The landmark settlement of Richard B. Clark v. AdvanceMe Inc. in 2011 was pivotal for the merchant cash advance (MCA) industry. In the class action's aftermath, many alternative funding providers indelibly reshaped the way they do business. And the ripple effect has spawned a new wave of innovation in this sector with seemingly unlimited possibilities and merchants as the designated beneficiaries.
The case was particularly significant in that it targeted the progenitor of modern day MCA, AdvanceMe Inc., the MCA arm of Capital Access Network Inc. Founded in 1998, CAN is reportedly on track to fund about $600 million in MCAs and business loans through its two subsidiaries, AdvanceMe and NewLogic Business Loans.
Another notable aspect of the litigation was its serial nature. AMI was not the first company to advance funds to California merchants that would face Anat Levy, an attorney with Anat Levy & Associates PC in Beverly Hills, Calif. In 2004, Levy filed a similar lawsuit against Rewards Network Inc. on behalf of approximately 3,000 California restaurant owners alleging the dining rewards company violated California usury laws and California's Unfair Business Practices Act.
Admitting no wrongdoing, Rewards Network eventually settled the case in 2007, agreeing to pay plaintiffs about $20 million and to forgo collection of about $35 million in payments from plaintiffs. The court concluded "in part that the business transactions at issue were 'loans' based on an application of the doctrine of judicial estoppel," since Rewards Network had referred to its products as loans in previous lawsuits seeking repayment from restaurant owners. (Judicial estoppel precludes an entity or person from taking a position in a lawsuit that contradicts a position the entity or person has taken in prior legal proceedings.)
In the lawsuit filed by Levy in 2008 against AMI, plaintiffs alleged that MCAs were "not purchases of future credit card receivables, as claimed by Defendant, but rather disguised loans with interest rates that violate California's usury laws and California Business & Professions Code Section 17200." Usury is the act of lending money at an unreasonably high interest rate as defined by state law, which varies by state.
AMI admitted no wrongdoing when it agreed to a settlement payment of $23.4 million and forfeited the right to pursue further payments from plaintiffs. As part of the settlement, AMI also agreed to modify a section of its merchant agreement to read that, "Buyer, Seller and Principals acknowledge and agree that Seller going bankrupt or out of business, in and of itself, does not constitute a breach of the Seller Contractual Covenants" and that AMI would not request payments "from merchants who went out of business in the ordinary course and had not previously breached their merchant agreement."
Although not available for comment in The Green Sheet, Levy was quoted in a 2008 Inc. article as saying usury laws should apply to MCA providers. However, because MCAs represent the cash purchase of future card revenue assets, they have generally been exempt from state and federal agency regulations governing traditional loans.
That said, in an odd twist of legal fate, California finance lenders law does not require certain entities, such as banks and savings and loan associations, to obtain a lender license. But most other lenders that make more than one loan in a 12-month period are obligated to do so. And the usury limitation for commercial nonconsumer loans in California is 5 percent above the current interest rate established by the Federal Reserve Bank of San Francisco.
"We saw when the AdvanceMe case got filed," said Paul Rianda, a California-based payment attorney. "Some of my clients are cash advance guys. Obviously, they are interested in it. I've been following it and seeing the other ones popping up." He was referring to subsequent lawsuits that have since been filed in the state of California against MCA providers that operate there.
In addressing the latest round of lawsuits in the pipeline, Merchant Processing Resource, an educational resource and industry tracker, wrote in a blog that "as of early March 2011, at least three other MCA providers are now facing the same situation. We've seen the court filings, and it's essentially the same challenge and question of licensed lending."
Rianda said that at this point the lawsuits seem to be geographically limited, and for that reason, some businesses may elect to stay out of California. But he doesn't see it slowing many people down. "I think it just points out the fact that there is this ongoing usury issue that's been sitting there for as long as we've had this industry and that one law firm figured it out," he said.
In light of recent developments in California, payment attorney Adam Atlas, who represents several MCA clients in the state of New York, said it's important to keep in mind that each case is different. For example, he said, "A court that decides on one form of contract does not make a decision for all the forms of contract, and each cash advance provider has their own individual form."
While Atlas believes the cash advance model will prevail, it doesn't mean entrepreneurial plaintiffs won't test it. He said the fact of one case being settled against one MCA provider does not preclude plaintiffs from suing another provider under the advice of attorneys who specialize in this type of legal matter.
"And the bigger the cash advance company, the more attractive a defendant they become, because you can create a bigger pool of possible plaintiffs," Atlas noted. "I'm licensed only in New York, so you mustn't interpret what I say as a California law legal opinion.
"But for what it's worth, I do not believe that the purchase of future receivables for a fee - when the purchaser is truly taking a fixed percentage of merchant receivables in order to recoup what they paid out to the merchant, plus a fee - when that occurs, I'm of the view that that is not a loan."
Atlas has also observed that the economic downturn has effectively weeded out lesser MCA entities in the space that may have had more risky underwriting policies and were less strict about compliance. He feels this has left a core of well-structured MCA businesses in the field that are in it for the long term.
Statistically, California has consistently ranked as one of the top four states in terms of MCA dollars funded and the number of MCAs completed. So it's understandable why industry onlookers have been watchful of recent developments in the state, not only for the potential impacts of doing business in the state, but also for the looming possibility that other states may one day follow in California's footsteps.
"A lot of companies stopped funding for a short time period to assess what was happening," said Sean Murray, Chief Executive Officer of Raharney Capital LLC and founder of Merchant Processing Resource. "It caused them to blink. There are certain states where the purchase of future sales is perfectly fine, but California is really strict on that."
Murray said most MCA companies are becoming licensed, starting in California, and are systematically reviewing other states in which licensing might apply. He said once MCA providers realized that by becoming licensed lenders they could continue to offer MCAs, the funding perimeter broadened.
"I would argue that the AdvanceMe settlement caused the cash advance industry to triple and quadruple in size, because cash advance companies are now able to tap into a larger pool of merchants by being licensed lenders," Murray noted.
"The number and types of participants have evolved to such a great extent that merchant cash advance really no longer applies, or applies to such a small sliver of the business," said CAN CEO Glenn Goldman, whose company in April 2010 launched NewLogic Business Loans to provide loans to small to midsize businesses (SMBs) based on a fixed daily dollar remittance amount.
Goldman expects product innovation to continue to expand and that much of the expansion will revolve around daily remittance platforms. "That daily remittance platform really supports any type of funding to small businesses. It could be merchant cash advance, but you're seeing a lot more in the form of loans, lines of credit, putting the funding on a card and to support leases," he said. And daily access to data can be used to inform product and underwriting decisions.
"The interesting thing is that when we look at the impact of our funding on small businesses, on average what we've seen is that their card volume grows by just over 30 percent and that the uses of capital are more diverse," Goldman said. He's observed more online merchants funding the purchase of inventory. He said it also complements bank funding. For example, a franchisee with an 80 percent loan on real estate could fund the remaining 20 percent without taking on a partner.
Merchant Cash and Capital LLC is another company that has seen a lift in funding levels since it began charting new territory. According to Stephen Sheinbaum, CEO of MCC, the company recently rolled out its B2B Cash Advance Program. In this case, the advance amount is determined by total monthly bank deposits. Instead of strictly buying a fixed percentage of the merchant's credit card sales, MCC purchases a percentage of total sales based on bank deposits.
According to Murray, another trend that bodes well for MCA is that merchants are beginning to invest once again in inventory, advertising and business acquisition, as opposed to just focusing on staying afloat, as they did during the worst of the recession.
However, according Goldman, organic growth within existing businesses remains slow, and he hasn't seen a great number of new business formations compared with new ventures formed during previous economic cycles.
Fortunately, merchant awareness of funding alternatives seems to be on the increase. "I know American Express got into the game, so I think that really helped make merchants recognize these other alternative specialty financing options are available," stated Levi Rosenblum, co-founder of First Merchant Funding LLC.
In September 2011, American Express Co. introduced American Express Merchant Financing, a program that enables AmEx merchants who qualify, based on annual charge volume, to pay a fixed financing fee for access to capital. The program doesn't require a personal guarantee.
For Rosenblum, the MCA evolution has allowed his company to transition from starter advances for high-risk merchants to premium advances for merchants with excellent credit. "We're actually giving them a much greater dollar amount than they'd qualify for anywhere else," he said. "The way we do that is to really stretch the box and not do an eight-month program. We'll go up to 12 or 15 months on these deals, so they qualify for a tremendous amount of capital."
Due to the complex nature of the MCA business, any ISO or merchant level salesperson (MLS) considering entry in this sphere is advised to become educated. The Electronic Transactions Association offers a detailed white paper covering MCA basics, including legal and risk management considerations, card company regulations and industry best practices, which can be downloaded at www.electran.org/white_papers/MerchantCashAdvanceBestPractices4-8.pdf.
According to Murray, the Merchant Processing Resource website features a directory of the 32 largest names in MCA, who collectively underwrite advances for 80 percent of all MCA transactions in the United States. Another recommended resource is the complete listing of state usury laws, which can be found at www.usurylaw.com.
Offering advice to ISOs and MLSs looking for MCA providers, Murray said, "I would say reputation is number one. It really shouldn't be commission driven. It should be revenue contingent because you want to have a long-lasting relationship with the merchant. And you want to make sure that they get financing that's fair and quick, and it really shouldn't be a commission-driven experience."
According to Goldman, about 75 percent of AMI's eligible customers renew with the company. He advised ISOs to work with well-established MCA providers who have access to significant capital, offer a low cost of capital and have the ability to manage risk through access to data and historical performance. "These are going to be the determinants of success and the ability to solve pain points that small businesses face," Goldman said.
Marc Gardner, President and CEO of North American Bancard, an ISO that offers multiple cash advance options to merchants, agreed that as long as there is a lack of liquidity within the SMB marketplace, there will be continued need for capital. He also predicted that as the economy grows, so will the demand for cash.
While neither CAN nor the companies involved in the latest round of lawsuits were permitted to discuss the specifics of each case, the general consensus among those interviewed was that great lengths have been taken to see that MCA companies conform to business best practices.
This includes obtaining legal counsel in order to structure MCA transactions to ensure merchant documents are consistent with applicable laws.
It appears the MCA industry has moved on from what initially appeared to be an ominous cluster of lawsuits. Indeed, many insiders believe alternative funding is in a better position to sustain long-term growth than at any other time in its brief history.
The only potential downside is that the lawsuits still pending in California may linger for some time. Years from now, however, these lawsuits might come to be regarded as merely a temporary cost of doing business in an industry that continues to reinvent itself.
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