Law Firms and Accounting Practices: 6 Ethics Questions Before Settling MCA Debt

Yes, law firms and accounting practices can settle merchant cash advance debt, but these professionals should first wrestle with six ethics questions:

• Is the financing tied to fees paid for legal or accounting services?
• Is client trust money being touched by the financing?
• What client information gets shared as part of the financing?
• Is everything said in negotiation true?
• Where does the program’s money really go?
• How is forgiven debt reported for tax purposes?

When a merchant cash advance hits you hard, you can end up paying less, but that may only be part of the solution you need. A program that eases up on payment pressure, but that also demands a big ‘consulting fee’ or that does not actually remove the problem merchant cash advance, could be no improvement at all.

The Bar’s Ethics Rules

The first question is whether the funder’s repayment depends on the fees your firm earns on particular cases. They might be upfront about this, or they might not be. In 2018, the New York City Bar Association gave an opinion on this question, and its decision contains a useful reminder. Any contract where the financier pays your firm for the right to a cut of your fees in a specific matter will almost certainly run afoul of Rule 5.4, which forbids sharing fees with nonlawyers. But a loan at a fixed rate, even if secured by your receivables, and with no bonuses or extra charges if your fee income goes up, should be just fine.

If what you signed does in fact run afoul of the bar’s ethics rules, will that cancel the contract? The answer is not always yes. A New York court in 2015 was asked to void a law firm’s advance agreement as illegal fee sharing, and refused. Two lessons from that: First, you should always make sure you do not run into ethics pitfalls; and second, if you did, that may not mean you do not owe.

Rule 1.15(a) is the rule you do not want to run afoul of. This rule says that client property must always be kept in your trust account, separate from your own money. You are never allowed to use trust money to cover your personal bills or debts. A merchant cash advance is almost by definition your own expense, and so is unambiguously out of bounds when it comes to touching a client’s money.

In South Carolina, if you have advance fees paid to cover future services, you have to hold that money in trust until it is earned. Only if you have a written agreement from the client saying otherwise will you be free to touch it. And if there is a dispute over any part of the fee, that portion has to stay separate until the disagreement is resolved, and meanwhile you should promptly pay out the undisputed parts.

One red flag to look out for is if the funder asks for a list of your clients, and information about what each one owes you. Under Rule 1.6(a), you cannot, without an exception, reveal any information the client has entrusted to you, unless the client specifically agrees to let you do so. So in this situation you should check in with your clients before turning over anything like this.

Just as lawyers should beware of what client information a funder gets, accountants have their own rules to watch out for. Under the Code of Professional Conduct of the AICPA, CPAs can only share confidential client information with specific consent from the client, apart from narrow exceptions. And tax preparers face the IRS rules, where disclosing return information, or using it for your own advantage, can be a misdemeanor crime.

What exactly you can and cannot say during settlement talks is often a close call. As a general matter, you should not lie, and you should not make a material misstatement of fact. Anything intended to mislead the other side is outside the lines. On the other hand, routine puffing up your case or preening at how well you can argue is usually okay.

Relief Program

Relief from merchant cash advance debts can come in different flavors. There are professional negotiators who will help you hammer out a deal with the funder. There are lawyers who will give you legal advice and defend you if it comes to a suit. And there are MCA companies who give you new financing. If your relief program is strictly a negotiation business, it may not give you legal advice, and it may not defend you if you are sued.

If you have enrolled in a program to renegotiate your agreements, the “program payment” being debited from your bank account every month is not necessarily going directly to your funders. You should request an itemized statement from the relief company, so you can show what funds were deposited, what fees came out, what was sent to the funder, and what the relief program held back. Those records you get may be accurate; but they are only as trustworthy as your program itself, and you should always confirm the true balances.

One tactic some relief programs may use is to tell you to stop paying your agreement altogether, or make payments directly to the program. Failing to make payments, or directing funds to a program company, may be considered a default under your agreement, and that may let the funder take action against you. But enrolling in a program does not automatically amend your contracts with funders. You should look over the agreements you signed beforehand, and see exactly where they stand on this point.

Before putting your bank accounts and receivables on the line, be sure to find out the terms of the proposal. Will the relief company defend you if the funder refuses to negotiate, or if the funder sues? Who gets control of the law firm’s client trust account?

Keep Copies of All Your Records

Keeping an ongoing record of your advances will help you keep up with what you owe. If you settle for less than the full debt, make sure you keep track of what payment you have to make, and where you stand after each one. Find out if your program has any proof the agreement really was settled.

For federal income taxes, canceled debt counts as taxable income. If the debt is canceled, the lender may file a Form 1099-C with the IRS when $600 or more is forgiven. But even if you never get a 1099-C, you still have to claim the canceled debt on your taxes - unless you qualify for an exclusion like insolvency. If you want to exclude the amount, you have to file a Form 982 with your return.

If you are already sued, court papers come first. The judge will not necessarily stop the suit, or hold back a judgment, just because your funder now knows you are trying to settle the debt. It is always safer to have an attorney you have hired on your side to communicate with the other side’s lawyer, especially if you are already being sued.