Business Law

CAP CALL, LLC v. Foster (In re Shoot the Moon, LLC) (Bankr. D. MT)

The following is a case update written by W. Sloan Youkstetter, Resnik Hayes Moradi LLP, analyzing a recent decision of interest:

Summary

In Cap Call, LLC v. Foster (In re Shoot the Moon, LLC), 2020 WL 6588407 (Bankr. D. Mont. Nov. 6, 2020), the Bankruptcy Court denied cross motions for partial summary judgment filed by Cap Call, LLC (“CapCall”) and the Chapter 11 Trustee.  The central issue in both motions was whether the agreements entered into by the Debtor and CapCall were purchases of future receivables or a loan.  In a decision that may prove to be the start of something bigger, the Court found the characterization of the transaction factually intensive and ultimately concluded there were genuine disputes of material fact that compelled the denial of both motions.  To view the memorandum, click here

Factual Summary

The Debtor, Shoot the Moon, LLC operated restaurants in Idaho, Montana, and Washington.  When the Debtor needed financing, it entered into agreements with certain so called merchant cash advance companies, including CapCall.

CapCall provided the Debtor with immediate funds in exchange for CapCall receiving an agreed portion of future receivables generated by the restaurants’ operation.  CapCall also received confessions of judgment, personal guaranties from the Debtor’s principal, and UCC-1 financing statements.

Because some of the post-petition receivables that CapCall claimed an interest in were deposited into a restricted account, CapCall filed a complaint against the Trustee seeking declaratory relief that it owned the funds in the restricted account along with other causes of action.  The Trustee answered and included various counterclaims, including seeking declaratory relief that these transactions amounted to disguised loans, avoidance and recovery of pre-petition transfers to CapCall, and other causes of actions. 

CapCall filed a motion requesting a partial summary judgment ruling that the transactions should be classified as sales.  The Trustee opposed CapCall’s motion and cross-moved for a partial summary judgment order that the transactions were loans. 

Reasoning

The Court recognized that Article 9 of the Uniform Commercial Code (the “UCC”) does not delineate how a particular transaction is classified.

The Court relied on a “holistic, multipart framework” formulated by other courts to examine the substance of a given transaction.  It cited a notable law review article that cataloged the factors that are often considered: (1) whether the buyer has a right of recourse against the seller; (2) whether the seller continues to service the accounts and commingles receipts with its operating funds; (3) whether there was an independent investigation by the buyer of the account debtor; (4) whether the seller has a right to excess collections; (5) whether the seller retains an option to repurchase accounts; (6) whether the buyer can unilaterally alter the pricing terms; (7) whether the seller has the absolute power to alter or compromise the terms of the underlying asset; and (8) the language of the agreement and the conduct of the parties.[1]

The Court found that one consideration “transcends and unites” the factors, the nature of how parties allocated risk of loss.  In sales, the risk of loss from purchased assets usually passes to the buyer.  In disguised loans, various methods are used to allocate risk where the seller remains “exposed to the underlying receivables” or the agreement provided a “buyer recourse to sources of recovery beyond the receivables.”

CapCall’s Motion

The Court first considered CapCall’s request to declare that the transactions were sales rather than loans.  It looked at the security interest CapCall obtained from the Debtor.  For example, here the agreement purported to provide CapCall with “a security interest in all . . . payment and general intangibles (including but not limited to tax refunds, registered and unregistered patents, trademarks, service marks, copyrights, trade names, trade secrets, customer lists, licenses, [etc.]); goods; inventory; equipment and fixtures . . . and all proceeds of the foregoing.”  Additionally, the UCC-1 financing statement filed by CapCall described the collateral as “[a]ll assets of the Debtor, now existing and hereafter arising, wherever located.”  The Court questioned why a buyer of accounts should receive and perfect a security interest in assets beyond what it purchased.   

Next, the Court looked at CapCall’s recourse against property other than the receivables, such as the broad personal guarantee from the principal; the affidavit of confession of judgment against both the Debtor and guarantor; various protections against default; and a continuing obligation to provide CapCall with financial statements when requested.  Although the Court stated that none of these were dispositive, collectively they provided CapCall with conditional recourse against the Debtor and its principal.  These provisions reflect a risk allocation where CapCall was significantly protected over and above the value of the receivables it bought while the Debtor remains exposed.  Thus, the Court thought the arrangement was more consistent with a debtor-creditor relationship than a seller-buyer relationship.

Lastly, the Court looked at the parties’ course of performance.  The communications between the Debtor and CapCall describe the relationship as involving loans with terms.  The account the Debtor used to pay CapCall was an account owned by the Debtor and comingled with its receivables.  Nonetheless, the Court believed that the evidence of course of dealing and the relationship between the parties could be more developed at trial.

In conclusion the Court commented that the record favored the Trustee’s position that the transactions were disguised loans.  Specifically, factors 1, 2, and 8 support the loan characterization.  The Court also commented that the overall economic substance and risk allocation appear substantially similar to a loan.  As such, the Court denied CapCall’s motion.

The Trustee’s Motion

Although the Court found significant evidence that the transactions were loans, it also found that the record had some evidence supporting CapCall’s position that the transactions were true sales.

First, the underlying agreements included lengthy provisions regarding how the central transaction “is not intended to be, nor shall it be construed as a loan” but is a purchase of receivables for an amount that “equals the fair market value of such [r]eceipts.”

Second, CapCall’s position found some support in prior decisions where courts have found that similarly broad agreements were sale transactions based on the inclusion of the reconciliation provisions and the lack of fixed terms. 

Lastly, some of the factors supported CapCall’s position.  For example, there were no provisions allowing the Debtor to repurchase the receivables or permitting CapCall to alter the pricing terms.

Author’s Commentary

Bankruptcy attorneys who represent small businesses know that merchant cash advance lenders such as CapCall are often the last resort for businesses seeking capital when all other sources of traditional funding are not available.  Although the Court was rightfully suspicious of these kinds of agreements, the analysis to determine whether the transactions are sales or loans is, as the Court noted, factually intensive.  That said, the eight factors relied on by the Court here (and summarized in the law article, Characterization of a Transfer of Receivables as a Sale or a Secured Loan Upon Bankruptcy of the Transferor) are expected to be extremely helpful to practitioners when determining how to treat a merchant cash advance transaction in a plan of reorganization and/or whether to bring an avoidance action or declaratory action against such entities.  I think it is safe to assume that as these merchant cash advance transactions continue to grow, these companies will aggressively defend their business model and pursue debtors in their bankruptcy cases.  Thus, debtors will need to be equally aggressive, as it is likely not all of these transactions can survive detailed factual scrutiny as true sales.

These materials were authored by W. Sloan Youkstetter, Resnik Hayes Moradi LLP. Editorial contributions were made M. Douglas Flahaut, Partner at Arent Fox LLP.


[1] See Robert D. Aicher & William J. Fellerhoff, Characterization of a Transfer of Receivables as a Sale or a Secured Loan Upon Bankruptcy of the Transferor, 65 AM. BANKR. L.J. 181, 186-94 (1991).  

Forgot Password

Enter the email associated with you account. You will then receive a link in your inbox to reset your password.

Personal Information

Select Section(s)

CLA Membership is $99 and includes one section. Additional sections are $99 each.

Payment