Merchant Cash Advance Loans as Preferences: Contrasting Judgments

By: Donald L Swanson

Merchant cash advance loans provide ready-cash for businesses in desperate need of cash. Because of the desperation, terms of merchant cash advance loans can be oppressive. For example:

  • Repayments are made daily—by automatic cash withdrawals from debtor’s bank account;
  • Rates of return, if repaid as scheduled, often range from 50% per annum to 125% per annum; and
  • The arrangements are often styled as “sales” of receivables, rather than secured loans, to avoid usury issues.
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Contrasting Views

Two Cases With Judgments After Trial—And Contrasting Views

We might expect that preference cases against merchant cash lenders would abound, since borrows desperate for cash are the source of many bankruptcy filings. But such an expectation is wrong. There appears to be a paucity of such cases.

Nevertheless, we now have two bankruptcy court judgments, following trial, on preference claims against a merchant cash lender. The two cases are against the same lender (LG Funding LLC) and involve the same contract documentation, but the two cases reach opposite results.

In both cases, the bankruptcy courts found that all elements of a preference claim had been established by the evidence [Fn. 1], so the case turned on the ordinary course of business defense [Fn. 2].

–Illinois Case

The first case is Gecker v. LG Funding LLC (In re Network Salon), Adv. No. 17-00072, in the U.S. Bankruptcy Court for the Northern District of Illinois. Following trial, an opinion dated August 15, 2018, (Doc. 62) applies the ordinary course of business defense as follows:

  1. The first element requires that the debt be “incurred in the ordinary course of business.” In applying this element, courts examine “the normality of such incurrences in each party’s business operations generally.” In this case, (i) the merchant cash advance lender makes such loans in the ordinary course of its own business, and (ii) Debtor “began receiving” this type of financing in January 2013 and continued to do so “until the 2016 Petition Date,” with fourteen different merchant cash advance companies, and Debtor’s owner testified that there was “nothing out of the ordinary” about Debtor’s transactions with the Defendant.
  2. The second element requires a showing that the transfers “were made in the ordinary course of business between the parties or according to ordinary business terms.” Debtor was “able to stay in business” for several years using such loans, no fraud was involved, and Debtor satisfied its obligations to Defendant for “nearly five months” before filing bankruptcy.

Accordingly, the Bankruptcy Court rejected Plaintiff’s preference claims because of the ordinary course of business defense.

–Nebraska Case

The second case is Official Committee of Unsecured Creditors v. LG Funding LLC (In re Cornerstone Tower Services, Inc.), Adv. No. 17-04051, in the U.S. Bankruptcy Court for the District of Nebraska. The Nebraska Court, after trial, ruled that Defendant failed to meet its burden of proof on the ordinary course defense and entered judgment avoiding the payments Defendant received during the 90 day preference period.

The Nebraska ruling turns on the phrase, “incurred by the debtor in the ordinary course of business or financial affairs of the debtor,” in § 547(c)(2).

Here are pertinent facts for the ordinary course analysis in the Nebraska case:

  • Debtor filed Chapter 11 bankruptcy on May 13, 2016;
  • Debtor began using merchant cash advance loans shortly before the 90 day preference period: on November 27, 2015, Debtor obtained a merchant cash advance loan of $390,000;
  • Debtor’s use of merchant cash advance loans accelerated during a one month period within the 90 day preference time:

–On February 19, 2016, Debtor obtained a merchant cash advance loan of $100,000;
–On March 1, 2016, Debtor obtained a merchant cash advance loan from Defendant of $50,690; and
–On March 18, 2016, Debtor obtained a merchant cash advance loan of $75,000, which was its last of such loans.

The Bankruptcy Court’s ruling is that Defendant’s merchant cash advance loan was not incurred by Debtor in the ordinary course of business. The ruling includes the following analysis [Fn. 3]:

  1. Debtor and Defendant entered into their merchant cash advance agreement “approximately two-and-a-half months” before Debtor’s bankruptcy filing;
  2. The parties “do not have a baseline history of ‘routine’ or ordinary transactions as a layman would understand those terms”;
  3. The transactions between Debtor and Defendant “occurred only while [Debtor] was in financial straits”;
  4. Defendant was one of four merchant cash advance lenders that dealt with Debtor “within six months before the petition date”;
  5. This same Defendant, with its same contract documentation, “recently prevailed in a similar lawsuit in bankruptcy court in Illinois, Gecker v. LG Funding, LLC.”  However, that case is distinguishable, the Nebraska Judge ruled, because:

(i) the Illinois debtor “had been using [merchant cash advance] financing from various companies for several years before filing bankruptcy”;
(ii) The Debtor in this Nebraska case “utilized such funding for only a few months prior to bankruptcy”; and
(iii) The Illinois debtor “testified as to her business practices and her familiarity with and use” of such financing arrangements—but that did not happen in the Nebraska case.

–Appeals

No appeal occurred in the Illinois case.

An appeal of the Nebraska judgment to the Bankruptcy Appellate Panel for the Eight Circuit of Appeals did occur. However, that appeal has been dismissed at Appellant’s request, and the judgment has been “Satisfied” in the Nebraska Bankruptcy Court (see Doc. 78).

Conclusion

We now have two preference judgments, following trial, involving merchant cash advance loans.  The two cases are against the same defendant and on the same contract documentation. One of those preference judgments is in the lender’s favor. The other is in favor of the bankruptcy estate.

It will be interesting to see what other courts do on the same subject.

———————–

Footnote 1: The elements of a preference claim are established in 11 U.S.C. § 547(b).

Footnote 2: The ordinary course defense is provided in 11 U.S.C. § 547(c)(2) as follows:

(c) The trustee may not avoid under this section a transfer— . . . (2) to the extent that such transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and such transfer was—(A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or (B) made according to ordinary business terms.

Footnote 3: In this Nebraska case, the Bankruptcy Judge issued a written Order on summary judgment motions and then ruled from the bench following trial. Consequently, quotations herein from the Nebraska case are at page 14 of the summary judgment Order (Doc. 23).

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