What Happens If You Default on a Merchant Cash Advance

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Thank you for visiting our website. This article is about what happens if you default on a merchant cash advance.

An MCA Is Not Structured as a Loan

Now, it's important to say that an MCA is not structured as a loan. On paper, what the funder is saying is that they're buying a slice of your future receivables, and in exchange they're taking a fixed daily or weekly debit until they collect the agreed-upon amount. That structure is the whole crux of why MCAs exist. It's how the industry has argued for years that lending rules and interest rate caps do not apply to them.

But what happens when the payments stop and you are no longer able to keep up? Well, that's where the structure stops mattering. What matters is the contract you signed and how fast the funder is able to move on securing their receivables and collecting from you. Here's the realistic sequence and what the rules actually say, and where the outcome is genuinely uncertain depending on your own unique situation.

Events of Default

Default means more than just missing a payment. In almost every MCA contract, there will be an events of default section that exists. This is contractually required because this is what the lender will hold up when trying to enforce UCC liens and filing lawsuits. Most MCA agreements define default far more broadly than just simply non-payment.

There are many common triggers, including but not limited to:

• blocking or reversing the ACH daily debit
• closing or changing the bank account where the funder debits
• switching credit card processors
• taking another advance from a different funder while the first still exists
• transferring business assets
• filing bankruptcy
• or breaching any representation in the agreement

The far-reaching nature of default catches people off guard. A merchant who calls the bank to stop their daily payment, planning to work something out soon, has usually triggered some form of a formal default. So has a merchant who took a second advance to cover the first one. Stacking is treated as a breach in most agreements, and it's not just a business decision you have taken; you have violated the actual MCA agreement you signed.

The First Two Weeks

What happens when you default on a merchant cash advance? Let's talk about the first two weeks. First thing that'll happen is the ACH comes back unpaid. The funder will charge an NSF fee, even your bank will, often per attempt, and frequently a separate blocked account or default fee.

The Acceleration Clause

At this point, what catches people off guard is that the acceleration clause will fire off. This is the part that shakes people. You do not owe the money you received. You also owe the unpaid portion of the fully purchased amount, which includes the funder's entire profit.

Say you took $100,000 with a $145,000 purchase price and paid back $40,000. The demand letter will now say $105,000, not $60,000. Some agreements will also add other punitive fees like default fees, legal fees, pretty much any fee that they can throw at you.

After that, you will get a demand letter, and the file will move to either a collection firm or a law firm. Actual filings will often begin within days.

The Confession of Judgment

Now, one of the weapons that most lenders used to use was the confession of judgment, and here's what changed. Under New York CPLR 3218, a debtor can sign an affidavit in advance confessing to a judgment for a sum of money. If the funder decides to declare default, it can file that affidavit with the county clerk and get a judgment without a lawsuit, without any notice, and without any hearing.

New York State, though, changed that statute effective August 30th, 2019. A confession of judgment after that date can only be executed by a defendant who actually lives in New York State or whose business is in New York State. It can no longer be used against people who are outside of New York State. The affidavit has to state the New York county where the defendant resided when it was signed, and it must be filed in that county or where the defendant resides at filing.

Funders Have Adapted New Strategies

That amendment mattered, but it didn't necessarily end the problem. Funders have adapted new strategies by filing COJs in different states that are more friendly. In addition now, funders have adapted by suing in New York under forum selection clauses, by filing where the merchant actually is, and by moving towards arbitration.

You Have to Move to Vacate

New York-based merchants can also still deal with a signed confession of judgment. A confession can be challenged and vacated on grounds like procedural defects, a sum that does not match the contract, fraud, or usury. But you have to move to vacate. Nothing will happen automatically. The only thing that will happen automatically is the funder is able to secure a judgment against you.

The Freeze and the Lien

Now, the next thing to worry about after you've defaulted on a merchant cash advance is the freeze and the lien. Once there is a judgment, a restraining notice will go to your bank. The bank will automatically freeze funds, and it does so immediately. Things will start happening like payroll bouncing, vendor checks bouncing. Merchants typically only learn about a judgment when a card finally gets declined.

The UCC-1 Financing Statement

Separately, almost every MCA funder will file a UCC-1 financing statement at closing, which covers all the business's accounts and receivables. After a default, the funder can now notify your account debtors, meaning the customers you service, and instruct them to pay the MCA lender directly.

For a business that handles a lot of different clients or big clients, this is very destructive reputationally. It tells your customers you are in deep financial trouble, and it does so in writing. Now what they'll do is question the ability of your business to service them, and they'll try to find alternative vendors.

The Personal Guarantee

Another thing to worry about is the personal guarantee. The guarantees in this industry are not uniform. Many MCA agreements use a limited performance guarantee, where the owner personally guarantees against breaches of the contract, like blocking the account or misrepresenting revenue when applying, rather than guaranteeing repayment if the business simply fails. Others will also include a broad guarantee of the full amount. This is something you signed originally when signing the MCA contract, and it increases your personal exposure enormously. And it's worth having an attorney read the exact language rather than assuming.

Also worth knowing, in 2022 the FTC got an order banning RCG Advances and its owner from the MCA industry and debt collection industries, with millions returned. Part of the FTC's case was the company advertised no PG while its contracts required one.

Is Defaulting on a Merchant Cash Advance a Crime?

Let's answer the big question: is defaulting on a merchant cash advance a crime? The answer is no. Failing to repay a commercial financing agreement is a civil dispute. There's no statute that makes nonpayment of business debt a crime, and that does not change just because the default was deliberate.

Criminal exposure, if it exists, comes from conduct around the transaction rather than the default itself. For example, say you submitted fake bank statements, made up revenue figures, or fake invoices in order to get funding. That can create possible fraud claims. Say you diverted pledged collateral after a judgment. That's a different problem than being unable to pay. Those are different facts, and they are not present in most defaults.

Collection letters will sometimes blur this line on purpose, using phrases like fraud or referral to authorities. You should treat this as leverage in a negotiation that the lender is employing in order to convince you to work with them, not as a description of your legal position or theirs. Obviously, though, you should take it seriously enough to get advice before responding. Anything you say will be used against you later in litigation.

The Defense That Actually Has Strength to Win

Now let's talk about the defense that actually has strength to win. The strongest arguments we've seen assert the agreement was never a purchase at all. New York Second Department set out a framework in the LG Funding case where they looked at whether the agreement has a reconciliation clause, whether it has a finite term, and whether the funder has recourse if you actually go bankrupt. The underlying question they're really asking is who carries the risk that the receivables never actually materialize in the funder's account.

Reconciliation Language Does the Heavy Lifting

Reconciliation language, though, does the heavy lifting in all of this. If the contract says the funder may adjust the daily or weekly ACH at their sole discretion, courts have treated this as a fake reconciliation clause. If the reconciliation is mandatory and the funder actually honored requests, then the purchase characterization holds up a lot better in the court of law.

New York's Criminal Usury Statute

If a court characterizes the deal as a loan, then New York's criminal usury statute comes into play, which says interest above 25 percent or more is considered criminal. Business entities generally cannot raise civil usury as a defense, but criminal usury does remain available to them, and that can render an agreement unenforceable.

All of this is not theoretical. In People v. Richmond Capital Group, the New York AG brought a proceeding over thousands of merchant cash advances that were alleged to be usurious loans in disguise. The trial court ruled for the state in 2023, and a judgment exceeding $70 million followed.

But let's be honest about the limits. These outcomes are specifically fact-oriented. If a genuinely reconciled advance was presented to the court, then a different outcome is possible.

Bankruptcy and the Automatic Stay

Now, if you're about to default on a merchant cash advance, bankruptcy could be one potential option. Filing bankruptcy does trigger the automatic stay, which halts collection and enforcement. Using bankruptcy, the same recharacterization push returns with a different outcome. If the receivables were truly sold, they may not be estate property. If the deal was a disguised secured loan, then the funder becomes a secured creditor subject to the rules and the stay.

New York's Commercial Finance Disclosure Law

One more important distinction is New York's Commercial Finance Disclosure Law, effective 2023, which requires standardized disclosures, including estimated APR on commercial financing up to $2.5 million. This also includes factoring and sales-based financing. It's a disclosure law enforced by regulators. Having said that, a disclosure law is not by itself a documented defense to repayment. But this does give you teeth when trying to litigate the issue.

The Facts That Change the Results

What does this all add up to when you're contemplating defaulting on a merchant cash advance? Defaulting on an MCA is fast, both for you and for the funder. For you, defaulting simply means halting payments. But for the lender, they have a lot of tools which can help them damage you in this situation.

The facts that change the results are very narrow. For example:

• whether you signed a confession of judgment and where you lived when you signed it
• whether reconciliation is mandatory or discretionary
• whether the funder ever honored reconciliation
• whether your personal guarantee covers performance or repayment
• and whether your receivables sit with just a few customers who can be redirected

These facts are already cemented and exist. It's up to you to figure them out. Reading them before the demand letter arrives is worth more than any argument you can make in court after your account is frozen or in written documents to the lender once they've already secured everything that they need.

If you're contemplating defaulting on a merchant cash advance, we highly suggest you speak to a credible company first who can walk you through this process and discuss pros and cons. There may be other options available to you, but first you have to pick up the phone and call a company today.

Who Should You Call? Our Top-Rated MCA Debt Settlement Firms