Feds target predatory lenders to small business, but Pennsylvania remains a haven for the industry
The SEC, the FTC. Attorneys General in New York and New Jersey. They're all cracking down on merchant cash advance firms. But not so much in Pennsylvania,
Last summer, Philadelphia lawyer Shane Heskin told Congress that Pennsylvania has robust laws to prevent consumers from being gouged on loans — but none protecting business owners.
“Consumers have laws protecting them from usurious interest rates," he said. “But for small businesses, those protection laws don’t apply at all.”
Heskin defends business owners in court who get quick money from what he argues are deeply predatory “merchant cash advance” lenders. Although he and other industry critics have yet to gain traction among legislators in Harrisburg, warnings hit home when federal regulators brought a sweeping lawsuit against Par Funding, a Philadelphia lender of more than $600 million to small businesses nationwide.
The lawsuit described Par Funding as an “opportunistic” lender that charged merchants punishingly high interest — 50%, on average, but often astronomically more — to borrow cash. When debtors fell behind, the U.S. Securities and Exchange Commission alleged earlier this year, Par sued them by the hundreds, all the while hiding the massive number of loan defaults from investors who had put up the money that Par lent.
Par and others in the MCA industry, as it is known, thrived on two legal strategies.
One is a matter of semantics: The firms insist they aren’t making loans, but rather advancing money from profits on future sales. This frees MCAs from usury laws placing a ceiling on interest.
While Pennsylvania has no cap on business loans, other states do, including New Jersey, New York, Texas and California.
The other legal weapon, even more powerful, is what’s called a “confession of judgment.” Lenders such as Par include a clause in loan paperwork that requires borrowers, in effect, to “confess” up front that they won’t fight collection steps to garnishee their income.
Heskin detailed the abuses during a U.S. House hearing last year, titled “Crushed by Confessions of Judgment: The Small Business Story." In an interview, he summed up, “I’ve seen interest rates as high as 2,000% on short-term loans, paid off with other loans.”
Once a borrower misses payments, "they start taking money out of your account” based on those confessions of judgment. Heskin said Par and other MCAs take wages, siphon money from bank accounts, and even threaten to foreclose on borrowers' homes.
New York and New Jersey banned confessions of judgment in the last two years, joining a handful of other states, but no Pennsylvania legislator has proposed a ban.
Attorneys general in New York and New Jersey, the SEC, and the Federal Trade Commission have begun to crack down on cash-advance abuses, yet Pennsylvania Attorney General Josh Shapiro has yet to speak out on the issue.
In August, the FTC sued Yellowstone Capital, a New Jersey firm that was a pioneer in this controversial financing niche, accusing it of hitting up borrowers with hidden fees and overcharging them in collections. In June, the FTC and New York’s attorney general, Letitia James, together sued two other lenders, leveling similar accusations.
In the New York state suit, James alleged that one firm’s principal told a borrower: “I know where you live. I know where your mother lives. I will take your daughters from you. ... You have no idea what I’m going to do.’”
Par Funding, in particular, has been dogged by allegations that it is a modern take on loansharking.
In a lawsuit against it, a Miami borrower alleges that a debt collector repeatedly threatened and cursed employees and at one point threatened to break the legs of the firm’s owner. The federal suit says another collector, Renata “Gino” Gioe, showed up in the office in 2018 to say: “I need to resolve this problem now that I am here in Miami. This man needs to pay or I will use the old-style New York Italian way.”
(The suit was dismissed last month on technical grounds, unrelated to the allegations involving Gioe).
Last month, the FBI arrested Gioe, a felon and bodybuilder, and charged him with threatening a New Jersey debtor. In 2018, a Bloomberg Businessweek investigative series on merchant cash advances had identified Gioe as a collector for Par who merchants said had made threats.
Par Funding’s co-founder, Joseph LaForte, denied allegations of threats. He is a twice-convicted felon awaiting trial on charges of illegal possession of guns.
After the federal and state lawsuits were filed in New York, FTC commissioner Rohit Chopra issued a pointed statement, saying the agency had to make sure lenders were “serving small businesses, not exploiting them.”
Although some firms tout flexible payback terms, Chopra said this "may be a sham, since many of these products require fixed daily payments, and lenders can file ‘confessions of judgment’ upon any slowdown in payments, with no notice or due process for borrowers.”
Plugging a hole
Merchant cash advance firms became popular about two decades ago. Supporters say such retail and e-commerce giants as Amazon, Paypal and Shopify were among the first to become billion-dollar lenders of cash to small businesses, tying the loans to future sales.
Grant Phillips, a Long Beach, N.Y., lawyer who also defends debtors against the cash advance lenders, said the 2008 fiscal crisis generated big growth in merchant cash advance firms as conventional banks retrenched.
“This can be a viable alternative to conventional funding," Phillips said. "It’s very much an American invention, and it’s legal.”
“Small businesses couldn’t get loans after the Great Financial Crisis, and merchant cash advance lenders plugged that hole," Phillips said. “I can charge daily interest in excess of usury law, because technically I’m purchasing future sales. It’s not a loan.”
At the same time, Phillips said: “There’s no regulation, no interest cap. It opens the door to greed.”
Sean Murray, editor of deBanked.com, a trade publication that covers the merchant cash advance firms, said Amazon, PayPal and Shopify, as well as newcomers Kabbage and QuickBooks Capital, have operated with little controversy. By Murray’s estimate, the industry lent $8 billion to small businesses five years ago. By last year, he said, the amount had more than tripled.
“There are good people in this industry,” Murray said. “And there are many small businesses that can’t get a loan from a bank.”
'Powerful and drastic’
More than a half-century ago, the Pennsylvania Supreme Court, in Cutler Corp. v. Latshaw, called the confession-of-judgment clause a necessary evil.
It is, the court wrote in 1954, ″perhaps the most powerful and drastic document known to civil law” and “equivalent to a warrior of old entering a combat by discarding his shield and breaking his sword.” But the clause was legal, the court said, as long as borrowers' “helplessness and impoverishment was voluntarily accepted and consciously assumed.”
Nonetheless, the FTC banned confessions of judgment against consumers nationally in 1985. A growing number of states forbid them for either consumers or businesses. New York and New Jersey recently joined about seven other states in imposing total bans to protect businesses, too.
New York did so last August after Bloomberg Businessweek, in its 2018 investigative project, reported that the state had become a national magnet for merchant cash lawsuits against borrowers, and the filing ground for 25,000 suits. What lured lenders was a legal system overwhelmingly tilted in their favor: New York let them immediately tap into defendants' bank accounts and seize assets even before the borrowers had learned they had been sued.
New York in August 2019 banned confession of judgment suits against out-of-state defendants.
Par Funding, for one, suddenly began bringing hundreds more lawsuits in Philadelphia Common Pleas Court. Records show the firm filed 777 lawsuit there in 2019, nearly six times the number of the previous year.
“These clauses confer immense power and substantially limit due process,” said lawyer Benjamin Picker, with the McCausland Keen firm in Chester County, who also testified before Congress regarding merchant cash loans.
Once lenders are armed with a confession of judgment, he said, they can “skip the entire litigation process and proceed directly to obtaining a judgment against the other party without any opportunity to be heard by the court.”
As yet, lawsuits against Par Funding and other merchant cash advance lenders have not stirred any action in Harrisburg.
State Sen. Thomas Killion (R., Delaware), is the only GOP legislator from the Philadelphia region serving on the banking committee in the Republican-controlled upper chamber.
“We’ve been looking at payday lending abuses, but not lending on the commercial side,” Killion said in an interview. “I’ve been following the story and it’s something we need to look at.”
In Washington, the legislative fervor is somewhat stronger. An unlikely pair — Republican Sen. Marco Rubio of Florida and Democrat Sen. Sherrod Brown of Ohio — last year jointly introduced a bill to extend to businesses the FTC ban on consumer confessions of judgment. Their proposal has not made it out of committee.
In the U.S. House, U.S. Rep Nydia Velázquez, a Democrat from Brooklyn, has pushed a similar bill. Her measure was voted out of committee along partisan lines and awaits a vote by the full chamber. Republican opponents in the House said a ban on confessions of judgment would choke off a key source of loans and could “ultimately drive up the cost of credit for the smallest businesses.”
Locally, U.S. Rep Madeleine Dean, a Democrat who represents Montgomery County, is pursuing predatory lending issues in the Capitol, notably the Fair Debt Collection Practices for Servicemembers Act. It would prohibit debt collectors from making certain threats against military personnel, such as an assertion that they would lose rank if they didn’t pay up.
“We have a gap in our federal laws.” Dean said. “And we should follow New York’s lead on getting rid of confessions of judgment.”