– UCC Article 9 Business Reorganization –

There are countless reasons companies get into financial trouble, some predictable and others unexpected. Over the short term, most companies can draw on bank lines to temporarily fill the gap. If, however, underlying problems persist and cash flow continues to deteriorate, business owners can find themselves forced to pursue other lending sources, each more costly (and restrictive) than the last. 

Some companies eventually turn to Merchant Cash Advance (“MCA”) lenders. Unfortunately, MCA lenders are often referred to as “lenders of last resort”  . . .  and for good reason.

On the surface, MCA loans appear attractive. They are typically unsecured (although a personal guaranty is usually required) and can be approved in as little as 24-48 hours.  Repayments are taken as a percent of future sales, so if your sales go down, so does your repayment schedule. What could go wrong?

Below the surface, however, most MCA agreements contain traps, often obscured in arcane language:

  • Unregulated Business Practices. MCA lenders are unregulated, operating under the rules of the states Uniform Commercial Codes with no usury (or “stacking”) limitations.

  • No Disclosed Interest Rate. MCA lenders charge fees, not interest, and an effective interest rate is nowhere to be found. For traditional loans, interest rates are based on the amount borrowed and the amount and timing of scheduled repayments. MCA repayments, however, are set as a multiple of the amount borrowed, regardless of the timing of payments. As a result, the effective interest rates of MCAs typically range from the low 30’s to well over 200%. A recent client borrowed $1.0 million from an MCA lender in November 2019 and agreed to repay $1.7 million on or before March 2020. This equates to an effective interest rate of 88% after origination fees.

  • No Stated Prepayment Penalty. Notwithstanding there is no stated prepayment penalty, MCA fees must be paid in full regardless of when the loan is repaid. The earlier the repayment, therefore, the higher the effective rate. Had my client paid one month earlier, the effective rate would have jumped to 118%. Paying two months earlier would have been over 180%.

  • Direct Access to Operating Accounts. Since MCAs are repaid from sales, MCA lenders require direct access to business operating accounts, making traditional bank liens and priorities irrelevant. This is an existential threat to the business and its secured lenders. Companies that lose control over their operating accounts can quickly find themselves locked out of their ABL facility, with no ability to replenish inventories or pay their bills.  

  • Confession of Judgment. MCA contracts typically include a “confession of judgment” clause under which a borrower forfeits its right to defend itself.

The MCA Debt Trap. Using debt to solve cash flow problems, rather than doing the hard work of re-inventing the company to maximize liquidity and cash flow, can be a recipe for disaster. Despite the temporary relief provided by MCA loans, triple-digit interest rates and fixed fees can consume an increasingly larger share of a company’s declining cash flow.          

At the extreme, companies can fall into the MCA Debt Trap, where the only way to pay down a maturing MCA is to refinance with another more expensive MCA. Companies in this position are, for all intents and purposes, already insolvent and well down the path towards bankruptcy.

The Solution. Fortunately, business owners and senior lenders have a better option – a UCC Article 9 business reorganization that many are only recently discovering. In short, Article 9 is a streamlined, private, out-of-court short-sale of business assets that fully preserves business operations while eliminating all sub-debt of an over-leveraged, insolvent company. Better yet, most Article 9 sales can be accomplished in 30-60 days and at a very modest cost.

Win/Win for Owner, Borrower and Lender. Through an Article 9 reorganization, a borrower avoids bankruptcy and the loss of the business and its employees. Lender recoveries are often well above what would have been the case in a traditional bankruptcy.  Under an Article 9 sale:           

  • The senior creditor sells the assets of a still operational business to a purchaser intending on continuing operations with those assets. By statute, UCC Article 9 removes all liens and liabilities from the assets sold in the transaction.

  • The business operation, jobs and enterprise value are maintained as they pass to a new entity under new ownership and with all subordinate debt removed.

  • Business owners, by executing an employment or consulting agreement with the new company, can generate earnings from the new company while having a path to resolve personal guaranties and avoid financial devastation. Under the right circumstances, an equity stake in the new company is also possible. All this offers a clean slate and a fresh start for the business, the owner and the lender.

Two Steps to Recovery. For an Article 9 sale to work, two things must happen.       

  • First, create a viable go-forward restructuring plan addressing the underlying business issues. To maximize the likelihood a skeptical lender will support the sale, have the plan prepared by an experienced, hands-on turnaround expert rather than the incumbent management team. Take note: The earlier you start, the better. Nothing speaks louder than a company taking aggressive steps that are already beginning to show positive results.

  • Second, retain a firm with an excellent track record that specializes in Article 9 transactions as their primary line of work. As a practical matter, these firms do not have the high overhead of traditional bankruptcy firms and can provide their services at a lower cost.

Next Steps.  For assistance creating and executing a turnaround plan, or to learn whether an Article 9 reorganization might be best for you and your company, contact Gary Nacht, Synergy Enterprises, LLC at the email below or use this link to schedule a call.    

 About Gary Nacht and Synergy Enterprises, LLC

Gary Nacht, principal of Synergy Enterprises, has been acquiring and advising distressed and underperforming companies for over 25 years, from start-ups to over $1 billion in revenue across retail, wholesale, distribution and manufacturing.  His acquisitions include Northern Reflections (a 150-store Toronto-based retail women’s apparel chain ), AmerTac, Inc., (a designer and distributor of home lighting products and accessories), GPX, Inc. (a manufacturer and distributor of consumer audio/video products), Gemini Industries (a manufacturer and distributor of Philip’s-branded consumer electronics) and Kmart Canada (a $1.2 billion big-box discount retail store chain).     


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