The Merchant Cash Advance (MCA) industry came about as a byproduct of the fintech boom.¹ Commercial financiers began to utilize technology to pre-approve certain businesses for cash advances. The cash was easily handed out, and businesses fell victim to what many describe as predatory lending.² The Merchant Cash Advance industry was forced into a brief hiatus when the Paycheck Protection Program (PPP) money was available, but they have now reemerged.

What is a Merchant Cash Advance, and why should banks be concerned? As the name implies, it is simply a cash advance from a private commercial finance company (often referred to as the MCA) to a company in desperate need of funds. Repayment is made via weekly ACH debits by the MCA. The typical MCA contract purports to be a factoring agreement providing for the sale of future receivables; however, these agreements are often accused of being disguised loans.³ It is indicative that the MCA industry is not permitted to have membership in the International Factoring Association.⁴ When annualized, the rate of return (what the MCA might call their factoring “fee,” but what a court might call the “interest rate”) is often extremely high and would ordinarily exceed the applicable usury ceiling.⁵ Frankly, I have seen MCA deals that have effective annual yields as high as almost 80%. Attempting to structure the deal as a true sale account purchase/factoring transaction can help the MCA circumvent usury claims.

Why should banks care? First, the MCA does not care if you have a negative pledge covenant or additional indebtedness prohibition in your credit agreement (even if you add a tortuous interference/negative pledge warning notice on your UCC1). The MCA will stack its lien right behind yours and give money freely to your borrower. This violates the typical credit agreement and disturbs the collateral pool. Second, MCA’s will often notify account debtors under UCC Section 9.406, which freezes payments to your borrower and interferes with your flow of funds and acts in contravention to your lockbox requirements. Third, once there is a default by the borrower, they will deplete the bank account and file suit. Lastly, an MCA’s cash injection can create a false sense of security (e.g., the borrower’s tangible net worth may be artificially inflated by the money). In other words, it might mask a problem that would otherwise present itself before your next loan advance. An MCA “loan” is expensive, and I have experienced countless instances where the company simply cannot keep up with the weekly ACH schedule.⁶

What should banks do? I recommend my clients have a separate “MCA Warning Notice,” which states in bold print that the borrower is not allowed to incur additional indebtedness or grant junior liens on their assets so that there can be no mistake or claiming of ignorance by your customer. Additionally, I advise my clients to add the warning notice on their UCC1, warning potential secured parties like MCA’s that any junior lien would be a tortuous interference with our credit agreement. In my due diligence training classes, I always recommend that my clients re-run lien searches about every four to six months, which helps comply with the four-month rule regarding IRS liens and UCC Section 9-507(c)(2) (requiring that you amend your UCC1 within four months if the debtor’s name or jurisdiction changes).⁷ When doing this, you will get to see if any MCA has stacked its lien behind you. If you learn that your borrower has taken on an MCA, you should consider immediately re-notifying account debtors and putting both your borrower and the MCA on notice.

Every source of working capital has its place, and MCAs are filling a void in the market. But having a nonpermitted junior lienholder extend credit to your borrower at a high annual yield and siphoning large amounts from their bank account threatens the economic viability of your borrower and threatens your dominion over the accounts receivable. For these reasons, banks should be mindful of the potential dangers of a borrower taking on a Merchant Cash Advance.