On October 25, 2016, the New York Supreme Court of Westchester County issued a decision in Pearl Capital Rivis Ventures, LLC v. RDN Construction, Inc. that helps clarify the circumstances under which the provision of a merchant cash advance in exchange for the assignment of future receivables may be deemed a loan subject to usury restrictions, versus a non-loan purchase and sale agreement.
In Pearl Capital, the New York Supreme Court, which is the trial-level court in that state’s court system, considered whether the merchant cash advance arrangement between plaintiff Pearl Capital and defendant RDN Construction was either a loan subject to New York’s criminal usury restrictions or a non-loan contract for the purchase and sale of future accounts receivables. Athough New York’s civil usury laws do not apply to commercial loans, such loans are subject to the state criminal usury statute (N.Y. CLS Penal § 190.40), which imposes a 25 percent maximum interest rate. Under the terms of the parties’ agreement, the court deemed the arrangement to constitute a loan.
In explaining the differences between a loan and a non-loan contractual agreement, the court noted that:
There can be no usury unless the principal sum advanced is repayable absolutely. If it is payable upon some contingency that may not happen, and that really exposes the lender to a hazard of losing the sum advanced, then the reservation of more than legal interest will not render the transaction usurious, in the absence of a showing that the risk assumed was so unsubstantial as to bear no reasonable relation to the amount charged. The risk of loss is to be distinguished from the risk of nonpayment that is inherent in every loan and that may only be compensated for by statutory interest; the risk of loss by the death or insolvency of the borrower is the risk that every person runs who lends money on personal security only (72 N.Y. Jur 2d Interest and Usury, §87).
Although the defendant’s witness testified that by purchasing future receivables RDN Construction accepted business risks besides the normal risks of repayment common to a loan, the court discounted this testimony on the basis that “[m]erely telling the Court that risk is contemplated under the terms of the Agreement is inadequate, especially where, as here, the Agreement is illegible, with excessively small print.” In particular, the court noted the agreement did not specify that sales of receivables to the defendant were without recourse to the seller/plaintiff. In the absence of such language, the court determined that the plaintiff was absolutely obligated to repay and so the arrangement amounted to a loan. When viewed as a loan, the applicable interest rate was approximately 180 percent per year, which greatly exceeded the 25 percent maximum rate allowable under New York’s criminal usury statute.
The Pearl Capital case highlights the critical importance of paying close attention to the terms and conditions of any merchant capital advance agreement. In considering a judicial challenge to the parties’ agreement, a court is likely to look beyond the general nature of the relationship and probe the precise terms of the governing contract.
For a sale of receivables to be treated as a purchase and sale agreement versus a loan, the sale must be without recourse to the seller. In the case of a sale without recourse, the purchaser accepts the business risk that the seller may not perform as expected, and that the planned-for future receivables may not materialize. This point was emphasized by the New York Supreme Court of Nassau County in Platinum Rapid Funding Group Ltd. v. VIP Limousine Services, Inc., which likewise involved a dispute regarding the loan status of a merchant cash advance arrangement, but reached a different conclusion than Pearl Capital (i.e. that the parties’ arrangement did not constitute a loan) on the basis that: “Plaintiff [receivables buyer] took the risk that there could be no daily receipts, and defendants [receivables sellers] took the risk that if receipts were substantially greater than anticipated, repayment would occur over an abbreviated period. . .”
- A violation of certain representations and warranties in the merchant cash advance agreement may allow the purchaser of the receivables to proceed directly against the seller for breach of contract, such the seller’s opening other bank accounts, filing bankruptcy, or engaging in fraud or other misconduct.