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What Happens if You Default on a Merchant Cash Advance?

Updated on
March 16, 2024

Defaulting on a merchant cash advance can have severe consequences for a small business. Once you miss a payment, the merchant cash advance company will likely take swift legal action to get repaid. 

The first thing that usually happens is the MCA company will file a lawsuit against your business to collect on the debt. The lawsuit will seek the remaining balance owed, as well as fees and interest for defaulting.

In many cases, the MCA agreement contains a "confession of judgment" clause. This allows the lender to obtain a judgment against your business faster than through a normal lawsuit. The lender simply presents the signed confession document to the court as evidence you agreed to a judgment if you defaulted.

With a judgment in hand, the MCA company can then seek to freeze your bank accounts or put a hold on incoming receivables with your payment processor. This cuts off access to operating capital, which can cripple a small business.

Freezing bank accounts is done through a court ordered levy. The lender can seize funds from your accounts to satisfy the judgment. This leaves you without working capital to pay employees, vendors, rent, and other expenses.

If the MCA company doesn't freeze your bank account, they may contact your payment processor directly to hold your receivables. This will prevent you from accessing credit card and debit card sales, again disrupting your cash flow.

In summary, defaulting triggers legal action, judgments against your business, and loss of operating capital through frozen bank accounts or held receivables. Acting quickly is essential to mitigate the damage.

Do You Have to Go to Court If You Default?

Many merchant cash advances contain a confession of judgment clause (also known as a cognovit or consent judgment) in the contract. This gives the MCA lender the power to obtain a judgment against you without having to bring a lawsuit and argue the case in court.

With a confession of judgment, the lender can literally walk into court the day after you miss a payment and obtain a judgment against your business. There is no trial, no chance for you to present evidence or defend yourself. The judgment is automatically entered based on your prior signed confession.  

This immediate judgment allows the lender to start seizing your assets right away. They can freeze bank accounts, garnish wages, and place liens on your property. All without giving you any advance notice or opportunity to get caught up on payments.

While rules vary by state, lenders can often get these confessed judgments submitted and approved in as little as 1 day after a missed payment. Some funders even prepare the paperwork ahead of time so judgments are ready to file instantly.

So if you default on an MCA with a confession of judgment, expect the lender to obtain a judgment against you almost immediately. You likely won't get the chance to present your case in court first or try to work out alternative repayment options. The lender will be empowered to force collection actions against you and your business assets.

How Will Defaulting Affect My Credit Score? 

Defaulting on a merchant cash advance can significantly damage your credit score in several ways. 

First, any judgments against you will appear on your credit report and can remain for up to 7 years. Judgments indicate you failed to pay back a legal financial obligation and are considered very negative by credit scoring models.  

Secondly, missed or late payments will be reported by the merchant cash advance company. While normal late payments impact your score, defaulting altogether is an extremely derogatory mark that lenders frown upon. Too many missed payments in a short period devastates your score.

In addition to judgments and missed payments, high balances owed compared to your available credit limits negatively impact your score. The balance of the merchant cash advance can be substantial for small businesses and will lower your score if it exceeds 30% of your available business credit.  

Finally, the damage caused by defaulting on an MCA can take years to fully recover from. Your score will improve gradually over time as judgments and late payments fade into the past. But the presence of a default will make any new financing difficult to obtain until your credit profile rebuilds. Be prepared for a very difficult road to financial recovery after an MCA default.

What Assets Can a Lender Seize If I Default?

When you default on a merchant cash advance, the lender gains significant power to seize both your business and personal assets to satisfy the debt. This can put both your company and your own finances at great risk if you cannot come to an agreement or settlement with the lender.

Business Assets at Risk

If your business defaults, the lender can seize valuable business assets like:

  • Inventory - Any merchandise, goods, or products your business has in stock that can be sold. 
  • Equipment - Physical machinery, tools, furniture that is owned by your business. This can include vehicles.
  • Real estate - Any commercial property like an office, warehouse, or retail space that is owned by the business.

These types of assets allow your business to operate and generate revenue. By seizing them, the lender can sell them to recover their losses from the default. This can cripple or even shut down your business entirely.

Personal Assets May Also Be at Risk

While lenders must go through the legal system to seize personal assets, these items may also be at risk depending on state laws:

  • Bank accounts not protected by exemptions can potentially be frozen and levied.
  • Wages can be garnished in most states, deducting a portion from each paycheck.
  • Personal real estate, cars, and valuables are not protected in every state. Some states allow seizing a primary home.
  • Retirement accounts, pensions and disability income is usually exempt.
  • Jewelry, art, and collectibles can potentially be seized and sold.

Any personal assets not protected by your state's homestead or bankruptcy exemptions could potentially be at risk if you default on a business cash advance.

Should I Just File for Bankruptcy?

Filing for bankruptcy may seem like an easy way to halt collections and wipe your slate clean after defaulting on a merchant cash advance. However, there are serious downsides to consider before taking this step.

Business vs Personal Bankruptcy 

You have two main options if you decide to file bankruptcy:

Business bankruptcy - This involves filing Chapter 7 or Chapter 11 bankruptcy specifically for your company. It discharges business debts but does not protect your personal assets.

Personal bankruptcy - Filing Chapter 7 or Chapter 13 bankruptcy personally also discharges your business debts. However, it impacts your personal credit and assets as well.

The Automatic Stay 

The main benefit of filing bankruptcy is triggering an "automatic stay." This immediately stops any collection activity against you, including lawsuits and judgments related to the MCA default.

However, the stay only lasts until the bankruptcy case is closed. And lenders can petition to lift the stay in some cases. So it may only delay the inevitable collections rather than stop them.

Hurts Future Financing 

Declaring bankruptcy makes it very difficult to access business financing in the future. Most lenders will see you as too high risk to lend to again. Filing bankruptcy stays on your credit report for 7-10 years.

Even if you manage to get approved for financing, interest rates will likely be much higher after bankruptcy. This makes growth and recovery extremely difficult.

Long Term Credit Damage

Personal bankruptcy in particular does severe damage to your personal credit score and history. This affects your ability to access financing, rental housing, insurance rates, and more down the road. 

It's important to weigh the temporary halt on collections against the long term credit damage before opting to file bankruptcy after an MCA default.

How Can I Settle My MCA Debt After Default?

Defaulting on your merchant cash advance doesn't need to be the end of the road. There are still options available to work with the lender and settle your outstanding debt. Here are some tips to settle an MCA after default:

Work with a debt relief attorney or expert

Hiring an attorney or debt relief company that specializes in merchant cash advances can increase your chances of negotiating a favorable settlement. They understand the legal process and common settlement terms offered by MCA lenders. This expertise improves your leverage when trying to settle.

Negotiate a payment plan or settlement amount

One of the most common ways to settle an MCA debt is by agreeing to a payment plan, often paid out over several months. This allows you to pay back the balance over time while avoiding further legal action. Another option is negotiating a lump sum settlement for less than the full balance. Debt relief experts can help get a reasonable settlement offer in writing. 

Get any settlement offer in writing first

Before you agree to or make any settlement payments, make sure all terms are provided to you in writing by the lender. This includes the settlement amount, payment structure, timeline, and agreement that legal action will stop once payments are made. Don't send any money until the written agreement is signed.

Settling helps your credit vs continuing in default

Making consistent settlement payments shows good faith effort to repay and can begin improving your credit right away. Defaulting for many more months or years keeps the negative marks active and causes maximum damage to your score. Settling removes the default sooner and allows credit to rebound.

While defaulting on an MCA can seem devastating, take heart in knowing there are always options to resolve the debt. Seeking professional guidance can remove the stress and get you on the path to rebuilding your business.

Can I Get the MCA Judgment Removed? 

When you default on a merchant cash advance, the lender will likely obtain a judgment against you and your business. These judgments stay on public record for years and severely damage your credit and financing options.

However, in some states there are legal processes to have the judgment vacated or stricken from court records. The details vary by state law, but generally you can file a motion to vacate or strike the judgment if:

  1. The lender obtained the judgment improperly or without correct legal procedures
  2. You have grounds to appeal the judgment for reasons like lack of notice
  3. You reach a settlement agreement with the lender  

The process to vacate a judgment is complex, so it's important to have an attorney represent you. They can review the case details to see if you have valid grounds for the motion. If successful, it will remove the civil judgment so it no longer damages your credit profile and ability to get financing.

Some key steps if you want to attempt vacating an MCA default judgment:

  • Review the judgment - Get a copy of the court order and understand how it was rendered. Look for any procedural errors.
  • Consult an attorney - Have an experienced commercial litigation lawyer review the judgment and advise if you have grounds to vacate. 
  • File the motion - Your attorney can prepare the legal motion and represent you at the hearing before a judge.
  • Notify the lender - The lender must be informed of your motion to vacate the judgment against you.
  • Attend the hearing - The judge will hear arguments from both sides before deciding to grant or deny the motion.
  • Remove from credit report - If successful, take steps to get the judgment removed from business and personal credit reports.

Vacating a judgment takes time, legal fees, and the right circumstances, but it can help restart your business after an MCA default. Removing the judgment improves access to credit and financing options for the future. Discuss your situation with an attorney to understand if this process may help your business recover from the default.

How Do I Prevent Defaulting in the Future?

Defaulting on a merchant cash advance can be devastating for a small business. Here are some tips to help avoid finding yourself in that situation:

Take only what you can afford to repay

The #1 rule when taking a merchant cash advance is to be conservative and only accept an amount you are confident you can pay back. Consider your average monthly card receipts and cash flow, and take no more than 80% of this amount. This builds in a buffer so you aren't stretched thin.

Monitor cash flow and receivables closely 

Once you have the MCA, monitor your finances like a hawk. Watch for any drops in revenue that could impact your ability to make the fixed daily payments. If you see receivables trending down, take action immediately to cut costs or boost sales.

Contact lender at first sign of trouble

At the very first sign you may have trouble making payments, reach out proactively to your MCA lender. Explain the situation and see if they will work with you. Lenders want to get paid back, and may agree to adjust payment terms if you ask for help early.

Explore restructuring options

If your business is more fundamentally impacted, work with an accountant or debt specialist to explore restructuring the MCA obligation. This could mean asking the lender to lower the payment amount and extend the term. Or you may need to pay down part of the balance and refinance the remainder. Act before you miss a payment.

By being proactive, monitoring your finances diligently, and asking for help early, you can avoid the damaging consequences of defaulting on your business's merchant cash advance.

What If I Can No Longer Afford Payments?

If your financial situation changes and you can no longer afford your monthly MCA payments, it's absolutely critical that you communicate this to your lender right away. The worst thing you can do is simply stop making payments without any notice or explanation. 

As soon as you realize you may miss an upcoming payment, reach out to your lender and have a transparent conversation about your situation. Provide documentation to show why you are unable to make the agreed upon payments. This could include sales reports, bank statements, profit and loss statements, or anything else demonstrating your financial hardship.

Request an amended payment plan that better aligns with what you can realistically afford given your current cash flow. Your lender may be open to reducing the payment amount or temporarily pausing payments to help you get through this rough patch. Be reasonable in what you ask for and show a continued willingness to repay the advance. 

While your lender may work with you, also be prepared for them to begin more aggressive collection efforts. Once you've communicated that you cannot afford payments, they may freeze your bank account, initiate collection calls, or even file a creditor lawsuit faster than they otherwise would have. 

Having an open line of communication, providing evidence of hardship, and requesting revised repayment terms in good faith gives you the best shot at avoiding default. But be ready to protect both your business and personal assets if the lender refuses to make concessions.

Recovering My Business After an MCA Default  

The most important steps to recovering your business after defaulting on a merchant cash advance are:

  • Work with an attorney and accountant - You'll need professional help to deal with the legal and financial implications. An attorney can negotiate settlements or defend you in court. An accountant can analyze your finances and develop a recovery plan. Leaning on these experts is crucial.
  • Restructure debts and improve cash flow - With your accountant's help, rework your debts so they are more manageable. Prioritize paying bills that keep your business operating. Improve cash flow by collecting receivables faster, cutting expenses, or increasing revenue. Freeing up cash allows you to pay critical bills and your legal obligations.
  • Rebuild business and personal credit - Defaults devastate your credit, making it harder to get loans or credit cards. An attorney can get judgments removed. Work on repairing your credit by paying all bills on time, lowering balances, avoiding new applications. It takes time, but you can rebuild credit.
  • Create a plan to avoid future funding issues - Analyze what went wrong so you don't end up in this position again. Look for more affordable funding options, or ways to improve cash flow organically. Have an accountant review any future financing to ensure you can realistically repay it on the terms.

Recovering after an MCA default takes time but following these steps will get your business back on track. Don't wait to ask for help - contacting professionals immediately gives you the best chance of avoiding further damage and turning things around. With persistence and a solid plan, you can rebuild even after an MCA default.

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