What Happens If You Default on a Merchant Cash Advance

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Any violation of the agreement, not just non-payment, can constitute default. Most agreements contain a broad definition of an “event of default.” If you sell your business, switch card processors, or close your bank account, you may be in technical default on your cash advance contract. If you block, revoke or reverse the ACH authorization, that is a deliberate breach. It’s not a late payment. Most contracts explicitly say so. The better course is to keep talking to your funder. Let them know you are trying to fix a problem and pay as much as you can. Be open and transparent. But do not directly block your ACH. It is a cleaner trigger for the funder.

The first thing that happens after the default is the debit fails. At that point, you may have to pay twice: the bank’s NSF fee plus the funder’s failed-payment fee. The funder may retry, and each retry can bounce again, with more fees.

Then the funding agreement often accelerates the remainder of the balance plus additional default fees, attorneys fees and costs. The funder does not have to keep collecting payments. A funder can demand the entire balance due at once. A UCC financing statement was filed the day you funded. It sits there in the public record as a lien on your business assets. Other funders that run a UCC search may discover this UCC.

After a default, some funders will contact your customers directly. Funding agreements often permit the funder to send a notice to your customers, providing them instructions on where to direct future payments. This certainly can damage a merchant’s reputation and relationship with a customer. The funder may also contact your card processor. In fact, some funders will move the merchant to a bank account they control, so revenue gets diverted there. They take their share first and send the rest to the merchant. Losing control over your revenue stream can make it much harder to keep operating.

You may have a personal guarantee for the business debt. Do not ignore it just because you are an LLC or corporation. Do not consider it a formality. You can be held liable for the personal guarantee. The funder can file a lawsuit and ask the court for a judgment. Many borrowers never answer, and a default judgment is issued. Having a judgment against you can have dramatic consequences.

If the debit fails, you may think it’s just a late payment, and the funder will come back next month. That is a reasonable expectation if you have a business loan. But the dynamics of merchant cash advance defaults can hit fast and hard. You can have many of the problems all at once, and quite quickly. There is no standard speed for merchant cash advance litigation. Different court systems across the country work at different speeds. But remember, at some point after you default, there is no more leverage. Negotiating from a position of strength is far better. You are in your strongest position before the default.

When you take a second cash advance from another company, that company has its own funder agreement. You have two default clauses that can trigger simultaneously. Some funding agreements even contain ”cross default” clauses. That means the default on one agreement triggers the default on the other. Suddenly you have multiple funders calling the same card processor, or telling your customers to pay the funder. The worst agreement can cause a chain reaction, triggering everything else. If you let the agreement with the worst terms go into default, by cutting its daily debits, you may believe you can keep the rest in good standing. But it can backfire. You are not dealing with a couple of contracts. You are dealing with a single system.

Trying to refinance at the worst time, after a default, is often impossible. A recent NSF is a sign to any new funder that a merchant’s cash flow may not be sufficient for a new agreement. Once it starts, it is very hard to undo.

Stay Current

It’s important to understand these contracts and not wait to read the small print until you get in trouble. The best thing you can do is stay current. Work it out while you are still under contract and before the default occurs. Stay true to your agreement so you don’t give the funder reason to move faster to enforce its rights. You can ask for a true-up to reduce the debit if sales have fallen. Many contracts require that the funder look at the new payments and adjust. But keep making the payment on the old amount until the new is confirmed in writing.

Having a written payoff amount (not an estimate) for each and every advance is a top priority. Keep a careful list of all your existing advances in a single place. A spreadsheet is helpful. Many borrowers do not know exactly how much they owe.

The best advice is to be straightforward and transparent about your current revenue position and seek a satisfactory outcome before a default. Don’t shoot yourself in the foot with decisions that have serious and unanticipated consequences.