Merchant Cash Advance Litigation In Connecticut

The recipients of some merchant cash advances have an opportunity to defend, and even counterclaim for treble damages and attorneys’ fees, when funders of certain loans characterized as merchant cash advances sue them in Connecticut.  But it appears that most recipient defendants default, or negotiate a resolution instead.  By failing to raise these defenses and assert counterclaims, these recipients are surrendering valuable leverage during the resolution process.

Fairly recently, Connecticut seems to have become a favored jurisdiction for “merchant cash advance” funders, who require Connecticut law to govern their contracts.  They also, sometimes, require or allow for lawsuits based on those contracts to be brought in Connecticut state courts.

The state court dockets have, indeed, been inundated with hundreds of cases filed by such funders.  In these cases, funders seek to enforce what they call “merchant cash advance” contracts.  A merchant cash advance is a form of financing by which the funder, or “buyer,” purchases some portion or percentage of a business’s future income up to a certain amount.  These agreements are governed by contracts.  The contract terms generally require that the funder advance the purchase price to the “seller,” who receives a lump sum.  The funder subsequently begins debiting some amount from the seller’s account, weekly or even daily, and the amount may be the percentage of income based upon passed receipts.  These withdrawals continue until the originally agreed price (which is often significantly greater than the purchase price) is paid.  Practically speaking, these can be daily withdrawals of well over 50% of a business’s (past) average daily income—and if there is a downturn in business, the amount may not change.  The buyer may end up taking everything a business gets in a day or a week, and still demanding more.  The buyer then initiates suit and when the seller goes unrepresented, and obtains a judgment, may collect the full amount purportedly owed.

It is possible that funders came to favor Connecticut law because of the strong prejudgment remedy available here.  Under the prejudgment remedy statute, they could freeze seller bank accounts without a hearing or court order, so long as the merchant cash advance contract contained a waiver.  The General Assembly recently put an end to that practice by way of Public Act 23-201, which implemented new financing disclosure requirements and prevents certain merchant cash advance contracts (executed on or after July 1, 2024) from waiving the right to notice and a hearing before entry of a prejudgment remedy. 

As the vast majority of merchant cash advance litigation appears to be resolved without sellers obtaining counsel, only time will tell the impact of the new statute precluding prejudgment remedy waivers.  And for the same reason, as well as others such as the complexity of merchant cash advance contracts, opportunistic funders may take advantage of unsophisticated merchants by engaging practices that run afoul of the law.  And they might get away with it. 

But they might not: the language and contours of a merchant cash advance contract, or a funder’s actions following a contract’s execution, can show that certain merchant cash advances are in fact merely disguised loans that fall under laws applicable to loans.  Unlike legitimate merchant cash advances, certain merchant cash advances may actually be usurious loans that are unenforceable under Connecticut law.  And if that is true, such merchant cash advances might also create a cause of action for the seller to seek damages from the funder under federal law.

The nature of merchant cash advance transactions means that certain loans characterized  as merchant cash advances could be deemed potentially usurious loans.  Usury is a legal defense that loan-recipients/sellers may employ in such situations when the funder attempts to enforce the contract in Connecticut because state law prohibits actions on such loans, whether the lender seeks to recover either the principal or interest.  And in some cases where funders do collect on usurious loans characterized as merchant cash advances, the funder may even be liable to the seller for triple its damages and its attorneys’ fees. 

The usury defense in Connecticut has yet to be comprehensively litigated in these situations, and the legal theories for triple damages and attorneys’ fees do not appear to have been raised yet—in Connecticut, at least.  But before funders so frequently chose Connecticut as the source of law and forum for their merchant cash advance contracts, they frequently chose New York.  And state and federal courts in New York—including the Second Circuit—have held that merchant cash advances may indeed merely be disguised usurious loans.  And the Second Circuit has also agreed such loans may indeed give rise to liability under federal law.  The import of this cannot be overstated: the federal cause of action may entitle a claimant—that is, the recipient of an illegal loan—to treble damages and attorneys’ fees, separate from whatever defenses state usury laws create.

In Connecticut, like New York, courts may disregard a transaction’s form and determine whether the premium incurred is for the temporary use of the advance or for the transfer of underlying risk, and if it is for the former, apply the usury statutes.  Factors that Connecticut courts are likely to consider in determining whether a merchant cash advance is a disguised usurious loan include:

• whether the agreement allows for reconciliation of the seller’s business income and payment amounts;
• whether the agreement in fact has a finite term;
• whether the seller’s bankruptcy allows the funder any recourse;
• whether the payment amounts are based upon good faith estimates of the seller’s income;
• whether particular revenues or accounts were purchased, and who has responsibility to collect revenues from those accounts; and
• whether the repayment and remedy terms entitle the funder to immediate repayment of the full amount of the transaction outstanding.

In short, Connecticut has become a jurisdiction inundated with one-sided merchant cash advance litigation.  Whether that continues following Public Act 23-201 becoming effective has yet to be seen.  Either way, it seems clear that the recipients of loans masquerading as merchant cash advances may have valid defenses—and even counterclaims—that are not being fully utilized.  The state and federal courts in New York have paved the way, and Connecticut courts may very well follow when they are presented with the right arguments, facts, and law.