Merchant Cash Advance - The Law Has Evolved and Is Likely to Knock the MCA Industry on Its Heels
Written by: Marc Mellman, Managing Director, MCA Stacking Solutions
Marc Mellman, Managing Director at MCA Stacking Solutions, returns to update the current legal developments in the MCA Industry that will likely lead to the ultimate change in how MCAs can do business going forward
In my last article for IFA in October 2023, I suggested that the law here is evolving and, . . . in the next few years, we will see a seed change to the point where the True Sale interpretation of the classic MCA contract will fade away. Well, that time is close to coming to fruition.
On March 5, 2024, Letitia James, Attorney General of the State of New York, filed a 289-page Verified Complaint in New York County [Manhattan] of the Supreme Court of the State of New York [the trial level] against the largest MCA operator, Yellowstone Capital, LLC, and its successors, subsidiaries, and affiliated companies, as well as its owners, [“Yellowstone”], claiming that Yellowstone engaged in repeated fraudulent, deceptive, and illegal conduct, including civil and criminal usury. The State based its allegations on the following:
New York law prohibits usurious loans when masquerading as purchases of revenue.
Yellowstone contracts have fixed durations, and payment amounts that do not approximate a specified percentage of revenue.
During the repayment period, Yellowstone did not change the fixed durations and payment amounts based on the specified percentage.
The contract reconciliation clause is discretionary and not in tune with the specified percentage.
The specified percentage is irrelevant insofar as it relates to the reconciliation clause.
Yellowstone claimed the right to repayment in the event of bankruptcy or the merchant’s lack of revenue.
Yellowstone contracts used “interest rates” that significantly exceeded the legal limit.
Yellowstone misrepresented its business operations and transactions to the courts in prior litigation.
Yellowstone engaged in fraudulent conduct in its dealings with merchants.
Yellowstone’s primary successor-in-interest, Delta Bridge Funding LLC, was nothing more than a name change with Yellowstone just operating under a different name.
The individual defendants operated Yellowstone throughout its history knowing that their actions were contrary to the law of New York.
The State’s case rested on the premise that no such True Sale occurred under the Yellowstone contracts, and in essence the Yellowstone contracts were loans at usurious rates of interest. The Complaint named Yellowstone, 26 affiliated companies, some of which operated as an additional 48 separate entities as DBAs, and the company owners, as party-defendants. People of the State of New York v. Yellowstone Capital LLC et al., Index Number 450750/2024. Amongst the 27 named parties and the 48 additional DBAs, the parties-defendant represented the “Who’s Who” of the MCA industry.
As previously reported in prior Articles, for years, merchants have complained that the typical MCA contract, including those of Yellowstone, are not the illusion, the MCAs and in this case, Yellowstone suggests of being a True Sale. If these contracts were legally deemed to be a True Sale, then the merchant would have no basis to claim, typically in defense of a collection action brought by an MCA following a merchant’s default, that the contract was a loan at a usurious rate of interest. Even though the typical agreements historically and at present go to great lengths to couch the terms and conditions of the contract to avoid any reference to terms associated with loan agreements [e.g., specific finance amount, interest rates, finite length/term, etc.], a reading of the typical contract has lent itself to analyses that could conclude its not a True Sale but a loan in disguise. For example, although an MCA contract does not provide for an interest rate, an APR can be calculated by reviewing the contract’s salient terms. Typically, the APR, in a vast majority of all MCA contracts, would be far in excess 100%. In states with usury laws [which number less than half of the United States], such contracts would be criminally usurious. Notably, it is common today amongst several states who have enacted finance disclosure laws that MCAs are required to provide a written disclosure along with the contract. An APR is required to be disclosed, and it is common to see interest rates greater than 200% or more. Even knowing this, state and federal courts in New York, where most MCA disputes are litigated [because of the history of New York being a creditor friendly jurisdiction where a significant part of creditor’s rights law was developed], have upheld the determination that the MCA contract is a True Sale. During the past five years there have been several trial court decisions, and just a few appellate court decisions, holding that the particular contract in question before the court was or could represent a loan rather than a True Sale. These decisions then beg the question of whether the contracts were usurious. New York’s interest rate limit for these transactions is 16% above which would be civil usury, and 25% above which would be criminal usury. While the case decision trends have moved towards a finding that MCA contracts are Loans rather than True Sales, the case law has not reached the point of such an overriding determination; rather, the cases have been decided on a case-by-case basis.
It appears, however, that the Yellowstone case may be the case that will finally represent the seed change that the merchant world has been awaiting. On December 2, 2024, less than 9 months following the filing of the action against Yellowstone, the State notified the court that the Yellowstone litigation had been settled by an overwhelming majority of the defendants, namely Yellowstone and 24 of the other named companies that included World Global Capital LLC, operator of the 48 DBA companies, together with Yellowstone’s CEO Yitzhak “Isaac” Stern and President Jeffrey Reece. A Consent Order and Judgment was to be entered by the court resulting from the settlement of these parties. [the “Consent Order and Judgment”]. The only parties that did not settle at the time of writing this article were Delta Bridge Funding LLC, Cloudfund LLC, and the remaining 8 individual defendants. Delta Bridge was named in the State’s Complaint claiming, among other allegations, Delta Bridge was the successor-in-interest of Yellowstone resulting from a fraudulent conveyance, in other words, Yellowstone under a new name.
The pertinent terms of the Consent Order and Judgment were as follows:
The settling defendants are permanently barred from engaging in the MCA business.
All obligations owed by merchants or their guarantors, including but not limited to unpaid balances due, fees, attorney’s fees, settlement amount, and unsatisfied judgments are irrevocably cancelled.
The settling defendants are barred from any attempt to recover any cancelled debts.
The settling defendants will not assign, sell, or otherwise transfer to any other person or entity any claimed right to collect the cancelled debt.
All unsatisfied court judgments issued against merchants and guarantors are to be vacated.
All existing judgments are to be vacated.
All pending litigation by the settling parties against merchants and guarantors are to be dismissed with prejudice.
All UCCs filed by the settling defendants are to be terminated.
Yellowstone agreed to the entry of a judgment for $1.065 billion which amount will be offset by $534.6 million, which represents cancelled debt of the merchants/guarantors, once Yellowstone vacates any judgments against the merchants/guarantors.
Following application of the offset, the amount of the Judgment will be reduced to $531.0 million.
The Judgment requires an immediate payment to the State of $3.4 million from Yellowstone and $12.7 million from Stern and Reece, which would reduce the Judgment amount to $514.0 million following offset.
The State would have the right to collect the remaining $514.0 million from Yellowstone, although not likely considering Yellowstone will be judgment proof.
In a word, this result was amazing, especially recognizing that it was reached in less than 9 months from the time the lawsuit was first filed. In reaching the settlement with all but 2 of the Yellowstone corporate affiliates and other officers, New York knocked the largest industry player out.
Examples that the law is changing in favor of the merchant and guarantor, there are 2 recent cases of note to highlight for this discussion. In Fleetwood Servs., LLC v. Richmond Cap. Grp. LLC, No. 22-1885-CV, 2023 WL 388267 (2d Cir. June 8, 2023), the Second Circuit affirmed the New York trial court’s decision granting summary judgment finding, as a matter of law, that the MCA agreements were criminally usurious loans, the MCA company was a RICO enterprise, and the MCA owner was liable individually under RICO. In Apollo Funding v. Dave Reilly Construction, Index No. 035156/2023, a Rockland County New York case decided less than 6 weeks following the filing of the Yellowstone matter, the court denied the MCA’s motion for summary judgment because it found factual issues related to whether the MCA agreement was an unenforceable criminally usurious loan rather than a True Sale. The judge in Apollo noted the MCA agreement before the court resembles contracts recently alleged to be usurious loans by the New York State Attorney General in a new petition against over 30 companies on March 5, 2024.
The law has certainly evolved, and we are so close to the pendulum fully swinging. This not only will favor the merchants and guarantors who have historically turned to MCA financing when they had cash constraints and nowhere else to go, but it bodes well for the alternative finance industry such as factoring who should ultimately benefit from an increase in available business without the interference of merchant cash advance companies.
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