I have written short summaries of five instructive factoring cases from the first half of 2022. These cases address 5 issues:

(i) whether a merchant cash advance funder is charging usurious interest (as an aside, this case may signal a shift in the legal environment for MCAs);

(ii) the struggle between two funding sources over an intercreditor agreement;

(iii) a merchant cash advance funder trying to overcome failing to offer a term sheet as evidence;

(iv) a factor waiting too long to demand recourse from its client; and

(v) a medical receivable funder trying to keep its funding rate from being discoverable in a personal injury lawsuit.

Keep in mind that these cases are from various states and may not be predictive of the results in the states where you are conducting business. Also, some of these cases may be reversed on appeal. Finally, it is worth noting that many of these cases are about whether a case should be dismissed at the beginning of the case based on the facts alleged. They are not all deciding ultimate liability although the courts are conducting an extensive review in each case.

• • 1. Haymount Urgent Care PC v. GoFund Advance, LLC[1] (from the United States District Court for the Southern District of New York).

Question: The Racketeer Influenced and Corrupt Organizations Act (“RICO”) is a serious allegation and can include both civil and criminal penalties. A merchant cash advance funder was accused by its clients of RICO violations for charging usurious interest. Should a class action complaint against a merchant cash advance funder over RICO allegations for charging usurious interest be dismissed if the funding agreement required the merchant cash advance funder to adjust the payments if the client’s finances fall short of expectations (referred to as a reconciliation clause), lacked a stated term, and seemed to have no recourse for credit risk?

Answer: No. The complaint should not be dismissed. The court recognized that several decisions in recent years have been issued finding a merchant cash advance funder that (1) provides for mandatory reconciliation, (2) provides a repayment period that lacks a stated term, and (3) has no recourse against the client for credit risk is not a loan. These cases and their three-factor tests have created a safehaven used by many merchant cash advance funders in structuring their deals. In a break from these other courts, however, this court refused to accept those three factors as definitive or dispositive. The court noted that appellate courts have not yet decided on any specific framework for classifying merchant cash advance agreements. As a result, the court did not take the three factors cited by the merchant cash advance funders as dispositive and conducted a more traditional evaluation like we have seen for years in factoring. Specifically, the court looked at the substance of the transaction and the actual recourse risk to the funder. Ultimately, the court found that this transaction could be considered a loan, not a purchase of accounts, so the plaintiff’s allegations did not need to be dismissed. Another opinion in this same district by a different judge and issued at almost the same time took a similar approach—see Fleetwood Servs., LLC v. Ram Capital Funding[2] (United States District Court for the Southern District of New York). These opinions create risk for merchant cash advance funders especially given how influential courts in the Southern District of New York are on issues like this.

• • 2. CoFund II, LLC v. Hitachi Capital Am. Corp.[3] (from the United States Court of Appeals for the Third Circuit).

Question: A factor needs capital to keep operating so it obtains funds from two different financing sources. One of the sources has exclusive control over the bank account where payments from accounts debtors are made (the “controlling funder”) so the two funders enter into an intercreditor agreement. The agreement provides that the controlling funder will hold funds deposited into the account for the non-controlling funder from the non-controlling funder’s pro rata portion of the payments. The factor ended up in an involuntary bankruptcy. When funds were deposited into the blocked account from account debtors, the controlling funder kept the funds and paid itself rather than holding a portion for the non-controlling funder. The intercreditor agreement between the funders had a clause prohibiting the non-controlling funder from having any recourse against the controlling funder for failing to make any payment due to the non-controlling funder. Given this no recourse clause, can the non-controlling funder maintain a cause of action for breach of the intercreditor agreement against the controlling funder?

Answer: Yes. The no recourse provision in the intercreditor agreement only deals with payments due from the controlling funder to the non-controlling funder. The clause has nothing to do with the controlling funder’s breach from failing to withhold funds from the account that were supposed to have been remitted to the non-controlling funder.

• • 3. Hedaya Capital Group Inc. v. Park Falls Indus. Mgt., LLC[4] (from the Supreme Court of New York, New York County)

Question: Can a merchant cash advance funder recover $1.3 million in damages on a motion for summary judgment against its client even though it failed to attach a term sheet with key terms in the agreement and that was specifically referenced in the factoring agreement?

Answer: No. This is an example of how having incomplete documents can be costly. The funder is trying to win its case on a motion for summary judgment so it does not have to go to trial. To prevail, the funder had to show the court that there were no fact issues so it should win as a matter of law. The court, however, found numerous problems with the motion. The problem, however, that the court spent most of the opinion discussing was the missing term sheet. The court found that this term sheet held key provisions that were fundamental to the merchant cash advance funder’s claims and so summary judgment was not proper without that term sheet being submitted as evidence.

• • 4. Advance Bus. Cap., LLC v. Region Constr., Inc.[5] (from the United States District Court for the Northern District of Texas).

Question: A factor failed to request recourse from its client within the time period specified in the agreement because it was attempting to collect from the account debtor first. When the account debtor filed for bankruptcy protection, the factor began attempting to collect from the client under the recourse provision. Can the factor still maintain a breach of contract lawsuit against an account debtor for failing to repurchase unpaid invoices?

Answer: No. By failing to request repurchase of the invoices within the time specified in the factoring agreement, the factor did not allege sufficient facts to show that its client breached the factoring agreement. The factor alleged other breaches of the factoring agreement, but the court held that the factor also did not provide sufficient evidence of these other breaches. The factor’s complaint was dismissed but could be refiled.

• • 5. Tarleton v. D.G. La., LLC[6] (from the United States District Court for the Western District of Louisiana).

Question: Is evidence of a medical factor’s advance rate for medical bills discoverable in a personal injury lawsuit?

Answer: Yes. Over the past few years, this issue has repeatedly arisen in courts around the country, but especially in courts in Louisiana. The court held that the information is discoverable to show the amount that the personal injury plaintiff is truly obligated to pay. It is also relevant to show bias and to impeach the medical provider’s credibility. The court reasoned that the rate paid by the factor could influence the medical provider to charge higher rates for medical treatment so the evidence could prove bias.

Scot Pierce, Esq. is a trial lawyer and transactional attorney.  Click on his picture for his profile page.

Disclaimer: This post contains general opinions and analysis, is solely for educational purposes, and should not be treated as advice for any specific case.

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[1] 609 F. Supp. 3d 237 (S.D.N.Y. 2022).

2] 2022 U.S Dist. LEXIS 100837 (S.D.N.Y. 2022).

3] 2022 U.S. App. LEXIS 9917(3^rd Cir. 2022). The opinion also notes that under the Third Circuit’s internal operating procedures, this opinion is not considered a precedent that binds the court in future cases.

4] 2022 N.Y. Misc. LEXIS 1091 (N.Y. Sup. Ct. 2022).

5] 2022 U.S. Dist. LEXIS 77126 (N.D. Tex. 2022).

6] 2022 U.S. Dist. LEXIS 115145 (W.D. La. 2022).