What Happens When You Default on a Merchant Cash Advance?

A Merchant Cash Advance (MCA) provides businesses with an upfront sum of cash in exchange for a percentage of their future sales. This financing mechanism is distinct from a traditional loan, as it represents the purchase of future receivables rather than a debt with a fixed interest rate. Businesses typically repay an MCA through automated daily or weekly deductions directly from their credit and debit card sales, or from their business bank accounts. This structure allows for flexible repayment amounts that adjust with the business’s sales volume, meaning higher sales result in larger payments and slower periods lead to smaller deductions. While MCAs offer quick access to capital, understanding the implications of failing to meet repayment terms is important for any business owner.

Immediate Actions by Funders

When a business misses an MCA payment or experiences a significant decline in revenue, it generally triggers an “event of default” as defined in the advance agreement. Funders typically initiate contact promptly through phone calls, emails, and formal notices to address missed payments and press for their resumption.

Funders will continue attempting to collect payments through Automated Clearing House (ACH) debits from the business’s bank account, often on a daily or weekly basis. If the business account has insufficient funds, these failed ACH attempts can result in significant bank fees for the business, commonly ranging from $25 to $50 per returned debit. A common provision in MCA agreements is an “acceleration clause,” which allows the funder to declare the entire outstanding balance of the advance immediately due and payable upon default. This means the business becomes responsible for the full remaining amount, including any uncollected fees, rather than just the missed payment.

In some cases, funders may attempt to gain direct access to or control over the business’s bank accounts or merchant processing accounts. This could involve direct communication with payment processors to divert a percentage of future credit card sales directly to the funder. Such actions are designed to secure repayment by bypassing the business’s direct control over its incoming revenue streams.

Legal Recourse for Funders

Once a business defaults on an MCA, funders have several formal legal avenues to pursue recovery of the outstanding funds. One powerful tool found in many MCA agreements is a Confession of Judgment (COJ). A COJ is a pre-signed legal document that allows the funder to obtain a court judgment against the business without the need for a full trial or even prior notice. This mechanism significantly expedites the legal process, enabling the funder to secure a judgment swiftly, sometimes within days of filing.

The enforceability of COJs can vary by jurisdiction, with some states having banned or restricted their use, particularly for businesses located outside the state where the COJ is filed. If a COJ is not applicable, or in addition to its use, funders can file a lawsuit against the business for breach of contract.

This formal litigation process involves serving the business with a complaint, and if the business fails to respond within a specified timeframe, typically 20 to 30 days, the funder can seek a default judgment.

Whether obtained through a COJ or a successful lawsuit, a court judgment legally confirms the debt and the funder’s right to collect. These judgments are generally valid for an extended period, often 10 to 20 years, and can typically be renewed, allowing for long-term collection efforts. With a judgment in hand, funders can then enforce it through various methods against the business’s assets, including:

• Bank levies, which involve obtaining a court order to freeze and seize funds directly from the business’s bank accounts.
• Liens on business property, such as equipment, inventory, or real estate, making it difficult for the business to sell or transfer these assets without satisfying the judgment.
• A sheriff’s levy, which may be initiated, leading to the physical seizure of business assets to be sold at auction to satisfy the debt.
• Information subpoenas to compel the business to disclose financial details and asset locations, aiding collection efforts.

Personal Liability and Guarantees

A significant aspect of many MCA agreements is the personal guarantee (PG), which can extend liability beyond the business entity to the individual owner. A personal guarantee is a contractual agreement where the business owner personally pledges their assets to repay the MCA if the business defaults. This provision is almost universally required for MCAs, serving as additional security for the funder beyond the business’s assets.

There are typically two main types of personal guarantees. An “unlimited” personal guarantee makes the guarantor liable for the full outstanding balance of the MCA, including any associated fees and legal costs, putting all personal assets at risk upon default. In contrast, a “limited” or “bad boy” guarantee triggers personal liability only under specific circumstances, such as fraud, misrepresentation, or certain breaches of the MCA agreement. While bad boy guarantees exist, most MCA agreements include unlimited personal guarantees.

When a personal guarantee is triggered due to the business’s default, the funder can pursue the individual guarantor directly. These personal assets can include funds in personal bank accounts, equity in real estate like a home, vehicles, and in some cases, a portion of wages through wage garnishment.

Federal law typically limits wage garnishment to 25% of disposable earnings or the amount by which disposable earnings exceed 30 times the federal minimum wage, whichever is less.

A judgment against an individual, resulting from a triggered personal guarantee, can impact their personal credit score. While civil judgments no longer appear directly on credit reports as of 2017, the underlying financial behaviors that led to the judgment, such as late payments or delinquencies, can still negatively affect credit. Lenders can still access public records to find judgments, which can significantly hinder an individual’s ability to obtain future loans, mortgages, or even rental housing for many years, often up to seven years. Personal bankruptcy may become a consideration for individuals facing overwhelming personal liability from a triggered PG. While bankruptcy can discharge certain debts, it has substantial long-term consequences on an individual’s credit and financial standing.

In rare instances, business owners of incorporated entities might face personal liability even without a personal guarantee through a legal concept known as “piercing the corporate veil.” This occurs when courts determine that the business entity’s legal separation from its owners has not been properly maintained, or if fraud or other serious misconduct, such as commingling personal and business funds or inadequate capitalization, has occurred. However, courts generally uphold the limited liability protection of corporations, making piercing the corporate veil an uncommon outcome that requires specific legal grounds to be met.