Sean Murray is the President and Chief Editor of deBanked and the founder of the Broker Fair Conference. Connect with me on LinkedIn or follow me on twitter. You can view all future deBanked events here.
Articles by Sean Murray
The Unsung Disruption in Online Lending – Stacking, Litigation and Questionable Debt Negotiators
June 22, 2016
Give a small business two options, a low APR 3-year business loan and a short term loan with a high factor rate, and you’ll find advocates for each product arguing over which is better and why. We’ve been led to believe that it’s one versus the other, that one is good and one is bad, and that’s all there is to the story. Entire business models have been developed along the lines of this thinking, algorithms deployed and merchants funded, along with narratives framed in the mainstream media about why one system is superior to others.
But to hear the men and women in the phone rooms tell it, when given a choice between one funding option or the other, small businesses are often choosing both at the same time. Reuters said that stacking is the latest threat to online lenders, and in many ways they’re right. The practice isn’t new of course, the tendency for merchants to take on multiple layers of capital (often times in breach of other contracts) has been a central cause of tension between funding companies for the last few years. But the reason the story is bubbling over into traditional news media now as the latest threat, is because opponents of stacking assumed that the practice would be eradicated by now. There was this false sense of hope that government agents in black suits would show up one day unannounced after hearing that a merchant had taken a third advance or loan despite having not yet satisfied the obligations of the previous two. And when that didn’t happen, some of the models heralded as better for the merchant started to show cracks. What happens to the forecasts when the merchants priced ever so perfectly for a low rate long term loan go and take three or four short term loans almost immediately after? Back in October, Capify CEO David Goldin argued that long dated receivables were already dangerous to a lender regardless because the economy could turn south. “You’re done. You’re dead. You can’t save those boats. They are too far out to sea,” he told deBanked.
Sue everyone?
When it comes to disruption, nothing has changed the game as much as stacking, and companies must prepare for the likelihood that it could be around forever. That means forming a long-term business model that is equipped to deal with this practice. Several lawsuits have been waged in an attempt to generate case law to deter it, including one filed last year in Delaware by RapidAdvance against a rival. Patrick Siegfried, assistant general counsel of RapidAdvance told the Wall Street Journal last fall, “we’re doing it to establish the precedent,” he said. “This kind of thing is happening more and more.” At the time, a motion to dismiss the case entirely was pending. RapidAdvance since won that motion but only by a hair and with a judge that was very reluctant to move the case forward.
Last October, MyBusinessLoan.com, LLC, also known as Dealstruck, sued five companies at once, a mix of lenders and merchant cash advance companies after one of their borrowers defaulted, allegedly because of actions carried out by the co-defendants. They were greeted with several motions to dismiss for failure to state a claim.
Even if these funding companies don’t win, simply letting the world know that they’ll sue rivals for stacking can act as a deterrent. But it’s an expensive tactic, especially when some defendants are more than happy to litigate the claims. Litigation is definitely an underrated cost of doing business for online lenders and merchant cash advance companies. In one recent case, a merchant challenged the legitimacy of a contract with Platinum Rapid Funding Group, a company whom they sold a portion of their future receivables to. The merchant asked the judge to recharacterize the contract to a loan so that they could try to use a criminal usury defense. The judge refused in a well-written decision that called the merchant’s attempt to do that “unwarranted speculation.” But even with the precedent of a favorable ruling, countless merchants have attempted to come up with strategies to wriggle their way out of their agreements, sometimes with ample legal counsel at their side.
Debt negotiators and questionable characters
Stacking has become a cost of doing business, but something else is creeping in as well. An entire cottage industry of “debt negotiators” has set their sights on online lenders and merchant cash advance companies, and at times these self-professed business experts don’t even realize there’s a difference between the two. One MCA funder told debanked earlier this week that a merchant in default claimed to be represented by Second Wind Consultants, a debt restructuring firm that lists one Don Todrin as the CEO on their website. Not mentioned among Todrin’s accolades is that he is a disbarred attorney who pled guilty to federal bank fraud charges in 1994, according to an old report by the Boston Globe, after he filed at least nine false financial statements to acquire $1.4 million in loans.
Another purported debt negotiation firm, who has the irked the ire of merchant cash advance companies, is apparently trying to assert affiliation to a native American tribe and invoke tribal immunity in response to lawsuits against them, according to court filings in New York State.
And only three weeks ago, an attempted class action against a merchant cash advance company failed because each named class representative had waived its right to participate in a class action in exchange for business financing. The initial action, before being moved to federal court, was brought by a merchant represented by an attorney who had just been reinstated to practice law, following a long suspension for pleading guilty to identity theft.
On top of it all, there are merchants themselves that act in bad faith, with some preying on the perceived vulnerabilities of an online-only experience. In the November/December 2015 issue of deBanked Magazine, attorney Jamie Polon said some applicants don’t even own businesses at all, they just pretend to. “They’re not just fudging numbers – they’re fudging contact information,” he told deBanked. “It’s a pure bait and switch. There wasn’t even a company. It’s a scheme and it’s stealing money.”
Weeding out bad merchants is a job for the underwriting department but for the good merchants seemingly deserving of those 3-5 year loan programs, the future is not as easy to predict as it once was. They might stack regardless, no matter how favorable the terms are. And given that government agent ninjas aren’t likely to drop down from the sky to stop them any time soon, many funding companies are faced with hard choices. Are the initial forecasts still valid? Is it economically feasible to turn the client away for additional funds because they breached their original agreement, all while the cost to acquire that customer in the first place was really high? Do you sue your rivals, make them look bad in the press, or lobby for regulations that will hurt them? How do you handle the new breed of debt negotiators who use the same UCC lead lists as lenders and brokers?
Sure, things like marketing costs are going up and the capital markets are less inviting than they used to be. But once loans and deals are funded, making sure those agreements are lived up to can take time, resources, and undoubtedly a lot of lawyers. And realistically, these issues aren’t likely to change any time soon. Help, in whatever relief form some are hoping for, is not on the way. How’s that for disruption?
Business Finance Companies Visit Capitol Hill
June 17, 2016
Scores of companies providing working capital to small businesses descended on Capitol Hill in early May to educate policymakers about the benefits they provide to the economy. Among them was the Coalition for Responsible Business Finance (CRBF), the Electronic Transactions Association (ETA) and the Commercial Finance Coalition (CFC).
The inability of banks to satisfy the demands of small businesses is not new, nor is it a problem purely borne out of the recession, data indicates. That’s partially why the Small Business Administration (SBA) exists, according to a 2014 report co-authored by former SBA Administrator Karen Mills.
“If the market will give a small business a loan, there is no need for taxpayer support,” the report states. “However, there are small businesses for which the bank would like to make a loan but that business may not meet the bank’s standard credit criteria.” That occurs so often that the SBA actually had to temporarily suspend guarantees last year because they had reached their limit.
“The SBA has a portfolio of over $100 billion of loans that lenders would not make without credit support,” according to Mills’ report. If that number looks big, it’s because it’s comprised mainly of loans to the larger end of the small business spectrum. Smaller businesses or businesses with smaller needs anyway, continue to be underserved. The average 7(a) loan guaranteed by the SBA in fiscal year 2015 for example was $371,628. Compare that to the $20,000 – $35,000 average deal size reported by some members of the CFC.
“Small firms were hit harder than large firms during the crisis, with the smallest firms hit the hardest,” Mills’ report states, but it adds that small businesses have been responsible for adding two out of every three net new jobs since 2010.
Tom Sullivan, who leads the CRBF, emphasized to deBanked that job creation plays a crucial role in what their organization represents and stressed that it was very important to get the input of small business owners when policymakers consider new regulations.
The CFC meanwhile, estimates that aggregate funding between its members have preserved at least 1 million jobs. And OnDeck, who was on the Hill with the ETA, announced late last year that their first $3 billion in loans have generated an estimated $11 billion in US economic impact and actually created 74,000 jobs.
While the schedules and agendas of each group were different, the CFC reportedly met with nearly two-dozen House and Senate members or their staff in a single day.
Skintech? Fintech Lenders in China Accept Nude Photos As Collateral
June 14, 2016
Some online lenders in China are taking an invasive application process to a whole new level, according to People’s Daily, a Chinese state-owned newspaper. To increase the likelihood of repayment, applicants may be required to upload a nude photo of themselves while holding an ID card, along with contact information for their friends and family members. And if they don’t pay, they’ll threaten to distribute it to all of them accordingly.
People’s Daily wrote that the borrowers tend to be educated university students and they are willing participants to these harsh terms if it means they can get the loan they seek. After all, they actually have to take the photos and upload them to the lender in the first place. Insiders reportedly said that naked IOUs have been a practice for a long time.
A reporter for Sixth Tone, a hip media company overseen by the Chinese government, was able to find a student lender online during their journalistic investigation that indeed requested a nude photo and family contact information. The ability to actually repay the loan was not assessed by the lender.
Fu Jian, a lawyer at Yulong Law Firm based in Zhengzhou that was interviewed by Sixth Tone said that the use of a naked photo as collateral is not forbidden by law, even if it does raise ethical questions. Were the photo to be leaked, only then would the law have been broken. “The online lending industry is like a food chain with some huge financial groups on the top, followed by the platforms, then the middlemen,” Fu said to Sixth Tone. “Students, sadly, are just the prey.”
The highly predatory practice is obviously carried out by unscrupulous players and is not representative of the fintech industry in China.
Jason Reddish Talks Business Lending On Cleveland Radio
June 14, 2016Total Merchant Resources CEO Jason Reddish talked all things lending on AM 1490 in Cleveland, Ohio recently, including much about the alternative business financing industry. Have a listen below:
Reddish was also kind enough to give a shout out to deBanked at about 9 and a half minutes in.
Reddish and his business partner Val Pinkhasov made a splash in the industry after their appearance on ABC’s Shark Tank in 2013.
Industry Goes Par for the Course
June 13, 2016Two companies in the industry are sponsoring golfers in this year’s U.S. Open, Mike Van Sickle via Expansion Capital Group (ECG) and Billy Horschel via Lenders Marketing.
Back in February, ECG SVP Steve Beveridge said, “we are excited to announce our partnership with Mike as a member of the ECG team. His motivation, drive, and dedication represent the same core values that ECG admires in our business clients who are pursuing their own individual dreams.” (Below: Van Sickle in an Expansion Capital Group shirt)
Van Sickle is ranked 1,297th in the world.
Horschel by contrast is ranked 55th in the world. Lenders Marketing, a lead generation company, also sponsored Michael McCabe last year during the PGA Tour Barracuda Championship in Reno, Nevada. (Below: McCabe in the green hat and Justin Benton of Lenders Marketing behind him to the left with the glasses over a white hat)
Merchant Cash Advance Definitely NOT a Loan, New York Judge Rules
June 11, 2016
A New York Supreme Court Justice ruled that a purchase of future receivables is not a loan. And it’s not even close, according to a decision and order by The Honorable Jerome C. Murphy in Platinum Rapid Funding Group Ltd v. VIP Limousine Services, Inc. and Charles Cotton.
As a background, the corporate defendant agreed to sell their future receivables to plaintiff in return for an upfront payment, an arrangement commonly referred to as a merchant cash advance. Defendants breached and plaintiff filed a lawsuit accordingly. Defendants asserted twelve defenses including that plaintiff had committed civil and criminal usury. Plaintiff Platinum Rapid Funding Group then moved to dismiss their defenses.
In a 9-page decision, Justice Murphy dismissed nearly all of the defenses, including the one alleging usury, because as he put it, the agreement was not a loan, so there can be no usury. His ruling on that defense is quoted below:
Defendants’ contention that the Agreements violate General Obligation § Law 5-501[1] and Banking Law § 14-a[1], and are civilly and criminally usurious is without merit. A corporation is prohibited from asserting a defense of civil usury (Arbozova v. Skalet, 92 A.D.3d 816 [2d Dept. 2012]). An individual guarantor of a corporate obligation is also precluded from raising such a defense (Id.). Defendants have failed to adequately allege a defense of criminal usury in violation of Penal Law § 190.40, in that they failed to allege that the lender knowingly charged, took or received annual interest exceeding 25% on a loan or forbearance of money. In its bill of particulars, defendant hypothesizes that the terms of the Agreement could result in the payment of criminally excessive interest, but this is clearly insufficient under the pleading requirements.
Essentially, usury laws are applicable only to loans or forbearances, and if the transaction is not a loan, there can be no usury. As onerous as a repayment requirement may be, it is not usurious if it does not constitute a loan or forbearance. The Agreement was for the purchase of future receivables in return for an upfront payment. The repayment was based upon a percentage of daily receipts, and the period over which such payment would take place was indeterminate. Plaintiff took the risk that there could be no daily receipts, and defendants took the risk that, if receipts were substantially greater than anticipated, repayment of the obligation could occur over an abbreviated period, with the sum over and above the amount advanced being more than 25%. The request for the Court to convert the Agreement to a loan, with interest in excess of 25%, would require unwarranted speculation, and would contradict the explicit terms of the sale of future receivables in accordance with the Merchant Agreement.
The detailed explanation reaffirms the obvious distinctions that such a purchase has from a loan, even when such receivables purchased are future receivables. To the extent that defendants argued that a potential outcome of such an agreement could hypothetically be converted to a usurious interest rate, that is a risk that the defendants took, the Court said, and converting this sale agreement to a loan would require “unwarranted speculation.”
Christopher Murray of Giuliano McDonnell & Perrone, LLP is the attorney representing plaintiff Platinum Rapid Funding Group in this action. The case number is 604163/2015 in the New York Supreme Court.
‘We Cannot Have Opaque Black Boxes Running Our Economy,’ Says Director of US PIRG
June 9, 2016
During a marketplace lending event hosted by the FTC, one panelist said he was not impressed by the reliance that some consumer lenders have on proprietary algorithms and secret sauces to determine who gets approved for a loan. Ed Mierzwinski, Consumer Program Director for U.S. PIRG, a nonprofit consumer interest group, expressed that regulators should investigate these methodologies. “We cannot have opaque black boxes running our economy,” he said. “That may be something that excites the investors” but credit fairness has to come first, he added.
Meanwhile, Jessica Milano, a Deputy Assistant Secretary for the U.S. Treasury, explained that underwriting methodologies used by consumer marketplace lenders still produce results that are highly correlated with FICO. The Treasury published a much-talked-about report on marketplace lending just last month.
Peter Renton, who founded the LendAcademy blog and LendIt conference, countered Mierzwinski by explaining that alternative data sources are not so much about assessing credit-worthiness, but rather about verifying the identity of the applicant.
Milano and Renton both conceded that things were different on the business lending side of the industry.
This was an educational event, not an inquiry or hearing so nobody was officially being scrutinized. FTC Commissioner Edith Ramirez said in her introductory speech that “most observers agree that, given the advantages it offers both lenders and borrowers, marketplace lending is here to stay.”
You can watch a recap of the 3-hour event below. It starts at about 1 hour in to the recording.
Community Banks Worried That Marketplace Lenders Have Regulatory Advantage
June 8, 2016
Community banks have been slow to adopt services offered by marketplace lenders “out of fear of undue scrutiny by their prudential bank regulators,” wrote the Independent Community Bankers of America (ICBA) in a letter to the OCC last week. The banks would or could be more proactive in offering small loans in rapid fashion, if the regulators give “community banks the flexibility to lead the path,” they said.
One issue they raised was the consideration of a limited purpose federal bank charter, which, if implemented, would reduce the need for marketplace lenders to partner with chartered banks or eliminate the need for marketplace lenders to subject themselves to the maze of 50-state compliance. The ICBA, according to the letter, is all for this since it would subject marketplace lenders to federal oversight, but they fear it would not go far enough to truly level the playing field.
“For instance, if such a charter did not have authority to take deposits, the charter may be subject only to a compliance supervision and examination. ICBA believes that the recent problems that some of the online marketplace lenders have experienced with liquidity and earnings, as well as with compliance, makes it important that these lenders be subject to safety and soundness supervision and regulation.”
Their fear is that a limited charter would give marketplace lenders all the benefits but with less oversight than them, and that’s not fair. Not mentioned however is that marketplace lenders are for the most part regulated, albeit not in the exact same manner as banks. Another of the ICBA’s stated concerns is that marketplace lenders are exempt from safety and soundness oversight and thus their stability and liquidity is not being monitored.
“These companies have not experienced a serious economic downturn yet and already they have been subject to serious funding and capital issues,” they wrote.
While true, consumer deposits are not at risk since they don’t take them. And given the industry’s size at present, the potential danger to the economy should one or some fail, is relatively minor.
