Merchant Cash Advance (MCA) and Connecticut

MCAs Are Not Loans and Not Subject To Usury Laws

Introduction

Revenue-based financing, commonly called merchant cash advance (MCA), is often compared to and considered synonymous with traditional loans. This comparison is incorrect, however, both factually and legally. MCAs and loans are fundamentally different financial products in structure, principle and function.

An MCA is a form of commercial financing, where an MCA financing company purchases the future anticipated revenue of a business for a discounted lump sum advance. For example, in exchange for a $50,000 lump sum advance, a business may agree to sell $70,000 of its future receipts to an MCA funding company, to be repaid through 20% of the business’ daily or weekly sales.

In contrast, a traditional loan is a financial arrangement where one party (the lender), provides money to another party (the borrower), under an agreement that requires the borrower, regardless of the borrower’s financial performance, to repay the principal amount, with interest, within a specified timeframe, according to a repayment schedule.

Connecticut has become a prominent jurisdiction for the MCA industry, including due to its favorable prejudgment remedy laws. Most recently, the Connecticut legislature passed Public Act 23-201 (codified at Conn. Gen. Stat. Section 36a-861 et seq., and effective July 1, 2024), evidencing the growing importance of the MCA industry in Connecticut.

This article discusses why MCAs are not loans, highlighting the key differences that set MCAs apart from conventional lending options, including that MCAs are not subject to usury laws.

Key Differences Between Merchant Cash Advances and Traditional Loans

The single largest distinction between an MCA and a traditional loan lies in the repayment structure. MCAs, being a purchase and sale of future revenue, have a repayment model that is tied to and contingent upon future sales of the business, which can vary. There is no fixed payment amount or schedule. Instead, payments depend on the performance of the business. “Reconciliation,” an essential MCA feature, allows the repayment amount to be recalculated (up or down), so that the amount remains equal to the percentage of revenue purchased by the MCA funder. This makes the term of MCAs indefinite, being subject to extension and acceleration. In contrast, traditional loans have scheduled fixed payments over a set term, regardless of revenue fluctuations of the business (i.e., loan repayments are required even if the borrower’s revenue decreases).

Below is a summary of the key differences between MCAs and loans.

MCA or Revenue-Based Financing

An MCA is a funding arrangement where a business receives capital in exchange for selling a percentage of its future revenue, until a predetermined amount (repayment amount) is repaid.

Key Characteristics

• Purpose: Often used by growing businesses for operational expansion or working capital.
• Repayment Obligation: Tied to business’ revenue; repayment amounts fluctuate based on income levels of the business.
• Structure:
  • The financing company receives a percentage of the business’ daily or weekly revenue.
  • There is no fixed repayment schedule; repayments depend on the business’ performance.
  • Repayment ends once the repayment amount is reached (purchase price plus a financing factor rate).
• Allocation of Risk: Greater risk is allocated to MCA Funder because repayment depends on the business’ revenue; limited revenue or no revenue means limited repayment or no repayment.
• Examples: Financing for businesses with predictable cash flow.

Legal Framework

• Governed by contract law; structured as a purchase of future receivables or revenue-sharing agreement.
• Not subject to traditional lending laws but may involve disclosure obligations depending on the jurisdiction.
• Non-payment, in and of itself, is typically not considered breach of an MCA.
• Breach allows the MCA financing company to claim unpaid revenue.

Loan

A loan is a financial transaction in which a lender provides money to a borrower with a legal obligation to repay the principal amount, with interest, over a specified period.

Key Characteristics

• Purpose: General-purpose funding for personal or business use.
• Repayment Obligation: Fixed repayment terms regardless of the borrower’s financial performance.
• Structure:
  • Repayment is typically made in regular installments (e.g., monthly).
  • Interest is charged on the loan amount.
• Allocation of Risk: Greater risk is allocated to borrower because repayment is required in all circumstances, even if the borrower’s revenue decreases.
• Examples: Business loans, personal loans, or mortgages.

Legal Framework

• Governed by contract law and lending regulations.
• Non-payment is typically considered breach of a loan.
• Breach can lead to legal action to recover the debt or seize collateral.

Courts Agree that MCAs Are Not Loans

Courts have long distinguished MCAs and loans. It is well settled that for the agreement to be a loan, the party that provided the funds must be absolutely entitled to repayment in all circumstances. LG Funding, LLC v United Senior Props. of Olathe, LLC, 181 A.D.3d 664 (2020). The core feature of a loan transaction is that the principal sum advanced is repayable absolutely. Newco Cap. Grp. VI LLC v. La Rubia Rest. Inc., 2023 NYLJ LEXIS 3178 (2023). A loan is a contract where one party, transfers to another, a sum of money which that other agrees to repay absolutely. Bridgeport L.A.W. Corp. v. Levy, 110 Conn. 255 (1929).

Unless the principal sum advanced is repayable absolutely, the transaction is not a loan. Vox Funding LLC v. Champion Family Auto Sales LLC, 2024 N.Y. Misc. LEXIS 565 (2024). If the provider is not absolutely entitled to repayment, then the transaction is not a loan. Landmark Funding Grp. LLC v. Alt. Materials LLC, 2024 N.Y. Misc. LEXIS 852 (2024). A loan would not exist, if such funds were not absolutely repayable. Principis Capital, LLC v. I Do, Inc., 201 A.D.3d 752 (2022). Where accounts receivable are purchased, the MCA funder, and not the merchant, bears the risk of non-performance. Endico Potatoes v. CIT Group/Factoring, 67 F.3d 1063 (1995). In an MCA, unlike a loan, there is a risk on the part of the funder that the merchant may have reduced revenues or even no revenue. Landmark Funding Grp. LLC v. Alt. Materials LLC, 2024 N.Y. Misc. LEXIS 852 (2024).

Courts have developed a three-factor test to evaluate whether the arrangement is a loan or an MCA: (1) whether there is a reconciliation provision in the agreement; (2) whether the agreement has a finite term; and (3) whether there is any recourse should the merchant declare bankruptcy. Principis Capital, LLC v. I Do, Inc., 201 A.D.3d 752 (2022); In re Ortega’s Mexican Rest., LLC, 597 B.R. 442 (2019); Flash Funding, LLC v Horizons Connection Services, LLC, et al., HHD-CV23-6166130-S.

A reconciliation provision, the first factor, demonstrates that the funder is not absolutely entitled to repayment under all circumstances as payment rests on a contingency. Landmark Funding Grp. LLC v. Alt. Materials LLC, 2024 N.Y. Misc. LEXIS 852 (2024). The presence of a reconciliation provision strongly suggests that the transaction is not a loan, but rather a purchase where the purchaser bears the risk of loss if receivables are not paid. Lateral Recovery LLC v. Funderz.Net, LLC, 2024 U.S. Dist. LEXIS 10134 (2024).

Under the second factor, whether there is a finite term for payment: the existence of a fixed term is typical of a loan, while an indefinite term of receiving a percentage of actual receipts demonstrates that the MCA funder has assumed the risk associated with the receivables not being collectable. Lateral Recovery LLC v. Queen Funding, LLC, 2022 U.S. Dist. LEXIS 129032 (2022).

For the third factor, whether there is recourse if the merchant declares bankruptcy: if bankruptcy triggers a default, this factor would weigh in favor of finding the agreement to be a loan, as it would suggest that that the funder has not assumed the risk of loss of not collecting on the receivables. Lateral Recovery LLC v. Queen Funding, LLC, 2022 U.S. Dist. LEXIS 129032 (2022).

MCAs Are Not Subject to Usury Laws

A corollary of MCAs not being loans is that MCAs are not subject to usury laws. Usury laws limit the rate of interest that lenders can charge on loans with exception, and most states have usury laws. This topic is noteworthy, as merchants often claim, as a defense to a lawsuit for default on an MCA agreement, that the agreement was a loan in disguise that should be subject to usury laws and unenforceable. However, this litigation defense almost always fails, because as a matter of law, usury laws apply only to loans and not MCAs.

Courts categorically agree that usury laws apply only to loans or forbearances, and if the transaction is not a loan, there can be no usury, however unconscionable the contract may be. GEM Funding, LLC v. Z-Rite Plumbing & Heating Corp., 2024 N.Y. Misc. LEXIS 761 (2024). The determination as to whether a transaction constitutes a usurious loan is guided by principles which are well established. Vox Funding LLC v. Champion Family Auto Sales LLC, 2024 N.Y. Misc. LEXIS 565 (2024). “The rudimentary element of usury is the existence of a loan or forbearance of money, and where there is no loan, there can be no usury.” Principis Capital, LLC v. I Do, Inc., 201 A.D.3d 752 (2022). Connecticut has long recognized that a contract that is not a loan is not subject to the usury statutes. Belden v. Lamb, 17 Conn. 441 (1846) (“Usury is connected only with loans, and not with sales”). The law includes a strong presumption against a finding of usury and requires it to be supported by clear and convincing evidence. Ujueta v. Euro-Quest Corp., 29 A.D.3d 895 (2006). To determine whether a transaction constitutes a usurious loan, the court must examine whether the plaintiff is absolutely entitled to repayment under all circumstances. Unless the principal sum advanced is repayable absolutely, the transaction is not a loan. LG Funding, LLC v United Senior Props. of Olathe, LLC, 181 A.D.3d 664 (2020).

Conclusion

MCAs and traditional loans are fundamentally different financial products. An MCA is a purchase and sale of future contingent revenue with a flexible repayment model, whereas conventional loans involve a legal obligation to repay the principal, with interest, over a specified period.

Lucas B. Rocklin

Lucas B. Rocklin is a creditor rights attorney. He has extensive experience in representing financial institutions and creditors in workout and litigation matters (commercial and consumer) including collections, foreclosures, bankruptcy and landlord-tenant litigation. Attorney Rocklin also practices labor law including collective bargaining agreement negotiations and arbitrations.

Joseph R. Dunaj

Joseph R. Dunaj is a member of the firm’s commercial litigation, and bankruptcy and creditor rights groups. His extensive experience includes representation of financial institutions and creditors in various collection cases and foreclosure cases, inclusive of settlement negotiations, title matters, and both appellate and bankruptcy work.

John T. Szalan II

John T. Szalan is a member of the firm’s commercial litigation and creditor rights groups. His experience includes representation of financial institutions, creditors, and institutional real estate clients, inclusive of settlement negotiations, title issues, and real estate transactions.