Connecticut rethinks law that lets lenders go after small businesses nationwide : NPR

Jane received a worrying call from her daughter, away from college. His debit card had suddenly stopped working. There was something wrong with their shared bank account. What happened to all the money?

When Jane dialed her bank her heart sank. The funds were still there, the bank said, but frozen – every penny, in every account. This instruction came from a financial firm that provided a loan to his small business. There was no court order, no trial or hearing.

“It devastated my family and my business, without any warning,” says Jane. “They shut down my whole life – not just my business accounts, but my whole life.”

Jane runs a small firm in the medical industry in Indiana. She requested that NPR identify her by her middle name so she could speak openly about her debts, which she has not disclosed to her clients, employees or industry peers. Some of their financial settlement negotiations are still ongoing.

Jane found herself in an obscure and largely unregulated corner of the financial world, which also happens to be the fastest growing source of funding for American small businesses. One state, Connecticut, gave these lenders unusual power to go after business owners who fall behind on their loans. This spring, lawmakers plan to vote on the change.

Daily Payment for Emergency Assistance

Three months earlier, in October, Jane had borrowed $50,000 through Merchant Cash Advance, or MCA.

Like most entrepreneurs who choose this option, she hoped for an emergency lifeline: After two decades and several successful businesses in her field, Jane was starting a new firm, just as inflation soared and the 2024 election shocks prompted her clients to tighten their budgets. Sales were OK but not enough to make a profit. He needed cash, but traditional banks rejected him because his company was too new and, therefore, too high risk.

“When payroll is due, rent is due, you start to go through a little panic,” says Jen. He searched on Google and clicked on some forms. “All of a sudden, my phone started ringing, ‘We can give you $100,000 – just send me your bank statements from the last few months.'”

The hurdle came from MCA lenders, who often bridge the gap. The industry is vast and chaotic. A funder may be affiliated with a giant like Amazon or a loan shark; Many are backed by Wall Street or Silicon Valley money.

Their cash arrives fast – within a few hours – and with less paperwork. But it is expensive.

“I completely let fear get in the way and these guys took care of it,” says Jen.

The lump sum she received after various fees was just under $47,000. But he ultimately had to agree to pay back $72,500. And a key feature of an MCA is how it is paid: its lender receives a cut of its sale. And it withdrew $558 directly into his bank account every day.

Legally, there is no limit on fees at MCA. This is because a merchant cash advance is not technically a loan but a purchase of the borrower’s future sales. Therefore most loan laws do not apply. In most states, MCA lenders are not required to be licensed.

“They set up these small daily payments, and they seem fine — until you get into them and you start paying them,” says Jen. “And then I immediately realized that I had made a huge mistake.”

Special legal power in Connecticut

Jane lives in Indiana. Her lender, whom NPR is not naming to protect Jane’s request to remain anonymous, is based in New York. But their MCA contract, on page 9 of 21, names Connecticut as the state whose law will govern any potential disputes.

That’s because lenders there can add special language to their contracts to pull a rare and powerful lever: If they stop receiving someone’s loan payments, they can instruct the borrower’s banks to freeze all accounts rapidly and without judicial review – as they initiate lawsuits to recover what they’re owed.

The use of this legal strategy in Connecticut has increased rapidly in recent years. Many MCA companies moved there as an alternative to New York after the state tightened its laws in 2019. In a court statement in 2022, a New York MCA lender praised the Connecticut process as “probably the most effective way to at least get a merchant back to talking to you after you default.”

On paper, a borrower can challenge his asset freeze in court. But it takes time and money – hiring a Connecticut lawyer, waiting a week or more on court processes – all of which happens when they don’t have the money. Instead, business owners tend to compromise and work fast.

In 2023, Connecticut lawmakers will restrict the use of that contract-language lever to cash advances of less than $250,000, like Jane’s — it’s called the prejudgment remedy exemption. But some MCA lawyers quickly created their own interpretation of the new law to give those borrowers a leg up.

Just a few weeks after taking out her first cash advance, Jane struggled to sleep. She used to choose her food at meal time.

His emergency lifeline, with daily auto-withdrawals, quickly became a trap. Like many MCA borrowers, she resorted to more cash advances – four in total – each aimed at reducing the burden of the previous one.

“What happened is a snowball effect,” says Jen. “When your head’s spinning with fear, you just look at it – we’ll get over this hump, we can handle this. And then when I saw it wasn’t working, I thought, ‘Okay, we’ll go about our business and it’ll all be done.’ And you do it again.”

State legislature tries again

Connecticut lawyer Jonathan Jacobson likes to joke that he’s putting himself out of business.

As a civil litigator, he has represented a growing cadre of out-of-town business owners facing debt recovery by far-flung MCA lenders. He soon saw the asset-release strategy as an abuse at its worst.

“I consider this industry nothing less than the golden age of piracy, with the state of Connecticut becoming the main port of call,” Jacobson testified in the state legislature in February.

At that hearing, only a few witnesses testified against that specific provision. They included attorney Jared Alfin, whose law firm has handled hundreds of cases similar to Jane’s. He argued that the law would discourage lenders, leaving businesses with fewer funding options.

“There will be no protection for the funders,” Alphin testified. “When the merchants themselves are there to take the money and never return it, their ability to recover the money will inevitably be much lower.”

Much of the opposition to the bill has focused on a different provision: The legislation would make Connecticut the third state — after New York and California — to force MCA lenders to show their fees, like credit card or mortgage loans, by listing the estimated annual percentage rate (APR). The industry rejects it and has opposed similar proposals in other state legislatures in recent years, including Maryland and New Jersey.

Yet, even while opposing the new bill in Connecticut, an MCA group – the Revenue-Based Finance Coalition, which represents funders and brokers – expressed support for a ban on prejudgment measures. In a statement to NPR, Executive Director Mary Donohue said, “It establishes important guardrails that protect small business owners and promote a fair, balanced process.”

“It spiraled for me”

Jane saw that every penny earned from her business was wasted in daily and weekly loan payments. Then, in December, a relief came out of the blue in the form of a text message: Are these MCA loans troubling you? “Oh, yes, they are,” Jane thought. A firm was offering to help her renegotiate her high-cost loan. We can save you money.

As a first step, the new arbitrators recommended that Jane stop communicating directly with her lenders and stop her auto-payments to them. Then the firm disappeared with its fees. By then Jane had missed enough loan payments on her original MCA – “two or more,” by contract – for her lender to find her in default.

As the firm launched a collection lawsuit in Connecticut, an affidavit from the lender – a signed letter stating that she had failed to make required payments – was enough for a state marshal to instruct her bank to freeze her funds, because the bank had a branch in Connecticut.

Without access to her money, Jane calculated that her business would not last more than 10 days.

Jane says, “I wish I knew more, I know. That was my fault – it falls on me.” “After being in this industry for so many years and being proud of myself that I was able to step up the team and perform so well, for it to happen now at this level was extremely devastating.”

A notice will be mailed to Jane informing her of her right to challenge the stay in court, which will arrive well after she becomes life-threatening. He doesn’t remember seeing it.

Jane borrowed money from friends and planned to hire a lawyer in Connecticut. Within days, in January, he settled his case by making a large payment to that lender. She is still negotiating her remaining MCAs but says her business is doing well.

“It was amazing to me. It really happened,” says Jen. “By the grace of God, we are coming out of this.”

If she were to look back now with a trained eye, she would have seen warnings in the middle of her MCA contract, at the end of an entire page, written in capital letters: “This anti-bias exemption may result in your bank accounts being seized without prior notice or a court hearing.”

“I would say about 0% of the merchants that sign these things even know what it is and what it means,” says Jacobson, a state lawmaker and attorney.

Just a month after his bill was introduced, it has received bipartisan support from more than two dozen co-sponsors, including leaders from both parties in the House. The Connecticut Legislature is scheduled to vote on the measure before May 6.