Merchant Cash Advances in Connecticut: Illegal Financing in Connecticut Can Lead to a Borrower’s Windfall

By Matt Gibbons

There seems to be some debate over the legality, or illegality, of merchant cash advances (“MCAs”) in Connecticut.  There should not be, because the law is clear: an MCA that is in actuality merely a disguised loan, charging interest for the use of money that has been provided, is subject to Connecticut usury laws.  Businesses that have received and then paid back, or failed to pay back, an MCA may have legally enforceable rights as a result.

An MCA is a particular species of financing involving a cash payment in exchange for money paid over a later period of time.  The “advance” of cash is paid by the MCA financing provider, sometimes called a “funder” or “buyer.”  The recipient of the advance is an existing business, or “seller.”  The terms of an MCA are set out in contracts.

In a true MCA, the buyer purchases (at a discount) some amount of the seller’s “future receipts,” which are payments made to the seller’s business in its future sales.  That total amount is paid by the seller over time, in payments equal to some agreed-upon percentage of the business’ daily or weekly sales.  But this exchange of money is susceptible to—indeed, it lends itself to—exploitation.  And courts, recognizing this exploitation, have looked through the façade of contractual terms and declared that some MCAs are not true MCAs, but are instead usurious loans.

In Connecticut, a contract appearing to be a sale which merely cloaks an usurious loan is treated as a usurious loan, notwithstanding either its sales-related accoutrements or what the parties call the transaction.  The determinative question is whether the compensation paid is for the use of the money provided earlier, or for the transfer of risk.  Of course, the compensation can only be for the transfer of risk if the risk of loss actually transfers.  Courts have identified several considerations that are weighed in evaluating whether a transfer of risk actually occurred.  If the risk of loss did not, in fact, transfer from the seller to the buyer, then the MCA is probably a disguised loan.

Loans disguised as MCAs are likely to have exorbitant interest rates because of the nature of these funding agreements.  For example, one such agreement litigated in federal court in New York had “an annual interest rate of 99.8%,” which nearly tripled when fees for “excess withdrawals” were considered.  Fleetwood Servs., LLC v. Ram Cap. Funding, LLC, No. 20-CV-5120 (LJL), 2022 WL 1997207, at *5 (S.D.N.Y. June 6, 2022). 

Interest rates this high implicate state usury laws.  For example, Connecticut generally prohibits interest rates over 12% on loans, though some loans are excluded from the usury ban, and others may have interest rates of up to about 18%.  But so long as a loan masquerading as an MCA does not fall within a category of excluded loans, the effective interest rates will likely be far greater than 18%.

Lenders may not enforce usurious loans, nor can they even recover the principal loaned through a lawsuit.  Moreover, the federal racketeering statute provides a cause of action and treble damages for collecting certain unlawful loans.  MCA sellers who really were the recipients of usurious loans may, accordingly, have defenses to litigation initiated by an MCA funder, or even affirmative claims resulting from the funder’s collection activities. 

Connecticut businesses that have been targeted by MCA providers should carefully review the terms of their agreements and consider whether the transaction was, in substance, a high-interest loan disguised as a sale.  Courts will not be swayed by the form or title of the contract if its function was to extract unlawful interest in exchange for a cash advance.  When risk of financial loss remained with the business, and repayment is effectively fixed or guaranteed regardless of revenue, the law may deem the transaction a usurious loan—rendering it unenforceable and possibly allowing claims for damages.