Readers of WurstCaseScenario tell me that they never tire of MCA stories. This case is from one of the most well-respected Federal District Court Judges, Jed Rakoff (the judge in the Madoff cases, for example), and has the potential of getting ugly. Read on.
This action was brought as a putative class action but has not yet been certified. The claims allege fraudulent and usurious loans and abusive collection tactics employed by merchant cash advance (MCA) defendants GoFund Advance, LLC, Funding 123, LLC, Merchant Capital LLC and Alpha Recovery Partners, LLC and certain individuals. The plaintiffs are two small businesses, a North Carolina urgent care facility and a Texas construction contractor, that entered into MCA agreements with the defendants.
Judge Rakoff described MCAs as:
financial products, often marketed to small businesses through allegedly high-pressure sales operations resembling “boiler rooms,” that purport to purchase at a discount a portion of a business’s future receivables.
This decision determines the plaintiffs’ motion to convert a temporary restraining order granted at the start of the action to a preliminary injunction. The Court summarized the legal standard:
A party seeking a preliminary injunction must ordinarily establish (1) irreparable harm; (2) either (a) a likelihood of success on the merits, or (b) sufficiently serious questions going to the merits of its claims to make them fair ground for litigation, plus a balance of the hardships tipping decidedly in favor of the moving party; and (3) that a preliminary injunction is in the public interest.
It is important to note that in order to secure the preliminary injunction, the party only needs to demonstrate likelihood of success on one claim against each defendant. Here, the plaintiffs’ claims were for breach of contract and for RICO. The Court concluded that the plaintiffs demonstrated their likelihood of success on their breach of contract claims but not on their RICO claims.
Plaintiffs’ primary argument at this stage was that, assuming that the MCA agreements were valid as MCA transactions rather than as loans, the defendants breached them by failing to timely pay the purportedly agreed-upon purchase price, having withheld some $400,000 of the $1 million purchase price. Under the agreement, the defendants were to advance $1 million as a “purchase price” in exchange for the purported purchase of all of the plaintiffs’ receipts until the plaintiffs had repaid $1.499 million through daily ACH withdrawals of $60,000. On its face, the repayment should have been completed in approximately 25 days. However, the defendants initially provided the plaintiffs with only $400,000, after supposedly subtracting $100,000 in fees. After the plaintiffs had made approximately $785,000 in payments to the defendants (a little more than two weeks), the defendants deposited an additional $400,000, supposedly reflecting a deduction of another $100,000 in fees.
The plaintiffs were required to provide the defendants with 24 hours prior notice if any of the daily $60,000 ACH withdrawals would result in insufficient funds. The failure to provide notice was identified in the contract as an event of default. Several of the plaintiffs’ remittances resulted in ACH payments being returned for insufficient funds, but the plaintiffs did not notify the defendants as required.
The plaintiffs argued that the defendants breached the MCA agreement by initially depositing $400,000 of the $1 million, by withdrawing excessive fees and withholding until later the second $400,000 payment. The defendants were unable to demonstrate where in the MCA agreements they were entitled to the fees or where they were entitled to withhold portions of the purchase price. The Court then concluded that the plaintiffs were likely to prove that the defendants breached the contract by failing to send the full purchase price, minus applicable and appropriately disclosed fees.
The Court also accepted the plaintiffs’ argument that their own breach (tripping ACH payments) occurred as a result of the defendants’ failure to fully fund the purchase price and that the breach in ACH payment occurred after the defendants’ default.
Indeed, the payment may not have failed had the account been fully funded from the outset.
The defendants alleged a litany of harms that supposedly resulted from their default in payment. They argued that their default was clearly hastened because the defendants failed to timely deposit the cash advance in the plaintiffs’ account. Thus, the Court concluded:
Therefore, [the defendants are] likely to succeed in proving contract damages and, by extension, in prevailing on its breach of contract claim.
The Court went on to find that the plaintiffs had not demonstrated likelihood of success on each element of their RICO claim and, as a result, denied the preliminary injunction on that claim.
Next, the Court considered the other requirements to issue a preliminary injunction – irreparable harm and the public interest.
The papers establish that defendants’ issuance of UCC lien letters has frozen its bank and health insurance accounts, effectively locking up the urgent care center’s finances. If the urgent care center is unable to collect insurance reimbursements, and thus cannot make payroll or purchase medical supplies, there is a material risk of the business’s collapse. That would constitute an irreparable harm for which later payment of money damages would be inadequate.
The urgent care center’s inability to continue as a going concern would also disserve the public interest, because it would eliminate a source of medical care to the people of Fayetteville, N.C. To withdraw medical resources from any community would seriously harm the public interest at any time, but the implications are particularly serious in light of the continuing COVID-19 pandemic . . .
The Court granted the preliminary injunction and ordered:
During the pendency of this case, [defendants are] enjoined from continuing to debit unauthorized monetary amounts from bank accounts belonging to [plaintiffs] and from freezing bank accounts, health insurance accounts, assets and receivables belonging to [plaintiffs]. [Defendant] is further enjoined to withdraw and retract any UCC Lien Letters sent to third parties and to direct any other person or entity acting on its behalf to do the same.
So, what does this all mean? Yes, it is a victory for the plaintiffs and those who have been affected by the conduct of irreputable MCA providers. But that is not the end of the road. Plaintiffs still have a great burden ahead. Likelihood of success on the merits is not success on the merits. That will only come after trial. New York State Courts have, in numerous decisions to date, upheld MCA agreements. These facts may differ from the state court cases, and keep in mind that this federal judge is likely to look at this case with a fresh set of eyes.
Even if the case proceeds to trial, the next burden for the plaintiffs will be to succeed in getting certified as a class. That will not be easy. The defendants will likely be looking to settle this short of trial. A significant difference between this case and the New York State Court cases is the amount at issue. The New York State Court cases tended to revolve around small claims (under $50,000). Here the parties have more at risk. Are the plaintiffs looking to win a cause? If yes, then the class certification is important. If not, and the defendants are willing to walk away, then the plaintiffs will have won but without a precedent. If the defendants intend to stand their ground, then the issues will get flushed out and this will be a case to watch as it goes to trial and on to appeals that will certainly get the attention of the MCA industry.
We will be watching and reporting issues of significance.
Haymount Urgent Care PC; Robert A. Clinton, Jr.; et al v. Gofund Advance, LLC; Funding 123, LLC; Merchant Capital LLC; Alpha Recovery Partners, LLC; et al. 2022 WL 836743 (SDNY 3/21/2022)