In the alternative lending environment, lenders and borrowers alike depend on a well functioning ecosystem to deploy capital, create value, and renew the cycle. This ecosystem is characterized by established norms of order and transparency which benefit all parties by making efficient transactions possible and sustainable.
Merchant Cash Advances (MCAs) disrupt this symbiosis. MCA companies do not look at debt schedules. They do not negotiate inter-creditor agreements. They do not identify particular assets to lend against. And yet they still lend money from a subordinate position and wreak havoc for businesses and lenders in every region and industry in this country.
“This tool gives flexibility to secured lenders -to fund an opportunity without just saying ‘no’ because the picture looks bleak, or before they just try to close a business down.”
Harvey Gross, President, HSG Services Inc.
MCAs disrupt transparency.
Assets you thought you had as perfected collateral are no longer secured. MCAs have direct access to business operating accounts, so the priority list or debt schedule is completely irrelevant. This also renders inter-creditor agreements completely unnecessary for them; they can get access to operating accounts without them, and senior lenders would never approve these financial instruments in the first instance.
MCAs destroy general collateral value.
With access to the business operating accounts, MCAs can swipe cash without a 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. If a business stops operating, it’s collateral base is instantaneously depreciated by somewhere between 50-90%. Second, for ABLs that lend against receivables or non-notification factors, the MCA bank account access gives them first bite at the apple, that apple being the exact asset that was previously pledged as collateral: AR. So whether we are talking about the collateral itself, or a one-off collateral depreciation by virtue of the business being halted through a bank account sweep, MCAs can, do, and will cause myriad problems in their destruction of collateral value.
MCAs destroy specific collateral value.
At the first sign of financial struggle, MCAs send a letter to their borrowers’ client base demanding that all monies owed to the borrower be redirected to the MCA. 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 often a lawyer, yet still they are incredibly effective. Unsuspecting business people receive these Notices and routinely adhere to their direction, or freeze and sit on the money. Both actions can cripple the business and completely disrupt the lending relationship with senior secured lenders.
MCAs don’t play by ‘the rules’.
Regulation and legislation lag far behind the MCA industry which is not subject to the same regulations lenders are, because their products are not loans. And if you’re reading this, it’s simply a matter of fact that MCAs are going to continue to pop up all over your non-performing loan portfolio.
The solution: Strip MCA debt from the business via UCC Article 9.
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 will do it 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.
As a lender, you have a powerful option: The Article 9 business reorganization.
When a client has resorted to taking on MCA debt, they are by definition, insolvent. They have taken on an MCA because there was no other means of capitalizing their 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.
“There are a lot of people that can benefit from knowing this.. I think the awareness of this Article 9 opportunity should be known not just to borrowers, not just to lenders, not just to potential new lenders, but also trusted advisors – the CPAs, the lawyers, the turnaround professionals – that operate with this market.”
– Harvey Gross, HSG Services, Inc.
How does Article 9 remove MCA liens from business assets?
- Article 9 of the Uniform Commercial Code 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 who intends to continue operating those assets.
- By statute, UCC Article 9 removes all liens and liabilities from the assets in the transaction.
- Through the Article 9 sale of assets, the business operation, jobs and enterprise value are maintained as they pass through into a new entity, under new ownership, with all subordinate debt removed.
A win/win for borrower and lender.
Through an Article 9 reorganization, your borrower can avoid bankruptcy while also avoiding the destruction of the business and its jobs. And because your borrower can earn (in the form of an employment agreement or consultancy) from the new company, they have a path to fully resolving their 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 the senior lender in conducting the Article 9 sale.
As a lender, the Article 9 reorganization fully protects your collateral from the operational threat of MCA daily/weekly withdrawal or operating account sweeps. Not only is the MCA threat to your collateral removed, but the entire asset base is now unencumbered in the new entity for financing in first position – a true clean slate for the business and the lender.
As an ABL or factor, if you see an MCA risk for your clients, their operations, or your collateral, consider an Article 9 reorganization as the cleanest, most efficient, and expedient means of removing distress from a business.
– Harvey Gross, HGS Services & Aaron Todrin, Second Wind Consultants