A complaint filed March 23 by the bankruptcy trustee for Lam Cloud Management, LLC in the United States Bankruptcy Court for the District of New Jersey challenges two small business financing models: (i) merchant cash advances (“MCAs”); and (ii) small business loans originated under bank partnerships. While disposition of the complaint will take time, and all that is available for now are bare allegations, the complaint is another recent challenge involving usury and bank partner programs and warrants attention from entities involved in small business financing and lending.
The complaint involves claims arising from a series of four financing transactions. As Lam Cloud Management struggled to meet its obligations, it sought financing from various sources. After an initial purported MCA obtained from Retail Capital, the company engaged Synergy Capital as a broker to secure additional credit. Synergy facilitated a series of transactions including a loan originated through a bank partner program administered by Quick Bridge Funding and purported MCAs offered by Fast Business Funding and CapCall, LLC. In each case, the complaint alleges that the agreements were shams that actually involved disguised loans bearing usurious interest.
For the three purported MCA products, the core question is whether the product is a true advance based on business receivables or a disguised loan. In a properly-structured MCA, a financing source advances funds based on the business’ revenue or sales for a set period of time or until such time as a set value has been paid by the business. As distinct from loans, MCAs involve uncertainty as to the amount that will eventually be repaid separate from traditional credit default risk. Depending on the precise structure of the MCA and the jurisdiction involved, MCAs may be excluded from state usury limits because they do not involve an obligation repayable absolutely (or they may be considered not to violate rate limitations for other reasons).
The complaint alleges that the purported MCAs were actually disguised loans. According to the complaint, the factors supporting characterization of the transactions as loans include that: (i) the contracts were underwritten based on the business’ creditworthiness; (ii) the debtor’s principal was required to execute a personal guaranty, arguably increasing the likelihood that the amount advanced would be repaid absolutely; (iii) rather than determining payments based on the flow of the business’ revenue, as should have been the case based on the written contracts, the business was required to remit a set amount each business day; (iv) the financing source did not bear the risk of loss from the receivables; and (v) the financing source’s books allegedly treated the obligation as a loan.
For the loan product, the core question is whether the loan offered under the Quick Bridge program was made by the bank partner named as creditor on loan agreements or by Quick Bridge in a sham model. When properly executed, bank partnerships involve the origination of a loan by a bank, using a non-bank platform for supporting services such as marketing and/or application processing, and in some cases the subsequent sale of the loan, receivables from the loan, or participation interest in the loans to the non-bank platform or other investor. There are several reasons to rely on this model, such as only payment networks allow banks to issue branded credit cards, business convenience, or to minimize regulatory exposure to state usury requirements. An essential feature of the bank partnership model is that the bank is considered the “true lender,” because a failure to ensure such a determination can result in originated loans becoming void or otherwise impaired, the non-bank lending platform becoming subject to penalties for usurious lending, and general liability for violations of law, among other potential consequences.
The complaint attacks the Quick Bridge program as a “rent a charter” arrangement meant to circumvent state usury laws and regulations. To support the conclusion that the non-bank lending platform is the “true lender,” the plaintiff highlights that (i) the loan was immediately assigned from the bank to the non-bank platform, (ii) the debtor was advised and expected to be entering into a loan with the non-bank, and (iii) the non-bank generated, serviced, and assumed the risk of nonpayment for the loan. The allegations are fairly bare, but could be built out if the plaintiff is able to obtain program documents through discovery.
As the complaint represents the only side of the story told thus far, and there is the potential for the case to be dismissed for various reasons, it is too early to tell what impact this case will have on the various legal issues surrounding small business financing models. Nonetheless, this matter could present another important challenge to MCAs and/or bank partnership models. We will be following this and other pending cases.