Business Lending
Stacking: Is it Tortious Interference?
April 16, 2015
STACKING – the practice of entering into a cash advance transaction or loan knowing that the merchant already has one or more open cash advances or loans with a competitor – is causing a rift among merchant cash advance companies and small business lenders.
On one side are companies that only originate first-position deals. These companies generally include a clause in their contracts prohibiting the merchant from obtaining another merchant cash advance or loan until the company receives all of the future receivables it has purchased or is fully repaid. First-position companies view stacking as a threat to recovery of money advanced or loaned to merchants. On the other side are companies that routinely offer second or third-position deals. These companies argue that merchants with adequate cash flow to support additional advances should be free to obtain them.
In the last several months, at least two first-position companies have sued their stacking competitors, claiming that stacking constitutes tortious interference with contractual relations. These cases may ultimately result in a decision as to whether a stacker is liable for damages to a prior-position company when a merchant defaults. Although it varies by state, a claim of tortious interference with contractual relations claim generally includes all of the following elements:
1. The existence of its valid contract with
a third party;
2. The defendant’s knowledge of that contract;
3. The defendant’s intentional and improper procuring of a breach; and
4. Damages.
See White Plains Coat & Apron Co. v. Cintas Corp., 8 N.Y.3d 422, 425 (2007).
So when is advancing money to a willing merchant “improper” under the law?
No reported court decisions have tackled stacking, let alone discuss whether interfering with a prior merchant cash advance or loan contract is improper. In fact, few cases discuss this issue at all. According to Section 767 of the Restatement Second of Torts, the tort of tortious interference does not have hard-set rules. The issue in each case is whether the interference is improper under the circumstances and whether, upon a consideration of the relative significance of the factors involved, the court should permit the conduct without liability, despite its effect of harm to another. In other words, it is a fact-intensive analysis.
The New York Court of Appeals put it this way: “At bottom, as a matter of policy, courts are called upon to strike a balance between two valued interests: protection of enforceable contracts, which lends stability and predictability to parties’ dealings, and promotion of free and robust competition in the marketplace.” White Plains Coat & Apron Co. v. Cintas Corp., 8 N.Y.3d 422, 425, 867 N.E.2d 381, 383 (2007).
Because there are no reported court cases addressing stacking, we can only look to cases between other types of businesses to see what courts have said about “improper” interference. Maryland’s highest appellate court has held that inducing a breach of contract, even for competitive purposes, is improper. Macklin v. Robert Logan Associates, 334 Md. 287, 303 (1994). In contrast, New York courts have concluded that improper interference is conduct that goes beyond a minimum level of ethical behavior in the marketplace.
In the White Plains Coat & Apron case, a New York-based linen rental business sued a competitor in federal court for tortious interference with existing customer contracts. White Plains claimed that it had five-year exclusive service contracts with customers and that, knowing of these arrangements, Cintas induced dozens of White Plains’ customers to breach their contracts and enter into rental agreements with Cintas. White Plains alleged that Cintas trained its sales reps to convince its customers to abandon their contracts with White Plains even after the customers told Cintas that they had contracts with White Plains.
White Plains sent Cintas a letter demanding that Cintas stop soliciting and servicing White Plains’ contract customers, enclosing a list of customers allegedly solicited improperly. When Cintas refused to stop pursuing its customers, White Plains sued.
The court granted summary judgment for Cintas and dismissed the complaint. The court held that because Cintas and White Plains were business competitors, Cintas’ legitimate interest to make a profit was a defense to White Plains’ lawsuit. According to the trial court “the only answer … is to go out and do it also to the other guy.”
White Plains appealed to the Second Circuit Court of Appeals. Because there was an important open state law question regarding whether economic self-interest was a defense to a tortious interference claim, the Second Circuit certified the following question to the New York Court of Appeals, New York’s highest appellate court: “Does a generalized economic interest in soliciting business for profit constitute a defense to a claim of tortious interference with an existing contract for an alleged tortfeasor with no previous economic relationship with the breaching party?”
The New York Court of Appeals said no, holding that economic self-interest is not a defense. However, the court explained that business competition in and of itself is not a tort, stating that:
“[W]e note that protecting existing contractual relationships does not negate a competitor’s right to solicit business, where liability is limited to improper inducement of a third party to breach its contract. Sending regular advertising and soliciting business in the normal course does not constitute inducement of breach of contract. A competitor’s ultimate liability will depend on a showing that the inducement exceeded ‘a minimum level of ethical behavior in the marketplace.’”
In a Florida case, Azar v. Lehigh Corporation, 364 So.2d 860 (Fla. Dist. Ct. App. 1978), a Florida appellate court upheld a restraining order against a former salesman of a developer after he allegedly tortiously interfered with the developer’s contracts. Lehigh Corporation developed and sold real property in a large development project in Lee County, Florida. Part of Lehigh’s promotional campaign brought prospective purchasers to see the development and stay at the only local motel at Lehigh’s expense. Lehigh’s former salesman, Leroy Azar, would follow prospective customers to the motel and persuade them to rescind their contracts for the purchase of property and to purchase property from him at a lower price. Azar spotted customers by following people down the street and observing whether they were carrying big envelopes full of Lehigh sales literature. He then would then seek out the customers in their motel rooms and offer to handle the rescission of his contract if the customer would move out of the motel and buy a lot from him. Azar also equipped his car with a large sign advertising the sale of his lots and followed Lehigh’s tour bus full of prospective customers.
The trial court granted the restraining order against Azar. Azar appealed, arguing that customers had a legal right under federal law to rescind their contracts within three days and that he was merely providing them with an opportunity to be relieved of their contract and to obtain comparable property for lower prices.
In upholding the trial court’s restraining order against Azar, the appellate court explained that there is a narrow line between what constitutes vigorous competition in a free enterprise society and malicious interference with a favorable business relationship. The court also quoted the following passage from a well-known treatise:
Though trade warfare may be waged to the bitter end, there are certain rules of combat which must be observed. . . . W. Prosser, Law of Torts (4th ed. 1971) at 956.
The appellate court explained that the issue is whether the subject conduct is considered to be “unfair” according to contemporary business standards.
How courts will treat stacking among competing merchant cash advance companies and lenders remains to be seen. The analysis of what is “improper” interference versus vigorous, but acceptable, competition will be based on the specific facts of each case. In the meantime, merchant cash advance companies and lenders that engage in stacking should consider applicable state law, including case law, and whether their conduct could be considered improper under the circumstances.
Robert Cook, Cathy Brennan and Kate Fisher are partners in the Maryland office of Hudson Cook, LLP. Robert can be reached at 410-865-5401 or by email at rcook@hudco.com. Cathy can be reached at 410-865-5405 or by email at cbrennan@hudco.com. Kate can be reached at 410-782-2356 or by email at kfisher@hudco.com.
Year of the Broker
April 4, 2015
Many of the newcomers are fleeing hard times in the mortgage or payday loan businesses. Others are abandoning jobs selling insurance, car warranties or search-engine optimization.
“You have wandering souls trying to find their place in this industry, whether it be as a company or on their own,” said Amanda Kingsley, CEO of Sendto, a Florida-based company that assists new brokers.
Though exact counts appear difficult to obtain, Kingsley professed amazement at the volume of new entrants. “I’m swamped,” she said. “It’s crazy.”
Some of the new brokers discovered alternative financing in December, when OnDeck Capital’s initial public stock offering raised $200 million and valued the company at $1.3 billion. The Lending Club IPO that raised $1 billion the same month also raised public awareness of alternative loans.
Mesmerized with those whopping figures, salespeople from other businesses began committing themselves to a new career in alternative finance. In a business with virtually no barriers to entry, it’s easy to get started. To call themselves brokers, they just need a phone, someplace to sit and a list of leads they can buy online.
Virtually all of the entrants are pursuing dreams of lucrative paydays. Many even expect to make a fast buck with minimum effort.
If only it were that simple. Too often, the untutored new players are making mistakes simply because they don’t know any better, industry veterans maintained.
“A lot of people think you can just walk in and be successful,” said the sales manager of an established New York-based brokerage who asked for anonymity. “They don’t know what it takes to run a company. They don’t know what it takes to get a deal done.”
Worst of all – either unknowingly or with evil intent – new brokers are stacking deals. In other words, inexperienced salespeople pile second or third loans or advances on top of original positions. It’s an approach that clearly violates the industry’s standards, observers agreed.
In fact, virtually all contracts for a first loan or advance prohibit the merchant from taking on another similar obligation, noted Paul Rianda, an Irvine, Calif.-based attorney who specializes in payments and financing.
“I can’t remember one agreement I’ve seen that didn’t have that provision in it,” Rianda said.
Violating that stipulation could provide grounds for a lawsuit, and litigation is underway, according to David Goldin, president and CEO of New York-based AmeriMerchant and president of the North American Merchant Advance Association (NAMAA).
Bigger funders would sue smaller funders because the latter appear more likely to take on riskier, more problematic multiple-position deals, said Jared Weitz, CEO at United Capital Source LLC, a New York-based broker.
Plaintiffs have a case to make because stacking harms the broker and funder of the first position by increasing the risk that the merchant won’t meet the resulting financial obligations, Weitz said. “The guys going out 18 and 24 months to make this a more bankable product are being hurt by the people coming in and stacking those three-month high-rate loans,” he noted.
Deducting fees for more than one advance also impedes cash flow, adding another risk factor, Weitz said.
To further complicate matters, the company offering the second or even third deal sometimes moves the merchant’s transaction services to another processor, Rianda said. That forces the firms that made the first advance to approach the new processor to stake a claim to card receipts, he noted.
So the companies with the original deal suffer from the effects of stacking, but the practice’s shortcomings will haunt the stackers, too, observers maintained.
“It’s not a model that’s going to allow them to succeed,” a broker who asked to remain anonymous said of stackers’ long-term prospects.
Many hardly give a thought to staying power, according to Weitz. “A lot of people entering this space think it’s about fast money and not longevity,” he said.
Longevity requires that brokers build relationships with merchants, a process stacking undermines because too much credit can drive merchants out of business or merely prop up merchants already doomed to fail, sources said.
Yet stacking has become so widespread that it constitutes a business plan for some brokerage shops, said a broker who asked that his name and company not appear in the article.
It can begin when brokers buy lists of Uniform Commercial Code filings to find out what merchants have already taken out term loans or advances, said Zach Ramirez, vice president of sales and operations at Orange, Calif.- based Core Financial Inc.
The brokers then contact those merchants, many of whom are already over-extended financially, to offer additional credit or advances, Ramirez said.
Inexperienced brokers often resort to stacking because they don’t know how to generate leads that can bring alternative lending vehicles to merchants who weren’t aware of them.
Referrals from accountants or other business owners who deal with merchants can provide some of those greenfield prospects, Ramirez noted.
And leads aren’t the only area of cluelessness among newcomers, a broker who requested anonymity maintained.
“They don’t know why a bank declines a deal or approves a deal,” he said. “They don’t know what’s the basis for a good deal.”
To teach new brokers those basics of alternative business financing, the industry should establish standard policies and technology, according to Kingsley.
A credential, perhaps something similar to the Certified Payments Professional designation created by the Electronic Transactions Association, sources said. To earn the credential, candidates would pass an exam to show they’ve mastered the basics of the business, they proposed.
NAMAA is considering such a credential, said Goldin, the trade group’s president. It’s the kind of self-regulation that could forestall federal oversight, industry sources agreed.
But that might not matter, according to Tom McGovern, a vice president at Cypress Associates LLC, a New York-based advisory firm that raises capital for alternative lenders and merchant cash advance companies.
After all, McGovern noted, Barney Frank, former Democratic U.S. representative from Massachusetts and co-author of the Dodd-Frank Wall Street Reform and Consumer Protection Act, has gone on record as saying that piece of legislation focuses on consumers and does not govern business-to-business dealings like loans or advances to merchants.
That lack of regulation over B2B deals seems likely to continue, “especially in the world we’re in now with a Republican Congress,” said a broker who asked to remain nameless.
However, some members of the industry would welcome federal regulation as a way of barring incompetent or unscrupulous brokers. An agency patterned after the Financial Industry Regulatory Authority, know as FINRA, could do the job, suggested a broker who requested anonymity.
Whether a government regulator or an industry- supported association should police the market, problems could remain stubbornly in place, some said.
Many doubt an association could build the consensus required for united action on some issues – stacking in particular.
For one thing, cleaning up the business could reduce profits for brokerages that profit from stacking, noted a broker who asked that his name not appear in the article.
“Everybody wants to make money,” he said. “Everybody’s out for themselves.”
Another barrier to agreement arises because some brokerages fear cooperation could expose their trade secrets, said Sendto’s Kingsley.
Moreover, unscrupulous brokers want to keep their employees uninformed of the industry’s potential for big profits, Kingsley said. That way they suppress compensation for an underclass of prequalifiers who work the early stages of deals, she noted.
Prequalifiers earn from $150 to $500 a week, depending upon the location, and don’t qualify for benefits like health insurance, Kingsley said. Once they realize what a tiny portion of the profits they’re receiving, brokers terminate the prequalifiers and many go on to become brokers themselves, she observed.
Closers who take over from prequalifiers to wrap up the sale can earn up to 50% or occasionally even 60% of a brokerage house’s commission – if the closer originates the deal and sees it through to completion unassisted, Kingsley said.
Eventually, closers realize they could keep all of the commission if they strike out on their own and become brokers, she noted.
In a way, the progression from prequalifier to broker or closer represents a market correction. And many seasoned industry participants believe market forces will also work out other problems the influx of new brokers is causing.
A large number of the new brokers simply won’t last long because they don’t understand the industry, they’re stacking deals and they’re signing up merchants that won’t stay in business.
Meanwhile, funders are beginning to perform background checks on brokers to make sure they’re dealing with reputable people, sources said.
Some funders protect themselves by simply declining to do business with new brokers, according to observers.
And many new brokers are learning the industry with the help of experienced brokerages that act as mentors and conduits and call themselves super brokers, super ISOs, broker consultants or syndicators.
“So what I’m saying is, ‘Guys, let’s not compete. Let’s grow parallel together,’ ” Weitz said of United Capital Source’s relationships with new brokers. The company began working with new brokers in October 2014.
In such relationships new brokers get advice from the more seasoned brokers. The older brokers can also provide the newcomers with services that include accounting, marketing and reporting, he said.
New brokers can also benefit from the customer relationship management platform that United Capital Source developed, Weitz said.
The new brokers also capitalize on the older brokers’ relationships with funders. Established brokers have earned better rates and terms because of reputation and volume, Weitz noted. Companies like his also know which lenders work more quickly and thus capture more deals, he added.
Older brokers can also steer new brokers away from newer funders that offer shorter terms and demand higher rates, Weitz said. Of the 30 to 40 companies that call themselves funders, only eight or 10 deserve the name, he contended.
The less-respectable funders place only a small amount of money in a few deals, he said.
Newer brokers become aware of their need for help from more experienced brokers when they see how many sales they’re failing to close, Weitz said.
The new brokers also come to realize that the puzzle of running a brokerage office has a lot more pieces than they may have thought, said Kingsley.
The percentage of the commission that the older broker charges can vary, according to Weitz.
“If someone needs a lot of hand holding and a lot more resources, they would get a different structure,” he said.
While Weitz said his company plans to acquire only about 10% of its volume through new brokers, Sendto specializes in helping newcomers. Sendto’s Kingsley described the company as “a turnkey solution that provides training and placement of deals. It’s for new brokers or sales offices that do not have what they need to be part of this industry.”
There’s room for entrants because not all merchants know about alternative business financing, said McGovern.
The market can even seem like it doesn’t have enough brokers in the estimation of experienced players skillful enough to find the many merchants who haven’t been introduced to the industry, said Ramirez of Core Financial.
And the big banks don’t really want the business because the deals aren’t big enough to interest them, McGovern said.
But the potential profits look promising to outsiders disillusioned with sales jobs in other industries.
Some experienced brokers even prefer to hire salespeople from outside the alternative financing industry, noted Kingsley. That way, they avoid employees who have picked up bad habits at other brokerage houses, she said.
Long-time members of the industry sometimes enjoy belittling new entrants who can seem clueless about the business they’re trying to master, noted Ramirez of Core Financial. But he recalled the time not so long ago that he himself had a lot to learn.
And regardless of how unsophisticated they may seem, new players have a role, McGovern said.
“They are performing a service,” he maintained. “They’re like the missionaries of the industry going out to untapped areas of the market – of which there are many – and drumming up business.”
To Kingsley, brokers in general – old and new – are beginning to earn the respect they deserve.
“A lot of people are afraid of the word ‘broker,’ ” she said. “I feel that 2015 is the year of the broker, and people should embrace what a broker can actually do. It’s a great thing.”
