) 890-7337 or fill out our short contact form. There’s no obligation and we never share or sell your information.

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