In the last two months, the U.S. District Court for the Southern District of New York has issued three adverse decisions against revenue-based financing providers. In each case, the court sustained federal Racketeer Influenced and Corrupt Organizations Act ("RICO") claims against the funding companies or their principals. Each decision provides guidance on how to mitigate risk by updating contracts or adopting best practices. Providers of revenue-based financing must ensure that merchants can obtain reconciliations and that the daily or weekly payments disclosed in the contract represent a good-faith estimate of the merchant's future revenue. A summary of the most recent court decision, Lateral Recovery LLC v. Queen Funding, LLC, 2022 U.S. Dist. LEXIS 129032 (S.D. N.Y. July 20, 2022) appears below:
Lateral Recovery, LLC sued Queen Funding, LLC, Yehuda Klein and "John and Jane Doe Investors," claiming that they violated RICO by engaging in wire fraud and collecting unlawful debt. The defendants moved to dismiss the RICO claims, and the court denied the motion.
Queen Funding entered seven purchase of future receivables contracts (the "Contracts") with a merchant in 2017 and 2018. Each Contract required the merchant to pay a fixed amount every day, which the Contracts stated represented a "good-faith estimate" of 13% of the merchant's receivables. Over a two-year period, Queen Funding advanced approximately $6,500,000 in cash and collected about $10,500,000 in daily payments.
Wire Fraud Claim: Under RICO, "use of wire" includes email communication and wire transfers of money. The complaint alleged that Queen Funding and its owners used email to "originate, underwrite, service and collect upon" the Contracts. Queen Funding and its owners also allegedly collected amounts due under the Contracts through interstate electronic ACH debits.
The complaint alleged that the following false statements that appeared in all seven Contracts satisfied the fraud element of wire fraud:
Collecting an Unlawful Debt Claim: RICO defines "unlawful debt" as a debt that (1) is unenforceable in whole or in part because of usury with interest of at least twice the enforceable rate and (2) was incurred in connection with "the business of lending money."
The court explained that to determine whether a contract is a loan, courts examine whether the funder "is absolutely entitled to repayment under all circumstances" and whether the "principal sum advanced is repayable absolutely." The court examined the following four factors and concluded that the complaint sufficiently alleged that the Contracts were loans:
Lateral Recovery LLC v. Queen Funding, LLC, 2022 U.S. Dist. LEXIS 129032 (S.D. N.Y. July 20, 2022). The other two cases are Haymount Urgent Care PC v GoFund Advance, LLC, 2022 US Dist. LEXIS 112768 (S.D.N.Y. June 27, 2022) and Fleetwood Servs., LLC v Ram Capital Funding, LLC, 2022 US Dist. LEXIS 100837 (S.D.N.Y. June 6, 2022).