Beware of Sharks: NY Banks Scheme to Take Your Business
May 1, 2019
A vast criminal enterprise, originating in the State of New York, has been growing across the nation and ensnaring countless small business owners and leaving ruined businesses and shattered lives in its wake. It is called the merchant cash advance industry and it is nothing less than state sanctioned loan sharking.
An Alaska business owner, who was recently a victim of the merchant cash advance industry provides a tragic example of the pernicious nature of this business. Joe, whose name has been changed to protect his privacy, ran a thriving refinishing and repair service catering to Alaskan commercial fishing vessel owners. In 2018 Joe’s business was on the rise; the commercial fishing fleet had strong seasons in 2017 and 2018 and vessel owners, flush with cash, were reinvesting their profits in vessel up-keep, creating strong demand for Joe’s refinishing business. In fact, demand for Joe’s services was outpacing his business’s resources. Joe decided it was a good time to expand, hire more employees, and invest in new equipment. However, like many small business owners in Alaska, Joe had a problem: he needed capital to finance his plans for expansion, but banks were not interested in making small business loans. Since the 2008 financial crisis, bank loans for small businesses are exceedingly difficult to obtain, especially in Alaska.
In desperation, Joe eventually turned to a merchant cash advance company. This company promised Joe it would extend a “cash advance” to his business within 48 hours of application, regardless of his credit score or the size of his business. Without consulting an attorney, Joe signed a “Merchant Cash Advance Agreement” and in less than two days, the company transferred $43,000 to Joe’s business account. The terms of the cash advance were severe, but Joe was confident that he would be able to make the payments. In addition, the sales people at the company had intimated that a larger loan with better terms might be possible if Joe made all his payments on time.
Everything was going fine until one day Joe received a call from a stranger who claimed he was a “debt counselor.” He informed Joe that an obscure legal proceeding had been filed in the state of New York against his business, and that a merchant cash advance company was in the process of seizing his business assets. Joe had not received any word from the merchant cash advance company indicating that he had defaulted on his payments and he assumed the call was spam or a telemarketer.
The next day Joe awoke to find a notification from his bank that his company’s business account had been overdrawn. When he checked his account online he was horrified to discover that it had been all but cleaned out. Soon after this, Joe’s clients began contacting him saying they had received calls from a collection agency informing them that Joe had defaulted on a business loan and that a lien had been placed on all of Joe’s assets. Not surprisingly, many of Joe’s clients decided to take their business elsewhere, for fear that if they left their vessels in Joe’s possession they might be subject to that lien and seized.
Joe’s business has never recovered from this shock. Without new clients Joe will likely never be able to come up with the money the merchant cash advance company is demanding. Joe, his business and personal life in complete shambles, is contemplating filing bankruptcy and starting over.
According to the terms of his Merchant Cash Advance Agreement, Joe received $43,000 in return for making daily payments of $1,175. The term of the loan was about 2 months, at which point Joe would have repaid a total of $65,000. This means that Joe was paying the company nearly $22,000, in a period of less than 2 months to borrow $43,000. This translates to an annualized interest rate of 301 percent. Generally, state usury laws prohibit exorbitant interest rates on loans. In Alaska, anti-usury statutes cap interest rates at 10.5 percent. Under federal law it is a felony to charge an interest rate of more than 45 percent; doing so is punishable by up to 20 years in prison. However, companies like the merchant cash advance company Joe signed with have recently discovered that it is possible to circumvent these laws by characterizing their loans as “cash advances.” By simply never using the word “interest,” Merchant Cash Advance Agreements are able to avoid state usury laws, even though in practice their terms perfectly mirror a traditional loan agreement: money now in return for future repayment of the principal, plus an additional amount.
The merchant cash advance company gave Joe $43,000 and Joe agreed to pay back the $43,000, plus an additional $22,000 in two months’ time. If you think that sounds a lot like a loan, you are right, and you are not the only one. New York court filings show that many attorneys have tried to convince New York courts of this simple fact, but have thus far been unable to persuade judges, who insist that simply because these agreements do not contain the word “interest” they must not be loans. It doesn’t matter to them that many business owners enter these agreements under the impression that they are receiving a loan.
With this favorable treatment by the New York court system, and support from the finance industry, New York cash advance companies have grown to gargantuan proportions. In 2017 the merchant cash advance company Joe signed with reported $553 million in “cash advances” to its customers. That same company recently received $3 million in tax incentives from the state of New Jersey to move its corporate offices there. With annualized interest rates generally ranging between 275 and 300 percent on those “cash advances” one can only imagine what kind of profits these companies reap. Several merchant cash advance companies have recently gone public and their initial public offerings have attracted hundreds of millions of dollars from investors.
These companies are so attractive to investors because they have hit upon a legal formula which provides a virtually bulletproof method of collecting from defaulting borrowers. As part of all Merchant Cash Advance Agreements, borrowers must sign an arcane legal document called a “confession of judgment.” A confession of judgment is just what it sounds like: a signed confession of guilt. Once lenders have a signed confession of judgment in hand, the moment a borrower defaults, the lender can go directly to court, present the signed confession and obtain judgment against the borrower. Merchant cash advance companies can then present this signed and court-approved confession of judgment to the borrower’s bank and force the bank to hand over whatever amount of money the borrower owes. The lender never has to contact the borrower and inform him of his default. In many cases, borrowers are unaware that anything is wrong until they wake up one day to find their business account completely wiped clean. Lenders usually only contact the borrower directly if a balance remains after cleaning out the borrower’s account.
Confessions of judgment have been outlawed in every state except New York, where they are still allowed for business loans. Even though a confession of judgment is only valid in New York, if a resident borrower in another state uses a national bank that has a branch in New York his accounts are vulnerable.
The merchant cash advance industry is the new loan shark industry. Instead of receiving a visit from a burly local enforcer threatening to rearrange their kneecaps, business owners simply wake up one morning to find their bank accounts frozen, and their clients running for the hills.
The commercial fishing community in Alaska has a proud tradition of fostering and supporting small businesses, but these businesses are finding it harder than ever to obtain the financing necessary for expansion. A growing small business sector, hamstrung by limited access to capital, makes the Alaskan commercial fishing community a prime target for merchant cash advance companies, who typically prey on small business owners, desperate for an infusion of capital.
If your business needs capital to grow, or is facing a sudden unexpected expense, do NOT be tempted by the offers of the merchant cash advance industry. Merchant cash advance companies portray themselves as champions of the small business owner, providing financing in a time when the big banks have turned their backs on small businesses. Don’t believe these lies. Merchant cash advance companies are banking on their client’s eventual default; their entire business model depends on it.
Business financing is difficult to obtain for small businesses in Alaska, but not impossible. For example, the Alaska Department of Commerce, Division of Economic Development, can assist small businesses through the Small Business Economic Development Loan Program, which provides loans to businesses with net worth of less than $6 million. The Alaska Industrial Development and Export Authority can purchase business loans from eligible financial institutions which provides business owners the benefit of long-term variable or fixed rate financing on the portion of the loan purchased, reducing the business enterprise’s debt service. The Alaska State commercial fishing Loan Program provides low interest loans to promote the development of predominantly resident fisheries, and continued maintenance of commercial fishing vessels and gear.
The application process for these loan programs is more time consuming and complex than the application for a merchant cash advance, but their terms are fair. Most importantly, these programs are meant to help Alaskan businesses and promote long term growth, while merchant cash advance companies only care about their bottom line and have no interest in fostering real economic development.
Tom Walsh grew up in Southeast Alaska in the town of Petersburg and has worked on all manner of fishing boats, beginning as a deckhand on his father’s drift-gillnet vessel, the F/V Chesapeake, at the age of 12. Thomas, who earned his Juris Doctorate degree from Lewis & Clark Law School in Portland Oregon, is now an attorney at International Maritime Group, a Seattle based law firm specializing in maritime law in the Pacific Northwest.