How Personal Guarantees Work in MCA Agreements: 5 Clauses Owners Should Examine

If the business can’t make the payment, the funder can go to the owner for the money personally. The choices are laid out in the guarantee: Can the lender grab funds from your bank account, stake a claim to equity in your home, or demand personal property? What the lender can collect if you end up in default comes down to the wording of the guaranty, what a court decides to be collectible, and whether the advance contract itself is enforceable.

So pay attention to five specific areas in the guaranty:

• The first is who signed the agreement, how many people signed, and whether it was done jointly or proportionately.
• The second is what type of guarantee it was: absolute or limited. If it is limited, does a trigger flip it to absolute?
• Next, is there a confession of judgment in the guaranty or in the contract itself?
• Finally, does the advance have a reconciliation provision and a finite term?

Keep in mind that merchant cash advances (or MCAs) usually aren’t set up as loans. Instead, you get the funds now, but you agree to reimburse the funder by paying the advance plus any agreed on fees out of your future debit and credit card sales. So, on the surface, it’s not secured by any collateral and the provider shouldn’t be able to go after your personal assets - until you dig into the paperwork. Most funders ask you to sign a personal guarantee. When you do, you waive your corporate legal shield.

The Liability and Trigger Paragraphs

What seems like one of the most self-explanatory clauses can be one of the most confusing sections of a guaranty agreement. The first part is usually straightforward - name all the people or corporations involved in the contract. But the difference between each signing party being jointly or proportionally responsible can be significant. Proportional liability limits the person who signs the agreement to the percentage of their ownership stake in the company. You might think, “I own one-third of a company that’s applying for an advance. I’m not going to personally guarantee the whole thing, am I?” If you and two others sign a joint liability agreement, the whole amount is your debt, not just one-third or your share of the overall balance.

Another commonly found - and quickly glanced over - paragraph in guaranty agreements is the range of what the guarantee promises. An unconditional guarantee means your responsibility is not limited in any way and you are responsible for the full amount. This does give the lender the ability to jump past the actual debtor and go straight to you, the guarantor. Frequently an absolute guarantee covers late fees, collection costs, and legal fees, too, and a limited one caps your exposure at a set dollar figure or ownership percentage. If you’re a 25% owner, you might be liable for about a quarter of the unpaid balance.

The paperwork might also specify what conditions might cause the guaranty to become unlimited. Examples of potential triggers include withholding payments due to the funder, closing bank accounts, switching payment processors, or lying on the application. Hit a trigger, and your limited guarantee may become an absolute one.

A cash emergency makes moving the company’s money off the books a tempting prospect when dealing with an overeager lender. Unfortunately, this move to seemingly hide money can be the opening any funding company or lender may need to waive any limited liability they may have granted you. Read the liability and trigger paragraphs very, very carefully.

Confession of Judgment

Some lending agreements let the funding company that advanced you money to cash in the debt before you’ve had your day in court. A confession of judgment gives the funder the right to go to court and get a judgment against you, often quickly and with limited notice. Once the legal niceties of getting a judgment are checked off, the lender can go after your assets, including accounts, property, and real estate. In a complaint that may give you pause, the Federal Trade Commission alleged that an advance company insisted that both the business and the owners sign confessions of judgment, putting owners’ personal assets at risk too.

Whether a confession of judgment can be enforced or not depends on where you live. New York amended its rule in 2019. The change in law requires confession of judgment cases be filed only in the home county of the debtor. In Texas, HB 700 bars confession of judgment for business debts if it is included in a sales-based financing transaction.

Judgments that pursue repayment can claim a range of assets, depending on where you live. The lender or funding company can go after the money you have set aside in personal checking, savings, brokerage accounts, home equity and vehicles. You also might be vulnerable if you and another individual or business jointly own any real estate, investments, or vehicles. 401(k)s and IRAs are often off-limits, and your home may be protected by a state homestead exemption, which can keep up to a set dollar figure safe. Limits on how much a creditor can grab from your paycheck can vary widely.

A Loan Disguised as a Cash Advance

A guarantee is only as strong as the MCA deal it backs up. Courts increasingly look past the funder’s description of “receivables purchase” to see if the contract really acts like a loan. If you have fixed payments, rather than variable ones based on revenues, a specific time term and the possibility of default penalties, a judge might see the contract as a loan disguised as a cash advance, one that may be vulnerable to state usury laws. Under LG Funding v. United Senior Properties of Olathe, an appeals court asked three things to determine if an advance was a loan or an actual purchase of receivables:

• is there a reconciliation provision?
• Is there a finite term?
• Is there any recourse if the merchant goes bankrupt?

The third question about the LG Funding agreement left the door open to the possibility of personal liability. If the company went belly-up, the agreement said the funder could demand repayment of the full unpaid balance. That, in turn, gave them the power to enforce the owners’ personal guaranty of the debt and their signed confessions of judgment. That suggested all of the risk in the business still belonged to the owner, not the advance company. One case said the liability clause makes the whole debt immediately due if collateral is encumbered and allowed the funder to go after guarantors. Enforceability varies case-by-case. Guarantees that contain misleading language or outright deception on the part of the funder or their rep can be challenged in court. But don’t stop paying on the hope that a court will rescue you. Instead, see legal counsel about potential avenues of relief if you feel stuck.

Before it comes down to your own assets being at stake, you have choices to save the business. Resolving the underlying debt, most of the time, is the best option. Start with the original source of the debt, the funder, before they become a judgment-winning creditor. It is possible to have a difficult or demanding debt and get a reasonable and fair deal that puts you back in control of your financial situation. For the legal questions, a business attorney familiar with advance paperwork and your state’s laws is your best first step.