A merchant cash advance provides financing to your business in exchange for a percentage of your future credit card sales. You’ll get the money you need for many operations, and you will pay those funds back over time through a percentage of whatever credit card receipts you receive. It can be more convenient than a loan, as it doesn’t require a specific payment amount each week or month. It is also easier for businesses to qualify for advances, as they don’t require credit checks or collateral for use.
The legality of merchant cash advances is one concern to observe. The rules surrounding how you can use an advance will vary surrounding your location and what you are getting from a setup.
Why Might Cash Advances Be Illegal?
Merchant cash advances could be illegal in a state for many reasons. The APR on an advance could be higher than what a bank loan provides, for example. The factor rate on an advance shows what you’d spend on the total, but the cost may be high at times.
There’s also the concern of you having to spend more money at a time than you can afford. Since you’re paying for the advance with a percentage of your credit card receipts, your daily cash flow may become severely limited.
You’re also at risk of entering a debt cycle with an advance. An advance is expensive and needs to be paid back soon, making it possible for you to require a second advance not long after getting your first one. The effort puts you into a cycle of debt you can’t afford to manage in most situations.
Why There Aren’t Many Laws
There are many reasons why you might not come across many laws surrounding a merchant cash advance. These advances are not as commonly used as traditional loans, making it less likely for some groups to request limits on these advances.
Advances are also interpreted as sales instead of loans. Since you’re selling a portion of your future credit card receipts to another party, you’re not going to be subject to the same regulatory oversight that a loan provider might hold.
Fights In New York State
Merchant cash advances are legal in most states, but there are a few states where there are concerns abound. New York is one of those states where there are disputes over how merchant advances work.
New York State laws said in 2016 that a merchant advance is not a loan and that it is not subject to usury laws. But in 2020, the New York Attorney General dictated that cash advances should be interpreted as loans. They are deemed similar to loans because they are often marketed as though they were loans. The underwriting efforts also often entail looking at merchants’ credit ratings and bank statements instead of the credit card receivables they earn. Some providers may also not reconcile when merchants repay their advances. These terms prompted the state to determine that an advance is different, but it could still be treated as a loan if possible.
Confession of Judgment In New Jersey
New Jersey also has a separate rule for merchant cash advances. The state says that confessions of judgment cannot be used in business financing contracts in New Jersey. The confession of judgment here entails a contract where one party agrees to allow the other party to enter a judgment against that first entity. The defendant is admitted to being liable for a debt without entering a trial.
The merchant cash advance company must still assume the risk with an advance that it will not be repaid. Since the advance may not be subject to usury laws, it is possible for the advance provider to be liable for certain issues.
A merchant cash advance can still work in New Jersey if the seller can continue to collect its receivables and use them with other funds. There must also be an indefinite term for the advance, meaning the borrower can continue to pay for the total as necessary.
Florida Uses Many Terms
States like Florida will also use various rules for dictating if an advance is subject to the same rules as a loan. The state of Florida says that an advance must be defined as its own entity and should not include anything suggesting it might be a loan. Anything advertised to look like a loan must be treated as a loan and subject to the same usury laws used throughout Florida.
Challenges In California
California has some other terms for how advances can work. The state encourages cash advance providers to use sensible measures to protect their merchants if their receivables fall short of what they are expecting. There should be legitimate and earnest reasons why these receivables aren’t coming across.
California also has rules surrounding a breach of seller contractual efforts. A seller going bankrupt or planning to liquidate should not be interpreted as a breach of any contractual agreements the seller holds. There must be a reason as to why the seller is going bankrupt before an agreement can work.
The state also requires merchant cash advances to be subject to credit-like analysis processes. A provider must include a full disclosure surrounding the terms, fees, and other charges associated with the work. A proper warning is also necessary for low-credit businesses, as the costs for an advance might be too hard for some of these entities to cover.
Could Future Regulations Work?
Many states might establish new regulations surrounding merchant cash advances. These advances are legal throughout the country, but there’s always a chance these may be impacted by further laws as necessary.
Check the rules in your state to see what might occur surrounding merchant cash advances in your area. These terms can vary surrounding whatever is open in a state and how it might interpret operations and how they are seen as either advances or loans.