On March 5, 2024, the New York Attorney General (AG) Letitia James sued Yellowstone Capital LLC (Yellowstone) and various affiliates, accusing them of running a predatory lending operation by disguising the loans as purchases of merchants’ future revenues. Following Yellowstone’s settlement one year prior with the New Jersey AG on similar claims, this lawsuit marks a major development in the universe of merchant cash advances (MCAs), a financing structure that has grown increasingly popular in recent years.

Unlike loans, MCA products are not subject to usury caps under state law, and providers are generally not subject to the same state-level licensing and supervisory regime that applies to lenders. This distinction is key to the success of business models designed to minimize applicable regulatory requirements—including those of certain fintech companies that seek to offer innovative financing solutions. These business models are generally underpinned by contracts that are styled as a purchase of future account receivables and avoid the use of loan-related terminology. However, the New York AG’s lawsuit underscores how the increased scrutiny of MCA products could also look beyond the governing contract terms to the economic realities of the arrangement.   

Merchant Cash Advances

MCAs are a form of financing that is structured as a sale of future revenues. In these transactions, the MCA provider advances cash to the merchant and structures the advance as the purchase price for a fixed amount of the merchant’s future revenue. The merchant then remits receipts to the MCA provider over time in the form of periodic (monthly, weekly, or daily) payments, measured as the agreed upon percentage of the revenues for such period “sold” to the MCA provider. 

A properly structured MCA does not establish an unconditional obligation for the merchant to “repay” the MCA provider. Rather, the merchant only sells a portion of its future receipts to the extent that such receipts are actually generated by the business and collected by the merchant. Generally, the MCA provider bears the repayment risk in the event the merchant becomes insolvent or experiences a significant drop in revenue. Unlike a loan, which can have a fixed repayment schedule, an MCA provides for monthly payments that may vary with the merchant’s revenue stream, thus accelerating or extending the payment timeline. Careful attention to structure is critical: if not set up properly, such advances may run afoul of lender licensing requirements, and sometimes—as alleged in the current action—usury laws.

New York’s Allegations Regarding Yellowstone’s MCA Practices

The complaint filed by the New York AG alleges that Yellowstone’s transactions, while nominally MCAs, were actually usurious loans. The New York AG contends that, when underwriting MCA transactions, Yellowstone ignored the stated percentage of revenues that it was purportedly purchasing. Rather, Yellowstone allegedly backed into such a percentage in order to achieve a desired daily payment amount. Among other things, the complaint asserts the following allegations regarding Yellowstone’s transactions:

• The daily payment amount, whereby the merchant would remit funds to Yellowstone, was not based on the merchant’s revenues. Rather, it was calculated by dividing the total amount to be repaid by the number of days in the term of the deal.
• Representatives of Yellowstone and its affiliates regularly discussed a finite repayment term in internal communications and in communications with merchants and brokers.
• Multiple Yellowstone subsidiaries entered into separate MCA transactions with a single merchant, with each purporting to purchase the same percentage of the merchant’s revenue. However, each fixed a wildly different daily payment amount (despite each agreement representing that its daily payment amount represented a “good-faith approximation” of the agreed-upon percentage of the merchant’s revenue).
• Yellowstone strategically made it difficult, or even impossible, for merchants whose revenue declined during the term of the MCA to reduce their payment obligations.
• Yellowstone obtained a security interest in merchants’ assets, extending well beyond revenue.
• Yellowstone repeatedly used the term “loan” in communications with merchants, and merchants understood the transactions to be loans.
• Yellowstone engaged in highly aggressive enforcement tactics, including pursuing business owners personally even after their business ceased operations.

The complaint alleges that these and other alleged conduct taken together are indicative of an illegal and fraudulent predatory lending scheme, with interest rates as high as 819 percent.

Similar violations had been alleged in an action brought by the New Jersey AG in 2020, and other unfair and deceptive conduct by Yellowstone was alleged in an FTC complaint filed that same year. Pursuant to settlements in those actions, Yellowstone was required to pay monetary judgments and to modify its MCA agreements and servicing practices.¹

Takeaways

Companies providing revenue financing services structured as sales should be careful to make sure that their transactions have the substantive features of an actual sale, including, most importantly, having the financing provider bear the risk of the merchant going out of business or experiencing a significant drop in revenues. While no single factor is necessarily sufficient to turn a purported sale into a loan, the inclusion of numerous loan-like features, combined with aggressive enforcement practices, may draw regulatory scrutiny. Merchants, meanwhile, should make sure that they fully understand the terms of any financing that is offered to them, to avoid falling prey to predatory lenders. 

[1] See Stipulated Order in FTC action and Consent Order in action brought by New Jersey Attorney General.