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Taking out a merchant cash advance can provide much-needed working capital for a small business. However, failing to repay the advance as agreed can result in serious financial and legal consequences. In this article, we’ll break down what happens when you default on a merchant cash advance agreement.
What is a Merchant Cash Advance?
A merchant cash advance (MCA) provides a lump sum payment to a business in exchange for an agreed upon percentage of future credit card sales. It is not technically a loan, so MCAs are not subject to the same regulations.
The advantage of an MCA is that it can provide funds more quickly and with fewer requirements than a traditional small business loan. The downside is that the total cost of repayment is usually much higher.
MCA repayments are taken automatically from a portion of daily credit card receipts. If sales drop, the payback period extends automatically. There is usually no set end date for repayment.
Consequences of Defaulting on an MCA Agreement
Unlike other lending products, defaulting on an MCA does not impact your personal credit score or result in bankruptcy. However, that does not mean there are no consequences. Some potential repercussions include:
Confession of Judgment
Many MCA agreements contain a confession of judgment (COJ) clause. This allows the funder to obtain a legal judgment against your business for the full outstanding amount without advance notice.
With a COJ in place, the funder can seize assets, freeze bank accounts, and garnish wages without standard legal proceedings. You lose the right to argue against the judgment before a court.
Accelerated Repayment
Upon default, the full remaining balance typically becomes due immediately. Default interest rates upwards of 60% may also take effect. This can result in repayment obligations that are completely unmanageable.
Ongoing Collection Efforts
Expect aggressive collection efforts from MCA funders and third party collection agencies. You may face frequent calls, letters demanding payment, and even threats of legal action.
This constant harassment can disrupt normal business operations. The stress can negatively impact your health and relationships as well.
Damage to Business Relationships
Your suppliers, vendors, and customers may become aware of collection efforts. This can harm your credibility and make it difficult to maintain essential business relationships.
Loss of Revenue Streams
If you default, the MCA provider can notify your merchant processor to take control of credit card settlement amounts. Instead of that money being deposited into your bank account, it goes directly to repay what you owe.
This diversion of cash flow can cripple operations and ultimately force you to shut down.
Legal Action
As mentioned above, COJ clauses allow MCA providers to obtain court judgments without your involvement. However, they can also choose to sue you separately.
Expect to incur legal expenses defending yourself. Beyond the judgment itself, you may be responsible for interest, penalties, and the funder’s attorney fees.
Impact on Future Funding
News of your default will spread quickly among MCA funders and alternative lenders. Even if you resolve the situation, it will still show up on business credit reports.
This black mark makes it much harder to secure financing in the future when you need it.
Personal Guarantees
While MCA repayments are tied to business performance, funders often require a personal guarantee as well. This commits your personal assets – including property – as additional collateral.
It is not uncommon for providers to pursue legal action against guarantors individually for repayment. Wage and tax garnishment are possibilities.
Tips to Avoid Defaulting on an MCA
Defaulting on an MCA should absolutely be avoided if at all possible due to the potential consequences. Here are some tips:
- Be conservative when projecting the monthly repayment percentage you can afford.
- Only use MCA funds for working capital, not other expenses.
- Closely monitor cash flow on a weekly basis.
- Have a plan to cover payments if sales decline seasonally.
- Communicate early with the funder if you anticipate issues repaying.
- Seek help from a business advisor or financial expert if needed.
Also keep in mind that not all MCA providers operate the same upon default. Be sure to read the agreement carefully so you understand the repercussions before signing.
What to Do if You Default on an MCA
If you do end up defaulting, don’t panic. And don’t try to avoid the funder; this will only make matters worse. Instead, here are some constructive steps to take:
- Seek help from an attorney. An experienced commercial litigation lawyer can review your options and defend you if legal action is pursued. They may be able to negotiate alternative repayment terms on your behalf.
- Contact the funder directly. Explain your financial situation openly and honestly. If cash flow is the issue, offer updated revenue projections. Often funders would prefer to modify agreements than force a business closure.
- Explore refinancing the balance with another provider. This can deliver more affordable payments if you qualify. Be cautious about piling on more high-cost debt though.
- Prioritize making at least some payments. Even small amounts show good faith while you work to improve business performance. This can motivate funders to be more patient.
- Consider business credit counseling. An expert advisor can help you implement financial changes to stabilize cash flow. This makes it more feasible to resume MCA payments.
- Develop a robust credit rebuilding plan. Eventually you will need capital again, so it is critical to repair damaged business credit reports over time.
Consequences of an MCA Default Can be Severe
While merchant cash advances provide easy access to working capital, they come with considerable risk. Failing to repay as agreed can negatively impact your business in numerous ways – some even personally.
Avoid finding yourself in this situation by only securing what you reasonably expect to afford. Have contingency plans to address financial challenges before they become a default. If you do default however, take proactive measures right away to demonstrate good faith and possibly mitigate harm. With expert help, it is possible to resolve MCA defaults while preserving your business.
What Happens When You Default on an MCA Agreement?
- Confession of Judgment clause allows funder to obtain legal judgment without advance notice
- Outstanding balance can be demanded in full immediately
- Ongoing harassment from collection agencies
- Harm to crucial business relationships
- Loss of revenue streams as repayments are taken from merchant processor
- Legal action and lawsuits
- Difficulty securing financing in the future
Tips to Avoid Defaulting on an MCA
- Conservative monthly repayment percentage
- Only use funds for working capital
- Closely monitor cash flow
- Plan for seasonal sales declines
- Communicate early with funder if issues repaying
- Seek help from financial experts
Steps to Take if You Default on an MCA
- Seek legal help from an attorney
- Contact funder directly to discuss situation
- Explore refinancing with another provider
- Prioritize making some payments
- Enroll in business credit counseling
- Begin credit rebuilding process
Why Defaulting on an MCA is So Risky
Defaulting on a merchant cash advance can seriously harm your business through:
- Loss of assets to collection efforts
- Disruption of operations from decreased cash flow
- Inability to access financing when needed most
- Extreme stress negatively impacting health and relationships
Avoid finding yourself in this situation at all costs. Have plans to address financial challenges before they spiral into a default.
How Can a Business Attorney Help with an MCA Default?
Here are some of the ways an experienced commercial litigation attorney can assist if you default:
- Reviewing your rights and repayment responsibilities
- Negotiating alternative repayment terms
- Defending against lawsuits and collection efforts
- Protecting your personal assets from seizure
- Exploring options to refinance or modify existing agreement
- Providing counsel to help stabilize cash flow
- Helping rebuild damaged credit over time
With expert legal guidance, it may be possible to resolve an MCA default without forcing business closure.
IF YOU’RE LOOKING FOR A BUSINESS DEBT SETTLEMENT COMPANY, VISIT DELANCEY STREET. CLICK HERE NOW.
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