Following a warning from earlier this year, the FTC recently filed a complaint against a group of corporate and individual defendants for allegedly misleading and deceiving small business "merchant cash advance" (MCA) customers. Structured properly, an MCA product offers an alternative to standard commercial credit under which the MCA provider purchases the right to receive a fixed amount of the customer's receivables to be paid based on a percentage of the customer's daily receipts.
Specifically, the FTC alleged that the defendants misrepresented the amount of financing small business customers would receive relative to their requests, misrepresented the necessity of collateral and personal guarantees, and engaged in unauthorized withdrawals from customers' bank accounts even after receiving the agreed upon amount of the customers' receivables. The complaint calls for permanent injunctive relief, rescission or reformation of the MCA contracts, restitution, refund and disgorgement.
The FTC's enforcement action is just one of its recent efforts to police alleged unfair and deceptive practices targeting small businesses. Given the current economic disruptions caused by COVID-19, we can expect that the FTC will continue to attack both deception and improper debt collection aimed at small businesses.
How MCAs Work
While there is no universal definition, an MCA is generally defined as an alternative financing product that involves a lump-sum payment to a merchant in return for a specified amount of the merchant's future receivables, to be paid to the MCA provider through an agreed-upon percentage of the merchant's daily credit card and/or debit card sales. When structured properly, an MCA is a purchase and sale transaction and should not be considered a loan or extension of credit under federal or state law. If not structured properly, an MCA may be subject to various federal and state laws and regulations governing extensions of credit, including: (1) state licensing and conduct requirements for lenders and loan brokers; (2) state usury limits; and (3) adverse action notice requirements under the federal Equal Credit Opportunity Act, among other requirements. In addition, as demonstrated by the FTC's recent enforcement action, MCAs are potentially subject to federal and state laws and regulations prohibiting unfair or deceptive acts and practices ("UDAP").
Misrepresentations of Collateral and Personal Guarantees
According to the FTC, the defendants mischaracterized "key" aspects of the MCAs, including that the MCAs did not require collateral or a personal guarantee, when the defendants did in fact require business owners to personally guarantee the MCAs. If the business defaulted, the defendants frequently filed lawsuits against the individual business owners who provided the personal guarantees. The complaint referenced the defendants' online advertisements, which included the alleged statements "No Personal Guarantee Loans" & "We Provide Capital With No Personal Guarantee."
Misrepresentations of Financing Amount
The FTC alleged that the defendants provided customers with "substantially less" financing than the total amount set out in the "Purchase Price" of the customers' contracts. The contracts defined "Purchase Price" as the total dollar amount to be provided to the customer in exchange for the "Purchased Amount" which represents the amount of the customers' receivables that the defendants were entitled to receive. Yet, customers received less financing than detailed due to the defendants withholding fees. According to the complaint, customers where made aware of the actual amount they would receive in a brief telephone call only after the customers signed their contracts.
The complaint also alleged that the defendants engaged in unauthorized withdrawals from customer accounts by withdrawing daily payments from the accounts after the defendants had already received the full "Purchased Amount." According to the complaint, the defendants knew about the overpayments because their recordkeeping processes created a "lag" or "debit delay" that resulted in them collecting an additional 4–5 or more unauthorized payments.
This latest action follows the FTC's warning earlier this year that ISOs, brokers and lead generators that market MCAs and other financing products should avoid potentially false or unsubstantiated advertising claims. Director of the FTC's Bureau of Consumer Protection, Andrew Smith, noted that "[m]aking sure that lenders and funders don't deceive business borrowers or engage in servicing abuses is a big priority for the FTC." MCA providers are officially on notice that the FTC is paying close attention to the industry.
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As discussed, the key to offering an MCA product is to make sure that it is designed properly from the outset — both to ensure that the MCA does not involve any unfair or deceptive practices and to avoid triggering federal and state laws governing loans. With respect to advertising the MCA, the provider should ensure that all key terms are disclosed clearly and conspicuously. Taking these, and other similar steps, are critical for minimizing risk and ensuring that the product is provided in a safe and responsible way.
For more information on factors impacting the recharacterization of an MCA as a loan or other MCA and commercial financing issues, please contact the authors.