Merchant Cash Advances Are Loans, Not Sales, And Violate Usury Laws (In re Shoot the Moon)

A death knell? (photo by Marilyn Swanson)

By: Donald L Swanson

Merchant cash advances are the business version of payday loans: a relatively small amount of money loaned at a high rate of interest.

  • Payday loans are repaid from debtor’s next paycheck, while merchant cash advances are repaid by daily withdrawals from debtor’s bank account.

Merchant cash advances are easy to get—but once received, are a death knell for the borrowing business.  Once a business heads down the merchant cash advance road, its impending demise is assured: that’s because a business cannot survive on interest rates of 50%, 100% or 300%.

Some courts are protecting merchant cash advance lenders (see, e.g., In re R&J Pizza Corp, Bankr. E.D.N.Y. 2020)). 

However, a recent opinion provides a different view: CapCall, LLC v. Foster (In re Shoot the Moon, LLC). [Fn. 1]  This Shoot the Moon opinion declares:

  • The merchant cash advances in question are loans, not sales; and
  • Such transactions violate local usury laws and create liability for the merchant cash lender.

 What follows is an attempt to summarize the Shoot the Moon opinion.

Facts

Before filing bankruptcy, Shoot the Moon consists of nineteen LLCs that own and operate sixteen restaurants throughout Montana, Idaho and Washington.  They obtain financing from various lenders—some of whom obtained perfected liens on accounts receivable.

Then, to deal with financial pressures, Shoot the Moon restaurants obtain eighteen merchant cash transactions with CapCall, documented by merchant agreements, confessions of judgment, personal guaranties from principals, and UCC-1 financing statements.  CapCall selects the terms and conditions of these agreements by using its form documents.

Under such transactions, CapCall provides Shoot the Moon entities with immediate cash to operate, in exchange for a portion of future receivables generated through restaurant operations.

Repayments to CapCall are by fixed daily ACH debits from specified bank accounts.  The debits are to continue under each agreement until CapCall receives payment in full.

A majority of the transactions flow through the bank account of Shoot the Moon Grizzly, LLC, which entity is not party to any of the agreements and does not operate any restaurant generating receivables.

Bankruptcy

On October 20, 2015, all nineteen Shoot the Moon entities merge into Shoot the Moon, LLC, which files Chapter 11 bankruptcy the next day.

During the bankruptcy, Trustee Jeremiah J. Foster sells substantially all the bankruptcy estate’s assets under § 363(b).  The net sale proceeds are substantially less than the claims of secured creditors (including those with perfected liens senior to CapCall).  CapCall does not object to the sale or to a stipulation regarding distribution of sale proceeds to senior secured creditors.

Also during the bankruptcy, CapCall claims to own customer credit card payments processed prepetition but transferred post-petition to Shoot the Moon accounts—Trustee disputes this claim.  Since Trustee already used some of these payments, (i) CapCall files a proof of claim for conversion, and (ii) the remaining $228,449.93 is held in a segregated account pending resolution of the dispute.

Adversary Proceeding

Then, CapCall files a Complaint in the Bankruptcy Court, seeking a declaration that it owns the $228,449.93 segregated funds and is entitled to recover converted proceeds.

Trustee counterclaims, seeking the following relief:

  • Declarations that (i) the transactions are disguised loans, not sales, and (ii) the bankruptcy estate has unencumbered title to the segregated account;
  • Judgment for violations of Montana’s usury law;
  • Judgement for avoidance and recovery of preferential transfers; and
  • Award of attorney fees under Montana law.

Trial occurs with evidence from live witnesses.  The Bankruptcy Court’s ruling is as follows.

Sale v. Loan Dispute

–Controlling Law

The question of how to differentiate true sales from loans is governed by state law.  And the parties disagree on which state’s law controls.  CapCall says New York law controls; Trustee says Montana law controls.

In classifying a transaction as a sale or loan, courts consider these factors:

  1. whether the buyer has a right of recourse against the seller;
  2. whether the seller continues to service the accounts and commingles receipts with its operating funds;
  3. whether there was an independent investigation by the buyer of the account debtor;
  4. whether the seller has a right to excess collections;
  5. whether the seller retains an option to repurchase accounts;
  6. whether the buyer can unilaterally alter the pricing terms;
  7. whether the seller has the absolute power to alter or compromise the terms of the underlying asset; and
  8. the language of the agreement and the conduct of the parties.

No individual factor or combination is determinative.  The inquiry is a fact-intensive,  comprehensive and based on totality of circumstances.  An overlaying and uniting factor is how the parties allocate risk:

  • A sale occurs when the risk of loss passes to the buyer; but
  • In a disguised loan, various methods are employed to allocate risk, such as granting other sources of recovery to buyer.

The result of the sale v. loan dispute is the same, regardless of which state law controls:

  • New York law applies the factors described above and acknowledges that a transaction “must be judged by its real character, rather than by the form and color which the parties have seen fit to give it”; and
  • Montana law also applies the same factors and also “looks to the substance rather than the form.” 

–Application of Law to Facts

In applying the factors identified above to the totality of the record established at trial, the Bankruptcy Court determines that the transactions at issue are loans.  Here’s why.

Lien Provisions

The documents grant blanket security interests to CapCall.  The collateral includes, in addition to receivables, tax refunds, patents, trademarks, goods, inventory, equipment and fixtures.  Related UCC filings describe the collateral as “all assets of the Debtor, now existing and hereafter arising, wherever located.”

There is no reason why CapCall should receive and perfect security interests in assets other than the purchased receivables, if the transaction is truly a sale.  The blanket lien indicates a loan—and is powerful evidence in favor of a loan classification.

CapCall’s witness at trial “chose to outright deny CapCall’s security interests in anything but the receivables,” despite contrary language in the documents.

Debtor Designation

Each agreement identifies the Shoot the Moon entity as a “debtor.” CapCall could easily have used the word “seller” . . . but it didn’t.

Additional Rights and Recourses

The agreements give CapCall additional rights and recourses.  Here’s a common example.  The agreements and related documents provide:

  • A broad personal guaranty by Debtor’s principal—an “absolute, primary, and continuing guaranty of payment and performance” and “not merely a guaranty of collection,” that renders the guarantor “primarily liable, jointly and severally”;
  • An affidavit of confession of judgment by both Shoot the Moon and the personal guarantor in a fixed “debt” amount that includes “interest at the rate of 16% per annum”;
  • Other “Protections Against Default,” including a broad power of attorney, acceleration of the “full uncollected Purchased Amount,” enforcement of the “security interest in” all collateral (not just the receivables), exercising an assignment of lease of Shoot the Moon restaurants, and debiting deposit accounts; and
  • A continuing requirement to provide financial statements upon CapCall’s request, with a failure to comply as “a material breach.”

CapCall’s witness at trial, in familiar fashion, denies that CapCall ever enforced such rights:

  • Such denial is unavailing and meaningless—refraining from enforcement does not render forgone rights void ab initio or strip them from a contract;
  • In fact, the agreements explicitly preserve for CapCall any rights it declines to enforce; and
  • CapCall drafted the agreements, extending itself significant protections that cannot now simply be disclaimed to reframe the transactions as sales.

The collective effect of the additional rights and recourses weighs heavily in favor of characterizing the transactions as loans. 

Course of Performance

The parties’ course of performance also reflects a debtor-creditor relationship. Evidence at trial demonstrates:

  • The parties often refer to the transactions as “loans” with “terms” and “balances” (emails are replete with such terms) — such jargon reflects the parties’ subjective understanding, and Debtor’s witness testified that he conceptualized the transactions as “notes” akin to promissory notes he signed for traditional bank loans;
  • Payments to CapCall were made through the account of an entity with no relationship to CapCal, which account commingles receivables with other funds, including those used to operate the restaurants—CapCall knew about the comingling and expressed no objection, even encouraging Debtor to structure the flow of funds however he preferred; and
  • The parties “stacked” or “rolled” funds from one transaction to the next (i.e., committing proceeds from a later transaction to satisfy outstanding obligations of earlier transactions, effectively refinancing the earlier transactions)—such circuitous behavior is nonsensical in a sale context.

The evidence reveals a course of performance deeply inconsistent with a true sale of receivables, and CapCall presented no countervailing evidence. As such, the court concludes that the parties’ actions show that they intended loan transactions.

–Summary

Considered in conjunction with the overall economic substance and risk allocation that connects the factors, the court concludes that the transactions are substantially similar to a loan.

Contrary Considerations

The Court’s opinion then acknowledges several items favorable to CapCall’s position—and then rejects them.  Here’s how.

The agreements contain lengthy provisions on how the transaction “is not intended to be, nor shall it be construed as a loan.”

  • The Court responds: “this ipse dixit is hardly convincing”—simply calling transactions “sales” does not make them so.  The evidence reveals that the term “sale” in the agreements is nothing more than a conclusory and self-serving label.

In some case law, courts find similar agreements to be sale transactions, based on the inclusion of reconciliation provisions and the absence of fixed terms.

  • The Court responds: at least some agreements include reconciliation provisions and none specify a fixed term—but these aspects do not outweigh the contrary and overwhelming evidence.

A few of the determining factors support CapCall’s position.

  • The Court responds: it would be the rare case when every factor points in the same direction—the legal test requires a holistic approach and a weighing of factors, and any evidentiary support in CapCall’s favor is insignificant and insufficient to overcome the contrary factors.

Results

Based upon the foregoing, the Bankruptcy Court also rules against CapCall on a variety of other issues, as explained next.

–Usury Claim

Trustee claims that the loans to entities formed under Montana law violate Montana’s usury law.

CapCall, in opposition, urges application of New York law. Since New York lacks a usury statute analogous to Montana’s, the state law adopted has drastic implications for the Trustee’s usury claim.

Bankruptcy Court applies the Ninth Circuit’s “federal” choice-of-law rules (based on the Restatement (Second) of Conflict of Laws), concludes that Montana’s usury law applies, and enters a $1,216,685 judgment against CapCall on the usury claim.

–Preference Claim

CapCall received funds within the 90 days preference period on account of its loans to Shoot the Moon entities. Trustee claims these transfers are avoidable and recoverable preferences.

Bankruptcy Court finds all preference elements established by the evidence and, after eliminating any overlap between recovery on the preference claim and recovery on the usury claim, enters a $1,129,071 preference judgment against CapCall.

–Claims to Credit Card Receipts

Bankruptcy Court finds that, since CapCall lacks an ownership or enforceable security interest in receivables, its claim to credit card receipts is a nonstarter—Trustee is entitled to all such funds.

 –CapCall’s General Unsecured Claim

Bankruptcy Court finds that, since CapCall is obligated to the bankruptcy estate on the preference claim, it is not entitled to a dividend on its proof of claim until the preference judgment is satisfied.  Thus, CapCall’s claim is presently disallowed, but it may file an amended proof of claim within 30 days after satisfying the preference judgment.

–Attorneys Fees and Costs

Trustee seeks an attorney fee award against CapCall.  Montana’s reciprocal fee statute makes unilateral fee provisions bilateral regarding “any action on the contract” and entitles the prevailing party “to recover reasonable attorney fees from the losing party.”

Bankruptcy Court finds that various portions of the adversary proceeding constitute an “action on the contract” for purposes of Montana’s fee-shifting statute and award Trustee’s attorney fees against CapCall in the amount of $424,756.58.

Appeal

The ruling is, of course, on appeal to the U.S. District Court in Montana (Case No. 21-cv-00107).  The District Court’s cm/ecf docket shows two entries in that appeal thus far.

Conclusion

What will happen with the Shoot the Moon opinion on appeal?  And will other courts follow its reasoning in the meantime?

Time will tell.  But the opinion certainly changes the dynamic, out in the bankruptcy world, for merchant cash advance claimants and their adversaries.

—————-

Footnote 1. This opinion appears at Case No. 17-0028, Doc. 279, Montana Bankruptcy Court (decided September 10, 2021).

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