In November, 2018, I published an article in the ABF Journal entitled Why Are MCAs Doing So Well in the Courts? First, let’s agree that there are many MCA providers that practice within the scope of what is fair, reasonable and legal. Those MCA providers tend to view the growing number of unscrupulous MCA providers as being damaging to their growing lending niche.
With few exceptions, MCAs have fared well in the courts. A very recent decision from the United States District Court for the Eastern District of Pennsylvania may be an indication that things may be changing.
In this case the plaintiff asserted claims for violations of the federal Racketeer Influenced and Corrupt Organizations Act (RICO) and Texas law against Defendants Complete Business Solutions Group, Inc. (CBSG), Prime Time Funding, LLC (PTF), and unnamed John and Jane Does. Plaintiffs asserted that the Defendants worked together to exploit cash-strapped small businesses by luring them into endless cycles of usurious debt under the guise of false promises of consulting services and debt reduction.
The plaintiff (Fleetwood Services) ultimately received a traditional small business loan that it used to repay Defendants in full, including what Plaintiffs characterize as an undisclosed annualized percentage rate of interest at 114.07%.
The defendants brought a motion to dismiss the complaint. In its decision denying the motion, the Court described the relationship between the parties as follows:
The relationship between Plaintiffs and CBSG was governed by the terms of the “Factoring Agreement,” which … obligated CBSG to provide Fleetwood Services with $370,000 (the Purchase Price) allegedly in exchange for $547,000 worth of Fleetwood Services accounts receivables (the Receipts Purchased Amount)…. However, allegedly unlike a traditional factoring agreement, the fair market value of the accounts receivable (i.e., the Receipts Purchased Amount) was unilaterally dictated by CBSG and based upon the creditworthiness of Fleetwood Services—not the creditworthiness of the customers who were to pay the accounts receivable or any appraisal of the actual value of Fleetwood Services’ accounts receivable…. The Factoring Agreement obligated Fleetwood Services to repay the Receipts Purchased Amount in 110 daily installments of $5,000.25, which were effectuated by electronic automated clearing house debits from Fleetwood Services’ Texas-based bank accounts. These daily payments were, like the Receipts Purchased Amount, also divorced from Fleetwood Services’ actual accounts receivable because the Factoring Agreement made “any and all receivables from any customer in any amount based on any sale subject to Defendant CBSG for payment of the daily fixed debit.
The Factoring Agreement also provided for (1) a declaration that the money provided by CBSG to Fleetwood Services “is not intended to be, nor shall it be construed as a loan”; (2) CBSG’s promise to refund Fleetwood Services any amount greater than the maximum lawful interest rate, in the event “a court determines that [CBSG] has charged or received interest” under the Agreement; and (3) a Pennsylvania choice of law provision.
Along with the Factoring Agreement, the Defendants also required Fleetwood Services to ensure repayment by granting CBSG security interests in “all accounts, chattel paper, documents, equipment, general intangibles, instruments and inventory…now or hereafter owned or acquired by [Fleetwood Services] and (b) all proceeds, as that term is defined in Article 9 of the UCC”, and obligating the owners to personally guarantee that Fleetwood Services paid CBSG the Receipts Purchased Amount ($547,000).
The Court stated:
Before the Court can address the Defendants’ arguments, it must first characterize the Factoring Agreement. If the Factoring Agreement is in substance a factoring agreement, i.e., a purchase of accounts receivable below their face value, then there can be no usury….If the Factoring Agreement functions as a loan, however, the Court must …determine whether it is subject to the usury laws of Pennsylvania or Texas, as the Agreement calls for the application of Pennsylvania law but the Plaintiffs assert Texas law applies…
The Court went on to rule (only for the purposes of the motion to dismiss) that the Factoring Agreement was not a “true factoring agreement” and, thus, was a “loan” subject to the usury laws of Texas which has a rather harsh usury law.
What glares out the most from this decision is the Court’s characterization of the MCA industry:
CBSG and PTF are engaged in the merchant cash advance industry, which is the merchant-to-merchant equivalent of consumer pay-day lending—an industry allegedly notorious for its predatory practices and extremely high interest rates.
Whether this case will spark closer scrutiny of providers of merchant cash advances is yet to be seen. Those MCA providers that offer “true sale” factoring and/or rates that are reasonable based upon the credit risk being taken and below any usury limit will have nothing to fear and will likely benefit from those less scrupulous providers being punished for their greed.
Fleetwood Services, LLC v Complete Business Solutions Group, Inc. doing business as Par Funding, 2019 WL 1558087 (April 10, 2019, EDPA)