The Evolution of Cash Advances
Over the years, the way that cash advances to merchants have been funded and collected has changed. Below I will review the way the industry has changed and discuss some of the implications of those changes.
The Pure Cash Advance
In the beginning, the cash advance model was closely linked to the credit card processing of the merchants. Most companies only provided cash advances to merchants that could show a steady flow of credit and debit card receipts. The cash advance was repaid by way of split funding of the merchant’s payment processing. By that I mean the credit card processor would pay a certain percentage (usually less than 10%) of the merchant’s credit card processing receipts to the company that provided the cash advance with the balance paid to the merchant. This was usually accomplished by way of a redirection letter signed by the merchant and presented to the merchant’s processor directing how the funds were to be distributed.
The documents for these types of transactions were usually similar looking to those used in providing a loan to a merchant. The cash advance agreement was typically fairly long and included provisions like a personal guarantee and security pro
visions including calling for a UCC-
1 filing. As to the personal guarantee, most of the things that triggered it were really actions that amounted to fraud such as getting the cash advance and then switching to another payment processor in a couple of weeks to avoid having to repay the advance.
Possibly partly because of the similarity in the merchant advance agreement to loan documents, a number of lawsuits were filed by a San Diego law firm here in federal court Orange County, California. The lawsuits alleged that the cash advances were really disguised loans and hence violated the usury laws. A number of the lawsuits were settled for considerable amounts of money.
The Evolution
The first reaction of many companies in the cash advance business to these lawsuits was to simplify their cash advance agreements. Gone or severely limited were the personal guarantee provisions. As I stated above, maybe they are not really needed anyway given the fact that you could sue the owners of the merchants for fraud in most cases. Gone too were the long agreements. The new agreements were shorter, simpler to read and understand and did not have all the security provisions like a loan document. The upshot was the given that the characteristics of a loan were removed, the companies would have a better argument that it was not a loan disguised as something else.
But, the reliance on the need for split funding with a third party processor continued and necessarily limited companies in the space. They did not have control over the merchant’s funds so there was inevitably some additional risk. Some companies solved that problem by becoming independent sales organizations with control over the merchant’s funds. But others could not justify the expenditure or just did not want to get into that business. So what was the solution? Automated clearing house (ACH) transactions.
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