Senior Secured Bank vs. MCA: a Recurrent Financial Feud and How to Mitigate the Disputes

In the last ten years, hundreds of entrepreneurial financiers calling themselves Merchant Cash Advancers or “MCAs” have entered the middle and smallcap credit markets.  MCAs are aggressive competitors.  Traditional regulated financial service providers, banks especially, tend to look down on MCAs.  MCAs can often advance financing within a few days, or weeks, of meeting their potential new clients, they do so with minimal underwriting or handwringing, and they are none-too-shy about doing business with entities that already have fully collateralized loans with a bank.  These disruptive tactics have allowed MCAs to gain significant market share at the expense of more traditional competitors.   MCAs claim that this is what capitalism is all about.

Much of the demand for MCA financial products comes from entities that are already near insolvency either because they are fragile startups or because they are in turnaround situations.  Many of these entities do not survive.  This means that insolvency and turnaround specialists will be dealing with MCA products for years to come.  MCA products and MCAs themselves are already appearing regularly in published bankruptcy and state court insolvency cases.  We discuss certain salient cases below.

Traditional financial service providers are inclined to think that MCAs are unprofessional “corporate loan sharks” whose very business model is an invitation to litigation.  That invitation has often been accepted.  MCAs, of course, give as much criticism as they get, and accuse the banks of (among other things) failing to serve wide sectors of the economy.  The author takes no side in the matter — his particular clients, whether banks, factors, or MCAs, being entirely innocent and always in the right — and has friends and clients on both sides of the dispute.

Article 9 of the Uniform Commercial Code (“UCC”) has become the usual legal battleground in these fights between MCAs and more senior financial service providers, including banks and factors.  Factors, like MCAs, claim to buy their clients’ accounts receivable rather than make loans.  Factors differ from MCAs in that they are older and more familiar organizations, and in that they buy existing accounts, whereas MCAs claim to buy percentage interests of all future accounts.  Critically, both factors and MCAs insist that they do not lend money to anyone.  However, Section 109 of UCC-9[1] provides that UCC-9 applies to the purchase of accounts receivable.  This means that UCC-9 applies both to a classical asset-based loan provided by a bank, and the more purchase-based financing provided by factors and MCAs. 

The central thesis of this article is that, at first glimpse anyway, there appears to be an irreconcilable conflict between two of the most important legal concepts in the UCC-9.  One such concept favors traditional secured lenders due to the first-in-time UCC-1 filings that they make, while the second concept shields MCAs from attacks so long as the MCAs tap cash from a client’s checking account.  Litigation is similar to poker in that a good player must try to predict how long opponents will accept risk and stay in a fight.  If two competing poker players each believes that he or she holds a winning hand and that the other guy is bluffing, then escalation becomes the name of the game.  This creates outcomes that are dangerous for everyone. 

This conflict found in the UCC makes litigation between banks and MCAs[2] particularly expensive, surprisingly emotional, and highly destructive of value for all parties concerned.  The risk inherent in litigation is compounded because some judges at the trial court level may not be familiar with the more complex provisions of the UCC, which is no doubt a dense and challenging legal read.  Personalities, biases, and pure luck can unduly influence a lawsuit and make predicting outcomes all the more difficult in this charged environment.  The author has considerable experience with this litigation on both sides, and with the factoring, MCA and secured lending sectors generally.

This article first describes the legal issues and then offers a legal conclusion of which of the two conflicting concepts should prevail all else being equal, which of course it never is.  The article ends with a few suggestions for making these conflicts less destructive and fraught with risk for all parties concerned.

The confusing conflict between two powerful UCC-9 positions

By way of background, MCAs generally make a single initial lump sum advance of cash to their clients.  MCAs then make a contractually enumerated series of identical daily ACH cash withdrawals from the client’s checking account.  It is therefore a telltale indication that a company has contracted with an MCA when one sees, for example, 25 consecutive daily withdrawals of the same inexplicably precise amount — say $2,117.52 — made by an entity whose name indicates that it is a financing company of some sort. 

MCAs often start doing business with a client only after the client has already exhausted its credit lines with an existing secured lender and some cash flow emergency has arisen.  While actual documentation varies widely, the client’s existing bank loan documentation may prohibit the client from doing an MCA transaction, but the client, desperate for cash, proceeds with the MCA transaction.  This fact pattern is called “stacking” because the client-borrower has stacked one lender’s position upon another in order to effectively double finance the same assets.  “Stacking” scenarios likely occur thousands of times each year in the USA, and they put the interests of MCAs and other secured lenders on a direct collision course, especially if the shared client-borrower, in other words the stacker, then fails.

The two UCC-9 positions colliding with each other are (1) the rule generally awarding a first priority position to first-in-time UCC-1 filers on all collateral and proceeds thereof and (2) the rule that cash is special and must be particularly well guarded by secured lenders.  A second set of related rules protects those who take cash or other cash-like assets, such as purchasers of checks, holders in due course, and (most relevant here) transferees from checking accounts.

The typical position of a hypothetical senior secured bank.

The UCC-9 establishes a clear order of priority of rights in the assets of a borrower among competing secured lenders.  The UCC-9 achieves this goal using a publicly searchable filing system that allows a lender to announce that it has taken a lien on a borrower’s assets, much like a child might publicly call “dibs” on an attractive toy that other children would like to play with.  Section 9-322(a) gives first priority to any party that files its claim (called a UCC-1 financing statement) before anybody else files or otherwise perfects their own liens.  The “first to file” rule leaves no room for ambiguity, and any person seeking to know who has a first lien on a given borrower’s asserts need only conduct a public search to see whose UCC-1 financing statement is “first in time.”  The UCC affords a party filing first the right to prime a competing lender who claims to have lent first.  By making the UCC-1 filing date a trump card, the UCC avoids messy disputes about who lent money first, which would lead to a slew of other definitional issues and likely require resort to evidence.  Instead, the matter is kept objectively verifiable and simple.  First to lend does not win, first to file a UCC-1 does.

Sections 9-315(c) and 9-322(b) also provide that a secured party holding a first-priority lien on collateral also enjoys a first-priority lien on the “identifiable” cash proceeds of such collateral.  It is therefore relatively easy for a bank or secured lender holding the oldest UCC-1, which often perfects a “blanket” security interest on “all assets,” to create a strong argument that it holds a first position on all proceeds of such assets, which would include all cash paid by a borrower’s customers to pay off accounts receivable.  Once an entity holds a first-lien on everything, every new dollar that a borrower earns looks like “proceeds.”  For those instances where cash is not traceable back to the bank’s original collateral, the so-called 21-day rule applies, which requires the bank to have taken alternative or additional measures to ensure continuing priority and perfection over its collateral as that collateral changed forms from accounts receivable to cash.  See Section 9-315(d).

Bankers have been (incorrectly) taught from the beginning of their careers that they hold a first place lien on all borrower assets once they hold the oldest UCC-1 then in effect.  They get angry when they learn that long after the bank made a loan to Company XYZ and filed the earliest UCC-1, an MCA has been withdrawing cash from Company XYZ’s checking account.  And if that borrower later fails and the bankers are already looking around for creative ways of recovering losses, bankers tend to think of MCAs as relatively deep-pocketed targets who have stolen the bank’s collateral and need to give it back.  For banks and other more traditional secured lenders, collateral is sacred and something that they will fight to defend.

The typical MCA position.

MCAs live in a world in which collateral is important but not a primary concern.  For them, cash flow is king.  MCA transactions typically last only a few months, although they are often extended or rolled over.  MCAs therefore do not dwell like banks do on the long term viability of their clients in deciding to do a deal.  As described above, MCAs recover their investments in a client with daily ACH withdrawals of cash from a client’s corporate checking account.  They therefore focus on short term cash flow in their underwriting.  A common corporate checking or operating account is called a “deposit” account in the language of the UCC-9.  See definition found at Section 9-102(29).  This “deposit account,” it turns out, is often the point of the banks’ greatest weakness.

What bankers often fail to remember is that a UCC-1 financing statement cannot perfect a lien against absolutely all forms of collateral.  Under Section 9-312, the UCC-1 financing statement is powerless to perfect a lien against a “deposit” account, which happens to be the receptacle where most of a borrower’s free cash is held.  Rather, the only way to perfect a lien on a deposit account is through “control.”  Section 9-312(b).  Moreover, and this is critical, perfection of a lien by effect of “control” lasts only “while the secured party retains control.”  Section 9-314(b).  Control and the exercise of control require would-be senior secured lenders to do more than simply make a filing.  They must instead normally enter into three-way control agreements, called deposit account control agreements (DACA), with their borrower and with the bank that acts as the depository for the borrower’s corporate checking account.  

DACAs, in turn, normally require certain actions to be taken before the control theoretically provided for in their terms can be exercised.  Daily monitoring of the borrower’s checking account is required to do this job right, so that any offending payments that a borrower might otherwise want to make (such as to an MCA) can be prevented by a senior lender using payment veto rights created by a DACA.  Banks very often fail to pay proper attention to their DACAs.  After making the shocking discovery that somebody else has been siphoning off their borrowers’ cash, their most precious collateral, bankers demand repayment from MCAs or threaten litigation.  By that time, their borrowers have long ago signed an MCA agreement and have been allowing daily withdrawals by an MCA to go on for weeks, months, or years. 

The MCA response to a banker’s accusation is typically aggressive:  If you controlled your borrower’s cash, then how come we have it?  To the MCAs anyway, the fact that MCAs withdrew the cash from a client’s checking account is, ipso facto, dispositive evidence that the bank did not exercise control over its borrower’s checking accounts and accordingly did not hold a perfected lien on cash under Section 9-314(b).   

At this point, the debate tends to devolve into a now-familiar and somewhat futile exchange of prefabricated talking points.  With money, careers and reputations on the line, nobody volunteers to be persuaded by the other side’s arguments.  Bankers argue that they are not in a position to monitor where every last cent of their borrower’s cash is sent, and, moreover, they would be precluded from vetoing cash disbursements due to lender liability concerns.  Bankers accuse MCAs of teaching borrowers how to violate their contracts with banks, control of cash or no control of cash.  Bankers also argue that Section 9-312(b) creates an exception to the general rule that a lien against cash can only be perfected through control, an exception that allows liens on cash that is the “proceeds” of the bank’s collateral.  MCAs respond that it is not clear that any given dollar is truly the “identifiable” proceeds of the bank’s collateral, which is a condition to qualify for the clearest exception to Section 9-312(b).  See Section 9-315(d).  MCAs ask banks why they did not better tend to their clients’ capital needs, such that the clients had to come to MCAs to begin with.

It is normally at this point in the exchange of fire that MCAs roll out their heaviest cannon:  Section 9-332(b).  This section — much like the holder-in-due-course rule, the good faith purchaser rule, and a slew of similar legal doctrines —  is intended to protect the free flow of assets and money in the American economy.  It would be difficult or impossible to conduct business having to wonder what hidden liens might be attached to every dollar one receives from a counterparty.  For this reason, many lawyers believe that Section 9-332(b) strips the liens off of every dollar leaving a borrower’s checking account.  The language of Section 9-332(b) is short and direct by UCC standards:

A transferee of funds from a deposit account takes the funds free of a security interest in the deposit account unless the transferee acts in collusion with the debtor in violating the rights of the secured party.

At first glance, the language might appear to offer some hope to a jilted bank that thought it has first priority in everything, including borrower cash.  Was not the transaction between the MCA and the borrower, which converted the bank’s collateral, a form of “collusion”?  The answer is likely not.  Article 9 of the UCC borrows the word “collusion” from Article 8, which makes clear that “collusion” requires a lot of wrongdoing and requires active “complicity” in tort-like behavior.  Indeed, the official comments to article 8 make clear that knowing that a given action is wrongful is not enough to satisfy the collusion test.  See official comment 5 to Section 8-115 of the UCC.  For an unpublished opinion analyzing the issue of whether collusion exists, see Small Bus. Fin. Sols., LLC v. Pearl Beta Funding, LLC, No. 411478-V, 2017 Md. Cir. Ct. LEXIS 8 (Md. Cir. Ct. Sept. 29, 2017).  MCAs who might suspect or know that a client who signs an MCA contract is violating its already existing obligations to its bank are not necessarily “colluding” with the client.  The issue depends very much on the facts, which makes summary judgment on this issue difficult.

The author’s experiences in litigation

Most courts have viewed Section 9-332(b) as a game-winner, with the Fifth Circuit Court of Appeals being a notable exception.  Section 9-332(b) leaves little room for maneuver to a bank claiming that the funds that an MCA took from a borrower’s deposit account came with a bank lien still attached.  MCAs are without question “transferees” of funds from their clients’ deposit accounts.  While traditional secured lenders are able to show that they once had a lien under Section 9-315 on funds if those funds are identifiable proceeds of their collateral, most case law holds that the lien on funds is stripped away when the funds are transferred from a checking account into the possession of the MCAs.  

This leaves the banks with no lien-based theory of recovery against MCAs, which could otherwise be their most direct route to a recovery.  They can still resort, and often do, to standard tort theories such as “tortious interference with a contract.”  These tort theories, however, are weak because the banks were in a position to prevent their losses from happening in the first place if they had just paid attention to their borrowers’ deposit accounts.  Banks are frequently viewed by courts as sophisticated actors who “should have known better” and apparently preferred not to expend the resources necessary to take control over their borrowers’ cash.  At times, the very bank claiming to have been cheated was also the depository institution where the borrower maintained its checking account, making the bank’s constructive knowledge of what was happening easy to prove.  Even when the checking account is maintained at a third-party bank, at times it appears banks were aware of their borrowers’ dealings with MCAs and allowed those financings to happen because the extra money kept their borrowers from operational collapse.  

If a client’s music stops at the wrong moment from the MCAs’ point of view, they can also demonstrate in litigation that they put more money into a company than they took out.  This leaves banks with challenges in proving damages.  Sometimes banks allege that the MCA “ruined” their client, thereby indirectly causing financial losses.  Proving that complex causal argument at trial is difficult.  MCAs can answer bank lawsuits with general denials and a slew of affirmative defenses such as estoppel, waiver, failure to mitigate, and the like.  A bank’s tort-based attacks on MCAs can easily become bogged down in a hilly and swampy factual terrain favoring the defense. 

Salient case law

The UCC-based debate generally described above has dominated the discussions found in various fairly recent cases concerning Section 9-332(b).  Section 9-332(b) is a relatively recent addition to the UCC and replaces an older but similar provision once given the number 9-306.  Accordingly, there is still not a wide body of established law concerning Section 9-332(b) and lawyers cannot yet definitively label a position as the “majority” position, although the small body of national case law on Section 9-332(b) decidedly leans in a direction friendly to a party taking funds from a checking account.  Some of the more interesting or prominent cases include the following:

• In Stierwalt v. Associated Third Party Adm’rs, 16-mc-80059, 2016 U.S. Dist. LEXIS 68744 (N.D. Cal. May 25, 2016), a judgment creditor receiving funds out of a checking account by effect of a writ of execution trumped the claims of an earlier existing creditor who claimed that the money in the checking account was “proceeds” of its collateral. Id. at **15-25.  The court rejected the argument that a party taking funds from an account through a writ of execution was not a “transferee” for purposes of 9-332(b).  Id. at *23.

• In In re Delano Retail Partners, No. 11-37711-B-7, 2017 Bankr. LEXIS 2397 (Bankr. E.D. Cal. Aug. 14, 2017), a previously existing secured creditor claimed that a Chapter 7 bankruptcy trustee had no right to take funds held in a debtor’s checking account that were subject to a lien as the proceeds of the creditor’s collateral. Notably, the trustee had taken the funds using Bankruptcy Code Section 544 strong-arm powers, because no creditor had exercised prepetition control over the checking account, and accordingly no lien had been perfected.  at *24.  The court ruled that Section 9-332(b) stripped any proceeds-based lien from the funds held in the checking account.  Id. at **25-29.  The ruling in Delano is at direct odds with the Garner decision from the Fifth Circuit, discussed in detail below, because the Delano court ruled that all liens, not just liens focusing on deposit accounts themselves, were stripped by Section 9-332(b).  Id. at *20.  This included the funds held in a deposit account on which a third party had claimed a proceeds lien.   Id.

• In re Charleston Assocs., LLC, No. 13-10449-MKN, 2017 Bankr. LEXIS 4581 (Bankr. D. Nev. Dec. 12, 2017), a senior secured bank (U.S. Bank) obtained an agreement from a depository bank that supposedly gave it control over an account’s contents. Actual “control,” however, apparently was not exercised because funds still left the account in question and were transferred to City Bank.  The Charleston Assocs. court ruled that Section 9-332 protected City Bank (the recipient of the funds), trumping U.S. Bank’s security interest.  at **12-15. 

• In Orix Fin. Servs., Inc. v. Kovacs, 167 Cal. App. 4th 242 (2008), the court considered the terms of current Section 9-332 and compared it to a similar (and less stringent) analogue that previously existed as Section 9-306. That court determined that Section 9-332(b) was intentionally written to impose an even higher burden on secured parties attempting to disgorge cash from any third party who receives cash from a debtor’s checking account.  at 249.

• In VendorPass, Inc. v. Texo Solutions, L.L.C., No. A-4015-14T2, 2017 N.J. Unpub. LEXIS 256 (N.J. Super. Ct. February 2, 2017), a court ruled that the receipt by a creditor of funds from an account served as an effective affirmative defense to the claims of a competing creditor, even though the plaintiff admitted that it held no lien whatsoever on the funds or deposit account in question. at *14.  Section 9-332(b) would clearly seem irrelevant to this case, given the absence of any lien in the fact pattern, and yet the court notably used it to shield the funds in question from competing “claims” by the transferee/defendant.  The case is therefore strange and an arguable misuse of Section 9-332(b) in that it was used here to clear away claims and not liens, an expansion on its text.

• In Heartland Bank & Trust Co. v. Leiter Group, 2014 IL App (3d) 130498, a usurping junior creditor took certain checks from the debtor’s clients that were already subject to a senior bank’s lien, and then deposited those checks into its own checking account. The usurping junior creditor then argued, somewhat cheekily perhaps, that Section 9-322(b) applied to all funds leaving its own account.  This argument was summarily rejected, with the court correctly ruling that the “deposit account” referred to by Section 9-332(b) is the “debtor’s deposit account.”  at ¶ 29.

• In Yaddehige v. Epert Techs, No. 341035, 2019 Mich. App. LEXIS 1136 (Mich. Ct. of Appeals Apr. 18, 2019), a Michigan Court of Appeals directly rejected the argument to the effect that Section 9-332(b) applies only to liens on deposit accounts. at *3.  Yaddehige otherwise involved a typical fact pattern in which an older creditor who claimed a first-priority lien discovered that another creditor had subsequently taken a large sum of cash from the borrower’s checking account.  Id. at *1-2.  The court found the transfer to be entirely shielded by Section 9-332(b).  Id. at *4-5.  Interestingly, the court appeared to rule that both Sections 9-332(a) and 9-332(b) could simultaneously apply to the same transfer, and appeared to reason that the “funds” mentioned in Section 9-332(b) is also the “money” discussed in Section 9-332(a).  While the result is correct, this reasoning is dubious, as the UCC normally does not create two rules covering the same subject matter.

• In Marathon Petroleum Co., LLC v. Cohen (In re Delco Oil, Inc.), 599 F.3d 1255 (11th Cir. 2010), the Eleventh Circuit Court of Appeals upheld a bankruptcy trustee’s right to disgorge funds transferred from the bankruptcy estate without authorization after the start of the proceedings. at 1260-61.   The court rejected the transferee’s arguments that Section 9-332(b) shielded such transfers by stripping the lien from the funds.  The court did not dispute that the lien was stripped, but found that the existence of a lien “has no bearing” on whether the bankruptcy trustee could still rely on Bankruptcy Code Section 549 to recover the funds.  Id.   While the Court did not discuss preemption of a state statute (i.e., the UCC) by a federal one (the bankruptcy code), the case shows how preemption arguments could be raised in other cases.  As a general matter, the 9-332(b) cases do not appear to affect the duties or powers of federal bankruptcy trustees.

• At least two national cases have held that a depository bank’s traditional rights of setoff against funds held in a checking account (maintained at the depository bank) are not prejudiced by Section 9-332(b). These cases hold that depository banks are not “transferees” and accordingly cannot be accused of collusion with their customers if these banks setoff against funds held in an account that have been pledged to a third party.   See, e.g., First Dakota Nat’l Bank v. First Nat’l Bank of Plainview, 2011 U.S. Dist. LEXIS 106102, at *31 (D.S.D. 2011); see also, Ky. High Inv. Corp. v. Bank of Corbin, Inc., 217 S.W.3d 851, 857 (Ky. App. 2006).   First Dakota, however, appeared to rely partially on the fact that the third party pledgee had not exercised “control” of the deposit account in question, which opens a door for arguments that are dangerous for banks under other facts.  First Dakota, at *31.  Banks would have preferred a blanket ruling that their rights of setoff are always paramount, without regard to the “control” exercised by third parties.

Some of the cases discussed above cite to Stierwalt, Charleston, and Orix, suggesting, all else being equal, a budding national consensus that Section 9-332 is indeed an effective shield for parties taking funds from checking accounts.  However, even under the older and milder prior Section 9-306 language that Section 9-332 later replaced in 2001, courts stressed the importance of not interrupting the free flow of funds in the American economy.  Then federal circuit court Judge Stephen Breyer wrote about the policy foundations of old 9-306 as follows:

       [I]f Courts too readily impose liability upon those who receive funds from the debtor’s ordinary checking account[,] then ordinary suppliers, sellers of gas, electricity, tables, chairs, etc. might find themselves called upon to return ordinary payments (from a commingled account) to a debtor’s secured creditor . . .

Harley-Davidson Motor Co. v. Bank of New England, 897 F. 2d 611, 622 (1st. Cir. 1990).

The Garner Case

One powerful federal court has taken a position contrary to the cases above.  See Garner v. Knoll, Inc. (In re Tusa-Expo Holdings, Inc.), 811 F.3d 786 (5th Cir. 2016).  In Garner, the Fifth Circuit Court of Appeals confronted a bankruptcy preference action in which a key supplier and creditor of a bankrupt furniture retailer was accused of receiving a multi-million dollar preference by a bankruptcy trustee.  Id. at 790.  Preference defendant Knoll was the actual maker of the furniture and found itself exposed to a potential multi-million dollar loss through no real fault of its own, a fact which the author believes heavily influenced the Court.  The question of whether Knoll had received a preference turned on whether the cash Knoll had received from the debtor was Knoll’s own collateral anyway. 

The appellate court in Garner ruled that the money that Knoll had received was the proceeds of Knoll’s collateral, and that Knoll’s cash collateral that was still the subject of Knoll’s own perfected lien even when Knoll received it from the debtor’s deposit account.  Accordingly, Knoll received no preference despite receiving funds from a deposit account, the language of Section 9-332(b) notwithstanding.  For Knoll anyway, the humble furniture maker whose labor made the debtor’s business possible, this result seems intuitively fair, albeit at odds with the text of the UCC.  The court’s decision in Garner rescued the furniture maker from a $4.5 million preference action.

To arrive at this conclusion, the court took a decidedly narrow textualist approach that drew a distinction between (A) a lien on funds held in a deposit account and (B) a lien on the deposit account itself.  The Court ruled that under the plain meaning of Section 9-332(b), only liens on the deposit account were stripped by Section 9-332(b), and thus a lender’s Section 9-315(c) lien would continue to attach to the funds as they exited the account.  The court found that closely comparing the language of Sections 9-332(b) with 9-332(a), which applies to paper “money” as opposed to “funds,” compelled this result.  Id. at 795-96.

To the author, at least, the Garner decision appears incorrect and in open conflict with other provisions of the UCC.  The word “funds” is not defined by the UCC, nor does any provision of the UCC speak of how to perfect a security interest in “funds.”  It therefore seems strange that the Garner court assumed that the security interest in funds, which is nowhere directly contemplated by the UCC, was distinct and separate from the security interest in the deposit account where these funds reside.

It is also unclear why the UCC would create different rules for “funds” and for “money,” as the Fifth Circuit insists must exist.  Id. at 796.  It is equally unclear why a person wanting to take a lien on a deposit account must exercise control at all times or lose the lien under Section 9-314(b), and yet a different creditor holding a lien on cash “proceeds” can apparently take no care whatsoever as it concerns “funds” and still be safe, even though these funds are often held in a deposit account.  It is the very essence of accounts receivable, after all, that they usually change in form and become cash when account debtors pay their bills.  Creditors or buyers taking a lien in accounts receivable know that the collateral will eventually convert to cash.  No gentler standard of care as it pertains to cash need apply to them.

To the author, the UCC has intended “funds” to simply mean non-paper money, electronically held money, that can really only exist or be transferred so long as it is credited to and held within a deposit account or some other similar abstract and often electronic receptacle.  There is, therefore, no meaningful distinction between “funds “and “funds held in a deposit account,” which is why the author believes that the language of Sections 9-332(a) and 9-332(b) differ as they do without intending or commanding the result in Garner.  To the author, the phrase “held in a deposit account” was placed in Section 9-332(b) merely to add more information as to what the otherwise undefined “funds” might be, not to redirect Section 9-332(b) so that it no longer removed liens from “funds.”  Indeed, the official comment 2 to Section 9-315 expressly contemplates that Section 9-332 would strip a lien from “funds,” which also contradicts Garner.  The Fifth Circuit’s rigid textualist approach, in other words, finds and heeds a distinction that does not exist.  

Regardless of the legal merits, Garner would allow money to enter the stream of American commerce with invisible liens attached to every dollar, which is contrary to the policy so aptly described above by now Supreme Court Justice Breyer.  Those liens, in turn, could arguably still exist when the money passes still further downstream in commerce to subsequent transferees.  “Arguably” is an apt word, because somebody will eventually make this troubling argument, once money is on the line.  (See generally Sections 9-201(a) and 9-315(a), which provide for lien survival upon transfers of collateral, subject to various exceptions and defenses.) 

The best ruling concerning Section 9-332(b), albeit one that will at times lead to harsh results for incompetent creditors, would demand that holders of liens on funds in deposit accounts take all steps to ensure continuing liens on these funds using control and monitoring.  These chronic fights between MCAs and other lenders would be prevented if the exit of cash from the relevant accounts was itself prevented through bank control.  Section 9-332(b) should be given the broadest reading possible for the benefit of all parties concerned.  This would give banks and other secured lenders that do their jobs as secured lenders properly a decided competitive advantage, and it would allow them to prevent MCA usurpation of their positions without anybody having to litigate.  This same clear rule also helps MCAs tremendously, who will no longer be sued or treated as retroactive guarantors or insurers for bank loans that go bad.   Clarity helps everyone.

Some suggestions for improvement (or can’t we all get along?)

Both sides would be considerably aided by a better understanding of the law.  MCAs appear at times oblivious to the fact that, if a potential client already has a UCC-1 filing against all of its assets, then a third party considers accounts receivable to be spoken for.  It makes no difference if the MCA is a true sale buyer, since the UCC effectively does not recognize a difference between buying a receivable and lending against it.   See Section 9-109.  It also makes no difference if the MCA is only buying interest in future accounts, since any previously existing lender can still claim future or “after-acquired” collateral as its own.  See Section 9-204.  Thus, choosing to do business with a company whose assets are already covered by a third party’s UCC-1 filing is asking for trouble, even if there are colorable legal justifications for doing so.

Senior secured lenders appear at times to be equally oblivious to the amount of monitoring and administration that is required to truly have a watertight security interest on cash. As discussed above, they often fail to take steps to control cash, and as a result, they lose their most important and liquid collateral.  That first loss, in turn, compels them to the often unwise decision to take a second loss in the form of protracted and cost-ineffective litigation. 

If MCAs were to contact senior lenders and seek to make arrangements with them prior to advancing funds, this would greatly reduce the tension.  Banks are indeed helped when third parties help to keep their more fragile borrowers alive.  The two sides could then negotiate a suitable intercreditor agreement that would provide stability and predictability for both sides.  

Even when a full conflict is inevitable, both sides would be well served by dialing down the institutional contempt they claim to have for the other.  MCAs are here to stay, and they provide valuable survival money to hundreds of companies every year.  Many MCA managers are ex-bankers.  Yes, MCA money can be more expensive than most bank loans, but bank loans are not always available to startups and turnarounds.  Startups and turnarounds employ millions of Americans and provide this society with valuable products, and they do it with the help of MCAs.  MCA clients are not fools and should not be patronized.  If signing the MCA contracts did not make sophisticated corporate clients better off, they presumably would not sign.  These facts alone demonstrate that society needs MCAs, and any would-be corporate client that feels the money is simply too high-priced need only not take the deal.  On the other side, the value provided by banks to this society should be apparent to all.  There is room for mutual respect here.

Even when a fight over limited resources is inevitable, the costs of litigation could be further limited by at least allowing MCAs the chance to take back from a company the pure cash that they put into it, regardless of lien priorities.  Instead, banks ignore the money that MCAs have invested in the banks’ own clients, and then sue the MCAs for every dollar that they ever received.  This tactic arguably seeks a windfall and ensures a long legal fight.  As the UCC already recognizes in its provisions pertaining to purchase money security interests, senior lenders are not materially harmed when junior creditors inject new capital into a company.  This approach would leave the litigants fighting only about the excess money that the MCAs took from a borrower, rather than every last dollar that left the borrower’s account in route to an MCA.  

In sum, this pattern of ignoring realities on the front end and then fighting to the death on back end is not working for anybody. [3] 

[1]  UCC section citations are commonly referred to with the applicable UCC Article number preceding them, such that Section 109 of Article 9 of the UCC is called “Section 9-109.”  Due to slight variations and modifications made to the generic UCC enacted by each state, this article will specifically refer to the UCC in effect in Illinois.

[2]  While this article describes litigation between banks and MCAs, which is indeed the classic scenario, any financial service provider with a “first in time” UCC-1 filing is apt to file a lawsuit if it feels its position has been wrongfully usurped by a competitor and there are losses to be mitigated in so doing.  Substantively identical litigation can take place between MCAs, between banks, or between factors and MCAs.

[3]    The author thanks senior associate Matthew Schmidt for his research assistance in writing this article.   The author also thanks his partner Bevin Brennan for her edits and comments.