Legal Brief: Kalamata v. Biz2Credit and Itria Ventures
October 20, 2015
The typical merchant cash advance contract contains language that prohibits the merchant from stacking multiple merchant cash advances. Some cash advance companies, however, induce merchants to stack. This is where the legal concept of “tortious interference with contract” comes in. Tortious interference places legal liability on a person who wrongfully causes another person to breach an existing contract. In the merchant cash advance industry, these lawsuits usually involve disputes over whether a stacking cash advance company intentionally caused a merchant to stack additional cash advances, thereby breaching an existing contract. This is an evolving area of the law and what conduct constitutes tortious interference is a hot topic in the legal field.
Tortious interference is one of several claims that came up in Kalamata Capital’s recent lawsuit against Biz2Credit Inc. and Itria Ventures, LLC, and the court has already issued its first ruling on what conduct might constitute tortious interference with cash advance agreements.
Kalamata sued Biz2Credit and Itria for, among other things, stacking. One of Kalamata’s arguments was that Biz2Credit and Itria tortiously interfered with Kalamata’s contract. Biz2Credit and Itria filed a motion to dismiss. They argued that Kalamata failed to allege facts that would support a claim of tortious interference with contract. The court denied their motion because Kalamata alleged that 1) it had a business relationship with a merchant, 2) that Biz2Credit and Itria knew of that relationship and intentionally interfered with it, 3) that Biz2Credit and Itria acted solely out of malice, used improper means, illegal means, or means amounting to an independent tort, and 4) that the interference caused injury to Kalamata.
Kalamata alleged that, under its contract with Biz2Credit, Kalamata paid Biz2Credit commissions for referrals and for managing all of Kalamata’s accounts, including the referrals, on Biz2Credit’s online platform. Kalamata also alleged that the contract with Biz2Credit prohibited Biz2Credit from soliciting Kalamata’s merchants. The crux of the lawsuit is Kalamata’s claim that Biz2Credit secretly referred Kalamata’s merchants to Biz2Credit’s closely related company, Itria, and intentionally induced those merchants to stack additional cash advances in breach of the merchants’ contracts with Kalamata, despite an alleged agreement between Kalamata and Biz2Credit that prohibited Biz2Credit from doing so. Biz2Credit and Itria disputed Kalamata’s claims and argued that they were permitted to solicit any account that Biz2Credit referred to Kalamata or serviced for Kalamata.
Ultimately, the court found that if Biz2Credit was, solely for malicious purposes, sharing Kalamata’s confidential customer information with Itria, Kalamata’s competitor, and, if Itria and Biz2Credit were knowingly inducing Kalamata’s customers to breach their merchant agreements with Kalamata, then such conduct would rise to the level of tortious interference.
As this was a decision on a motion to dismiss, the motion focused on the legal sufficiency of Kalamata’s claims and did not address the merits of either party’s factual assertions.
Some Small Business Funders Are Pivoting or Closing Shop
October 20, 2015
One of the unique insights AltFinanceDaily gets as a company that sends a lot of email and snail mail to folks in the industry is the rejection rate. One day an entrepreneur is telling us all about their new lending business and the next day the Post Office returns their magazine for a vacant address. Sometimes there’s a change in the model or a partnership didn’t work out. Other times lead generation became too hard or too many merchants defaulted very early on. The truth is, as much as the industry is growing, some companies are pivoting or closing their doors.
At Lend360, there were whispers around the trade show floor that acquisition costs have spiked and it was being felt on the bottom lines. Broker houses are opening, closing, merging with each other and being acquired. Funders have reacted by giving them lines of credit to either help them grow or stay afloat, hoping that their sources of deal flow don’t fall apart.
On one conference panel titled, A Discussion of Best Practices: Advancing The Cause for Business Finance, veteran underwriter and industry consultant Andrew Hernandez of Central Diligence Group, said he’s watched a lot of new entrants in this industry make mistakes. “We’ve seen guys lose their shirt,” he said. He explained that too often small business funding companies look to cut their acquisition costs in the wrong places, like simply paying less for leads or paying brokers lower commissions. That only works to a point. “Underwriters can help keep the cost of acquisition down by funding the right deals and trying to get good deals done,” he said.
The owner of one funder summed up his dilemma for me, my brokers are making more on a deal than I am and I’m the one taking all the liability on it. Maybe I should become a broker instead. Not that there would be anything wrong with that. For some companies in this industry, the best path forward is achieved through trial and error. For example, World Business Lenders’ Alex Gemici said at the conference that they started off by making unsecured loans and now only do loans secured by real estate. Gemici also said he believes the industry is heading for a major shakeout within the next three years and that irrational exuberance keeps him up at night.
If he’s right, an economic downturn could squeeze out a lot of players that are already feeling the pinch of high acquisition costs.
For those newer to the industry, they might not remember that the effects of the 2008-2009 financial crisis and ensuing recession was brutal. More than half of the providers of merchant cash advances went out of business, some within weeks when their credit lines were pulled.
A lot of the “industry leaders” of 2008 aren’t around anymore: First Funds, Fast Capital, Second Source, Merit Capital, iFunds, Summit, Infinicap, Global Swift Funding, and more.
Given the favorable economic climate and regulatory environment, this is a bad time to be struggling. 2015 may be one of the last years to pivot in a major way before it’s too late.
World Business Lenders Makes Credit Prediction, Employs Different Model
October 19, 2015World Business Lenders (WBL) Managing Director Alex Gemici thinks the next credit correction will take place within three years, he told a crowd at Lend360 last week in Atlanta. When he and his fellow panelists were asked what keeps them up at night, Gemici said, “irrational exuberance.” He clarified that by saying that there was an incredible amount of capital pouring in right now and insinuated that it’s not all being deployed intelligently. He also pointed to the country’s economic history and said we’re naturally due for a shift in the credit cycle.
From Left to Right: Bob Coleman of the Coleman Report, Jason Rockman of CAN Capital, Craig Coleman of ForwardLine, Alex Gemici of World Business Lenders, David Gilbert of National Funding and Jeremiah Neal of Biz2credit
Part of WBL’s hedge (if you could call it that) against a future industry shakeout, is that their loans are actually collateralized, though they didn’t start out that way. When they launched in 2011, they initially offered unsecured loans and eventually evolved towards collateralizing them with all different types of assets. They have shifted even further in that direction and today the only collateral they accept is real estate. That makes WBL’s model quite traditional by comparison to competing products like merchant cash advances and OnDeck loans. Gemici says however, that they believe in technology and data mining to make better underwriting decisions, just like today’s unsecured fintech lenders.
But while they use technology, their process isn’t fully automated and that’s because Gemici believes algorithms aren’t advanced enough yet to make decisions on their own. You can’t ask Siri whether she’d approve a business loan yet, Gemici joked.
Will business loans backed by real-estate give them a long-term edge over unsecured lenders? Only time will tell. One thing many people agree on however is that there will most certainly be a shakeout when the next economic downturn hits.
Kabbage, Fora Financial and Square Have a Roaring Wednesday
October 15, 2015
Wednesday, October 14th was packed with exciting industry news. Right after Congressman David Scott blessed online lenders, Kabbage announced a Series E round investment led by Reverence Capital Partners for $135 million. The Wall Street Journal said the deal valued the company at over $1 billion, a figure that elevates Kabbage to unicorn status.
At the same time, Fora Financial announced that a Palladium Equity Partners affiliate had made a significant investment in the company. In the official release, Palladium principal Justin Green said, “we believe Fora Financial has developed a highly attractive credit offering and technology platform that have made it a valued provider of financing to thousands of small businesses seeking capital.”
Palladium once held a stake in Wise Foods, the potato chip snack company, and currently counts PROMÉRICA Bank, a full-service commercial bank in its active portfolio. They have more than $2 billion in assets under management.
And then there’s Square, the payment processor and merchant cash advance company who publicly filed their S-1 for an IPO. Their registration form uses the term merchant cash advance 16 times so there is no doubt it’s a significant part of their business. “Square Capital provides merchant cash advances to prequalified sellers,” the document states. “We make it easy for sellers to use our service by proactively reaching out to them with an offer of an advance based on their payment processing history. The terms are straightforward, sellers get their funds quickly (often the next business day), and in return, they agree to make payments equal to a percentage of the payment volume we process for them up to a fixed amount.”
As of June 30th, Square had already racked up a net loss for the year of nearly $78 million. In 2014, the company lost $154 million. While the losses stem mainly from their payment processing operations, they had outstanding merchant cash advance receivables of $32 million as of mid-year which illustrates how much exposure they have with that product.
The three announcements ironically coincided with comments made by SoFi CEO Mike Cagney about the industry’s lack of ambition. “The problem with fintech is that it’s not ambitious enough in terms of its objectives. It’s not really transforming anything,” he’s quoted as saying in the San Francisco Business Times. Cagney went on to categorize Lending Club as just an electronic interface bolted onto a bank to originate loans for them. While his comments hold weight given that his lending company recently just raised $1 billion in a Series E round led by Softbank, it may be fair to say however that Wednesday proved there was anything but a lack of ambition in the space right now.
Whoops! Lender Drafts Choice of Law Clause with Wrong State; Court Finds Interest Rate Usurious
October 9, 2015
A recent case out of Illinois serves as a reminder that when it comes to usury law compliance, its always best to double, or even triple check your contracts.
Preferred Capital Lending, a Nevada company that provides cash advances to attorneys working on personal injury cases, agreed to make a loan to the defendant. The defendant signed the promissory note in Preferred Capital’s Las Vegas office and the note expressly provided that it was executed in the State of Nevada. When the defendant later defaulted on the loan, Preferred Capital filed a breach of contract action in Nevada. The case, however, was transferred to Illinois pursuant to the loan contract’s choice of law clause which provided that that state’s law would govern.
In response to the complaint, the defendant filed a motion for summary judgment arguing that the loan carried an interest rate that exceeded Illinois’ usury cap. Preferred Capital countered that it had made a mistake when drafting the choice of law clause and that the clause should have stated that Nevada’s law applied. The court was unpersuaded by Preferred’s argument:
Preferred Capital contends that the Illinois choice-of-law provision was a mistake and the loan documents should have indicated that the law of Nevada, which has repealed its usury laws, applies to the loan documents. This assertion rings hollow in light of the fact that Preferred Capital analyzed its breach of contract claim under Illinois law in its opening motion for summary judgment, and expressly stated in a footnote that it was doing so pursuant to the Illinois choice-of-law provision in the promissory note at issue.
As a result, the court applied Illinois law and found that the amount of interest provided in the agreement violated the Illinois Interest Act.
Now to be fair, Preferred Capital operates offices in both Nevada and Illinois. So its understandable how a Illinois choice of law clause appeared in the loan documents. What’s less clear, though, is why Preferred Capital initially argued that the agreement should be governed by Illinois law given that it had originally filed the matter in Nevada. In any event, the oversight proved costly as Preferred Capital now finds itself defending a usury claim rather than collecting on the outstanding loan.
Preferred Capital Lending v. Chakwin, 2015 U.S. Dist. LEXIS 137383 (N.D. Ill. Oct. 7, 2015)
Stop Saying Alternative Lending Isn’t Regulated
October 7, 2015
I cringe every time I hear someone say that alternative business lending or merchant cash advances are completely unregulated. It’s true as a generality that there are fewer restrictions on commercial transactions than there are on consumer transactions, but fewer doesn’t mean none. If you are operating your funding business with the impression that it’s all unregulated, then you’re probably doing it wrong and should hire a lawyer (or several) immediately.
Things like interest rates, truth in advertising, and the banking system are already regulated. Who can invest and what has to be disclosed in an investment is regulated. Email marketing and telemarketing are regulated. The ACH network is regulated. Credit card processors and payment networks are regulated. Credit reporting and the process of declining someone for credit is regulated.
As de-banked as merchant cash advances and non-bank loans look, they all go through the traditional banking system and still obviously operate under state and federal laws just like everyone else. That means compliance with the OCC, OFAC, FED, FCC, FTC, SEC, IRS, state regulatory bodies and more. So when critics say there are no regulations in place for these products, one has to wonder what the heck they’re talking about.
In the context of merchant cash advances, there’s a pervasive myth that the process of purchasing future assets is really all just a loophole to charge Annual Percentage Rates (APRs) in excess of state usury caps. I can’t speak on behalf of all purchase agreements in general since every financial company structures theirs differently, but in a true purchase of future assets, it is literally impossible to calculate an APR. It’s not just a matter omitting the word loan from the agreement either, it’s the uncertainty of the seller’s future sales to which the agreement ultimately hinges upon (among other factors), that make such a calculation indeterminate even if one wanted to generate one just for comparison’s sake. These are purely commercial transactions that fall under the umbrella of factoring and they have no basis for comparison with loans. Oh, and they’re not new.
According to wikipedia, “factoring’s origins lie in the financing of trade, particularly international trade. It is said that factoring originated with ancient Mesopotamian culture, with rules of factoring preserved in the Code of Hammurabi [about 4,000 years ago]. Factoring as a fact of business life was underway in England prior to 1400, and it came to America with the Pilgrims, around 1620.”
While the subtle nuances of merchant cash advances may only be a couple decades old, the system on which they’re based precedes the arrival of Jesus. That makes the concept understandably new… if you’re a Stegosaurus.
But here in modern times, the courts in many states have reviewed these agreements and generally respect the arrangements when they are well-defined and compliant with state and federal laws. There’s that regulation thing again…
For funding companies that deal in actual loans, the industry is heavily regulated. The non-bank lenders we hear about on a daily basis have to acquire state licenses where applicable or forge partnerships with chartered banks to create a relationship in which the banks themselves are the ones that actually originate the loans. That means despite the excitement and fanfare of tech-based disruption, many of these lenders are really just servicing loans made by traditional banks. Kind of a bummer, isn’t it?
And when it comes to sales tactics, it’s important to remember that deceptive advertising is already illegal.
The regulation and compliance hurdles in FinTech are cumbersome even if some of the companies involved in the business appear scrappy and amateurish. According to a report that was recently published by accounting firm KPMG, titled Value-Based Compliance: A Marketplace Lending Call to Action, they offer a non-exhaustive list of federal legislation and networks:
- Anti-Money Laundering (AML)
- Bank Secrecy Act (BSA)
- Blue Sky Laws
- Card Act (CARD)
- Dodd-Frank Wall Street Reform and Consumer Protection Act
- Electronic Funds Transfer Act (EFTA)
- Electronic Signatures in Global and National Commerce Act (ESIGN)
- Equal Credit Opportunity Act (ECOA)
- Fair and Accurate Transactions Act (FACTA)
- Fair Credit Reporting Act (FCRA)
- Fair Debt Collection Practices Act (FDCPA)
- Fair Housing Act (FHAct)
- Financial Crimes Enforcement Network (FinCEN)
- Gramm-Leach Bliley Act (GLBA)
- Know Your Customer (KYC)
- Service Member Civil Relief Act (SCRA)
- Truth in Lending Act (TILA)
- Unfair, Deceptive or Abusive Acts or Practices (UDAAP)
- USA Patriot Act
Completely unregulated you say? You are sadly mistaken. =\
Fake Business Loan Application Fees Leads to Two Convictions
October 5, 2015
Two men were convicted last week of perpetrating an advance fee fraud scheme. David C. Jackson and Alexander D. Hurt defrauded more than 40 individuals out of $4.5 million, mainly by directing small businesses hoping to get a loan to pay phony application fees, collateral fees, or commitment fees. “These defendants and their co-conspirators took advantage of individuals and business owners who had limited options in acquiring business loans in the difficult financial environment that existed after the recession of 2008,” states a report issued by the Department of Justice.
Deirdre M. Daly, United States Attorney for the District of Connecticut, said that people need to be careful about loan offers online. “Those seeking business loans need to be wary of any provider of funding that requires significant fees in advance—especially those who use the Internet to prey upon trusting people who are unable to verify the representations made,” Daly said.
“Jackson was previously convicted of federal bank fraud and money laundering offenses in October 2006 and was sentenced to 41 months in prison, followed by five years of supervised release,” the DOJ report says. “He was released from federal prison in September 2009 and operated this advance fee fraud scheme while on supervised release.”
The two used a slew of personal aliases and business names to cover their trail. The business names included:
- Jalin Realty Capital Advisors, LLC
- American Capital Holdings, LLC
- Brightway Financial Group, LLC
An archived version of American Capital Holding’s website said the following on the home page:
“In today’s economic climate, finding reliable funding sources can be frustrating. Fortunately, we are partnered with an investment fund that provides commercial real estate development and acquisition projects. Due to our professionalism & honesty we have achieved massive trust worldwide.”
One lesson here would be to cautious of anyone who says they have “achieved massive trust” but another is to conduct background checks on the online lender you’re considering.
And of course never pay a fee upfront for the promise of a loan in return.
Coalition for Responsible Business Finance Submitted RFI on Behalf of Both Funders and Small Businesses
October 1, 2015
If you haven’t heard of the Coalition for Responsible Business Finance (not to be confused with the Responsible Business Lending Coalition), I recommend paying attention to it.
“The CRBF is a group of businesses and service providers that advocate for the value of alternative financing opportunities for small businesses,” they said in their response to the Treasury RFI. “We created the coalition to help educate Congress, Treasury, and other federal departments and agencies on how technology and innovation are providing small businesses access to capital that is necessary for growth.” Simply put, this coalition allows lenders, funders, and small businesses to have a unified voice to educate policymakers.
And yes, merchant cash advance companies are welcome, though representation is very diverse.
“Small business owners value choice and speed when looking at alternative finance and lending options,” the CRBF says in their response. “Any federal approach needs to balance new regulatory requirements with the impact on the alternative finance and lending sector and on the sector’s small business customers.”
The overall message in the submission is that regulators need not feel shy about opening a dialogue with those most likely to be affected by any change in policy.
For those reasons, CRBF recommends that Treasury create an alternative finance and lending interagency working group that will meet on a quarterly basis. We suggest that twice a year the working group meet as a group comprised solely of governmental personnel, with officials from SEC, SBA, FTC, Federal Reserve, OCC, and other relevant agencies. And, we suggest that twice a year the working group meet with business leaders from across the alternative finance and business lending spectrum including representatives from lead generators, aggregators, merchant cash advance professionals, peer-to-peer lenders, risk analytics services, direct lenders, marketplace lenders, and others. Meeting with different groups of businesses throughout the life span of an interagency working group will allow Treasury to keep up with a rapidly evolving business sector and will help ensure that any federal approach is sensitive to its impact on the sector and on its small business customers.
CRBF is committed to educate federal authorities on how alternative lending and finance benefits small business and the economy. We would certainly help Treasury establish any working group that serves the same purpose.
As I am currently an advisory board member of this coalition, I encourage you to consider the organization’s mission and purpose by visiting the website at http://www.responsiblefinance.com. If you’d like to learn more or consider support for it, email me at sean@debanked.com.
