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MCAs Are Back: Protect Collateral and Lending Relationships with UCC Article 9

Media Coverage | Oct 27, 2021

In a follow-up to an article from earlier this year, Robert DiNozzi of Second Wind Consultants and Harvey Gross of HSG Services expand on the benefits of a UCC Article 9 sale when it comes to protecting against merchant cash advance threats to a lender or factor’s portfolio.

After a long hiatus, merchant cash advance products are back with a vengeance, once again disrupting the lending and factoring ecosystems, threatening collateral and rendering opportunities unfinanceable. For alternative lenders, UCC Article 9 offers a mechanism for removing MCAs from business operations in order to protect a current relationship or to facilitate a new lending relationship when it would otherwise be impossible.

“Time after time, we see solid companies looking for financing because of a growth opportunity and find that they have already taken MCA money under the pretense that it was a legitimate bridge loan and are now over-leveraged and unfinanceable,” Haze Walker, director of sales at FSW Funding, says.

Alternative lending is an essential component of a free-market economy and is reliant upon rules and transparency among interdependent parties. There may be competition amongst those within the secondary lending world, but all participants rely on order and procedure to make sure the scope of risk is bound by underwriting. Lien position, for example, must always be predictable and can never be a variant if documented properly.

MCA providers do not play by the same rules. They do not provide transparency, do not honor properly perfected liens within the debt schedule and, therefore, cause unmitigated damage to businesses and the creditors that properly operate within the system.

MCAs Disrupt Transparency

When a borrower brings on an MCA, assets a lender thought it had as perfected collateral are no longer secured. MCA providers have direct access to business operating accounts, so the priority list or debt schedule is completely irrelevant. This also renders intercreditor agreements completely unnecessary for them, as they can get the access to operating accounts without these agreements and since senior lenders would never approve these financial instruments in the first instance.

MCAs Destroy Collateral Value

With access to business operating accounts, MCA providers can swipe cash without court order from a subordinate position. This can destroy a collateral value in two ways. First, operating account cash sweeps can almost immediately halt operations, and if a business stops operating, its collateral base will instantaneously depreciate by somewhere between 50% to 90%. Second, for asset-based lenders that lend against receivables or non-notification factors, an MCA provider’s bank account access gives them “the first bite of the apple” of the accounts receivable, which is the exact asset that was previously pledged as collateral: So whether we are talking about the collateral itself or a one-off collateral depreciation because a business was halted through a bank account sweep, MCA providers can, do and will cause myriad problems in their destruction of collateral value.

At the first sign of financial struggle, MCA providers send a letter to their borrowers’ client base demanding that all monies owed to the borrower be redirected to the MCA provider. These are called 406 notices because they cite an assignment provision of the UCC: 9-406. While MCAs, by definition, are a purchase of general future revenue, they go after specific receivables whether or not they were already pledged or factored. These 406 notices are not issued by a court, a judge, a clerk or even a lawyer, yet they are still incredibly effective. Unsuspecting business people receive these notices and routinely adhere to their direction or freeze and sit on the money. Both actions can damage the business and completely disrupt lending relationships with senior secured lenders.

MCAs Don’t Play by the Rules

MCA providers have outrun regulation and legislation thus far, as they are not subject to the same regulations as lenders because their products are not loans. However, it’s simply a matter of fact that MCAs are going to continue to pop up all over non-performing loan portfolio of lenders and factors.

A Solution

In an ideal world, you could get ahead of the MCA problem by ensuring your clients never sign up for one in the first place, either through education or a contractual provision. Unfortunately, many clients will do so anyway. Then what? Seeking remedy through litigation is both expensive and time consuming and it’s far more likely the business will die on the vine before any reasonable outcome is offered by a judge.

However, as a lender or factor, you have a powerful option: the Article 9 business reorganization.

When a client has resorted to taking on MCA debt, it is, by definition, insolvent. It has taken on an MCA because there was no other means of capitalizing the business. For overleveraged, insolvent companies, Article 9 of the UCC provides for a short sale of business assets that will fully preserve the business operation while eliminating all sub-debt.

UCC Article 9 can remove MCA liens from business assets in the following ways:

  • It allows a senior creditor to sell its collateral in a private out-of-court sale.

  • In the Article 9 short-sale, the senior creditor sells the assets of a still operational business to a purchaser that intends to continue operating those assets.

  • By statute, UCC Article 9 removes all liens and liabilities from the assets in a transaction.

  • Through the Article 9 sale of assets, business operation, jobs and enterprise value are maintained as they pass through into a new entity, under new ownership, with all subordinate debt removed.

Victory for All

Through an UCC Article 9 reorganization, borrowers and factor clients can avoid bankruptcy while also avoiding the destruction of the business and its jobs. And because the client can earn (in the form of an employment agreement or consultancy) from the new company, it can begin on the path to fully resolving its personal guaranties and avoiding financial devastation. By solving a defaulting borrower’s problem in its entirety, this path incentivizes the borrower to work cooperatively with its senior lender in conducting the UCC Article 9 sale.

On the other side, the UCC Article 9 reorganization fully protects a lender’s collateral from the operational threat of daily and/or weekly withdrawals or operating account sweeps from MCAs. Not only is the MCA threat to the collateral removed, but the entire asset base is now unencumbered in the new entity for financing in first position, making for a true clean slate for the business and the lender.

“It is an outstanding tool. We recently underwrote a business that was overleveraged and unfinanceable and that would otherwise not survive without a new line of credit,” Walker says. “Through the Article 9 process, the business was restructured and relaunched into a newco in a matter of weeks. FSW Funding was then able to come in with a financing line of credit to help the company moving forward.”

As an asset-based lender or factor, if you see an MCA risk for your clients, their operations or your collateral, consider an UCC Article 9 reorganization as the cleanest, most efficient and most expedient means of removing distress from a business.

Robert DiNozzi is the director of growth and business alliances at Second Wind Consultants.

Harvey Gross is the founder and president of HSG Services and the executive director of IFA Northeast.

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