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Part of Merchant Cash Advances: How the Contract Works
Merchant cash advances rules: five clauses to check first
Merchant cash advances rules show up in the contract first: five clauses to check, from reconciliation to confession of judgment, before you see a lawyer.
The rules that govern a merchant cash advance are mostly met as clauses in the agreement in front of you. A handful of them decide whether the deal is treated as a purchase or as a loan, and what the funder can do on default.
Five clauses are worth reading first, with a note on who keeps the rule behind each. None of this replaces a lawyer in your state; it tells you what to take to one.
What to take away
- The contract's description of itself does not settle whether an advance is a purchase or a loan. Courts and legislatures look at substance.
- The reconciliation clause, the term and your liability when receipts fall short are the clauses courts examine.
- A confession of judgment clause is the first thing to take to a lawyer.
- The governing-law clause may name a state that is not yours.
1. Sale or loan: the question every clause answers
An advance is drafted as a purchase of a share of your future receipts. If that drafting holds, lending law may not apply, because no money has been lent. If a court or a state statute looks through the drafting and calls it a loan, a different rulebook applies.
That rulebook covers interest limits, licensing and lending disclosure. Ordinary commercial borrowing sits outside the usury caps in most states, but a few, New York among them, keep a criminal usury statute that a court can reach if the advance is priced as a loan.
Sale or Loan: Who Decides
Sale
- Legal basis
- Purchase of receipts
- Rulebook
- Contract governs
- Cost ceiling
- None by default
- Disclosure duty
- State statutes vary
- Licensing
- May not apply
Loan
- Legal basis
- Money lent
- Rulebook
- Lending law applies
- Cost ceiling
- State usury law
- Disclosure duty
- Lending disclosure rules
- Licensing
- Regulator may require
According to the CFPB's small business lending rule FAQs, merchant cash advances are a form of financing that purports to be structured as a sale of potential future income. The question has been litigated and legislated, and the answer is not uniform.
The five clauses at a glance
The table pairs each clause with the question a court or regulator puts to it, so you know what to look for before the lawyer's meeting starts.
| Clause | What a court or regulator asks | Where to check |
|---|---|---|
| Reconciliation | Does the funder genuinely bear the risk that receipts fall short? | The adjustment mechanism in the agreement |
| Term and liability | Is the term fixed or open-ended, and are you liable whatever the business takes in? | Repayment and default provisions |
| Confession of judgment | Is one present, and is it allowed in your state? | The state's civil procedure rules |
| Governing law and venue | Which state's statutes apply, and where do disputes go? | The clause, then the state regulator's site |
| Guarantee and default | What triggers default, and what converts the guarantee? | Default and guarantee sections |
2. The reconciliation clause
Read the reconciliation clause first, because it matters legally and operationally. Courts examine whether the funder genuinely bears the risk that your receipts fall short, and a clause that adjusts payments to what the business actually takes in is evidence on that point.
Operationally, the same clause decides what happens in a slow month: whether the daily or weekly collection moves with your receipts or stays fixed. What that does to a real business over a bad quarter, rather than on the page, runs through merchant cash advances examples.
3. The term and your liability
Look at whether the term is fixed or truly open-ended, and whether you are liable regardless of what your business takes in. These are the other two questions courts examine when they decide whether the funder has lent money or bought receipts.
An agreement that calls itself a sale but binds you to a fixed schedule whatever your receipts do reads like a loan. An agreement that ends when the purchased share of receipts has been collected, and not before, reads more like a purchase. Read the actual wording, because labels settle nothing.
4. Confession of judgment
A confession of judgment lets a funder obtain a court judgment against you without a contested hearing. New York restricted confessions of judgment in merchant cash advance contracts in 2019, and other states have since limited them or debated doing so.
If the clause is in your document, it is the first thing to take to a lawyer in your state, before anything else. New York's restriction is why the language changed in many contracts after 2019, so an old template can mislead on what is allowed now.
5. Governing law and venue
The governing-law clause names a state, and it may not be yours. State commercial financing disclosure statutes reach agreements differently, and whether one reaches yours can depend on your state, the funder's state, the governing-law clause, and the size and form of the transaction.
California's Commercial Financing Disclosure Law, enacted as SB 1235, is one such statute. New York's Commercial Finance Disclosure Law is supervised by the New York Department of Financial Services. Utah's Commercial Financing Registration and Disclosure Act pairs disclosure with registration with the Utah Department of Financial Institutions, and Virginia has its own disclosure statute.
A state may regulate the disclosure of terms without regulating the terms themselves. Check the disclosure and licensing position in each state that could apply: your own, the funder's, and the one named in the clause.
6. Guarantee, default and the rest of the contract
Where the law is silent, the agreement rules, and in this product that is most of the ground. The collection mechanism, the default triggers, the guarantee and what converts it, the venue and arbitration terms and any early repayment discount all sit in the contract.
That is why reading the agreement is not an alternative to knowing the rules. It is most of the rules. For the cost side of the same document, the merchant cash advances calculator works the arithmetic with invented figures.
Federal rules sit around the contract
Federal rules reach how the product is sold and what data covered lenders report, not the contract's core terms. The FTC Act empowers the Commission to prevent unfair or deceptive acts or practices, and Section 5 is how it polices selling conduct.
The Federal Trade Commission Act is the statute behind that. Section 1071 of the Dodd-Frank Act directs the CFPB to collect small business lending data, and the rule's scope, coverage and timetable have been revised and litigated. Check the CFPB's own site rather than any commentary for where it stands now.
Finding the current position
- Read the governing-law and venue clauses of the proposed agreement, and note the state named. It may not be yours.
- Search that state's and your own state's financial regulator, such as California's Department of Financial Protection and Innovation, New York's Department of Financial Services or Utah's Department of Financial Institutions, for a commercial financing disclosure statute, a licensing or registration regime, and any register the funder or broker should appear in.
- Look up the state attorney general's guidance on commercial financing, which is often where enforcement priorities are described.
- Check whether a confession of judgment is present, and if so, take that clause to a lawyer before anything else.
- Ask the funder directly which body supervises it and whether it is registered anywhere. A plain answer is informative. An evasive one is more so.
Where to go for the rest
Whether to take an advance, and how to price it against alternatives, is covered in merchant cash advances. How to judge a funder before you sign is set out in a short funder checklist.
State law governs most of the rest, as who governs what shows for another product, and interest law is covered in term loans rules.
Common questions
My agreement says it is not a loan. Does that settle it?
No. Characterization is decided by courts and legislatures looking at the substance of the arrangement. The contract's description is evidence, not the answer.
Which state's rules apply to me?
Possibly more than one: your own, the funder's, and the one named in the governing-law clause. Check the disclosure and licensing position in each.
Are merchant cash advances regulated?
Unevenly, and mostly at state level. Federal rules reach how the product is sold and what data covered lenders report. The contract governs everything the law does not.
Where do I complain about a funder's conduct?
The state attorney general and the state financial regulator, and the FTC for unfair or deceptive practice. Keep the agreement, every statement, and a record of every contact.
