Should These Loans Be Legal?

November 26, 2018 at 9:26 am Leave a comment

On the day before Thanksgiving, one of my readers forwarded  this article to me  from Bloomberg Business Week that immediately got my attention. It reported that New York law has become the epicenter for merchant advance loans, loans which quickly provide often huge amounts of cash to small mom and pop businesses in return for confessions of judgment which enable lenders to quickly seize almost all of the businesses’ assets the second the loan goes delinquent or a payment term is unmet. The catch is that these lenders have figured out a way around New York’s usury laws and have utilized New York to circumvent laws in other states that forbid precisely these types of loans.

While the article over-simplifies the lending process, its conclusions as to how this loan works operationally are spot-on. My first question after reading the article was how do these lenders get around New York’s usury laws which cap loans at no greater than 25%?

Because technically these aren’t loans. A loan is an unequivocal commitment to pay back a specific sum. In contrast, the lender making  merchant advances typically receives a percentage of the borrowing business’ accounts receivable in return for making the loan Since repayment of the loan is contingent on there being enough money generated to repay the advance, there is theoretically no guarantee that the money will be repaid. Colonial Funding Network, Inc. for TVT Capital, LLC v. Epazz, Inc., 252 F. Supp. 3d 274, 278–79 (S.D.N.Y. 2017) compare Merch. Funding Servs., LLC v. Volunteer Pharmacy Inc., 55 Misc. 3d 316, 320, 44 N.Y.S.3d 876, 879 (N.Y. Sup. Ct. 2016). Legally this sounds good but in reality the loans must be repaid  very quickly  and with the use of confessions of judgment, lenders can quickly drain bank accounts and seize enough assets to make huge returns on even delinquent loans.

How can New York have jurisdiction over so many loans throughout the country? That’s easy enough. In addition to agreeing to a confession of judgment, the borrowers also agree that New York will have jurisdiction over the judgment. That’s how easy it is so long as it is properly disclosed to our borrowers. This is particularly important since according to the article many states outlaw merchant advances.

Now if I was one of the eight NY Democrat Senators taking office for the first time next year, this is the type of issue that I would be interested in pursuing as I look around for stuff to do. After all, Federal law already prohibits these types of advances for consumers and it really isn’t New York’s way to be the place where you go to take advantage of desperate small business owners.

That being said, let’s not throw out the baby with the bath water. Confessions of judgment have been around since the middle-ages, not because they are anti-consumer but because there are circumstances where it makes sense to have parties agree to forego litigation when there is truly no defense. In addition, while I find it disgusting that some people choose to make a living by being a glorified loan shark, let’s not overlook the fact that behind most of these loans was a very foolish decision. Ultimately a fool and his money are easily separated and no law or regulation is going to change this reality.

Entry filed under: General, Legal Watch, New York State. Tags: , , .

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Authored By:

Henry Meier, Esq., General Counsel, New York Credit Union Association.

The views Henry expresses are Henry’s alone and do not necessarily reflect the views of the Association. In addition, although Henry strives to give his readers useful and accurate information on a broad range of subjects, many of which involve legal disputes, his views are not a substitute for legal advise from retained counsel.

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