Advisory: Cash Conversion and Lending Clauses in Membership Agreements
Published: April 21, 2016
IRTA’s research on the February 25th, 2016, “Cryptocurrency Money Transmitter Advisory Memo”, (CMTAM), shed light on the need to clarify and modernize two important sections of barter exchange membership agreements:
I. Trade Dollar to Cash Conversion Clauses
II. Trade Dollar Lending Clauses
Background – Cash Conversion Clauses
As IRTA’s CMTAM outlined, the financial/banking sector is incorrectly categorizing barter exchanges as “money transmitters,” similar to Bitcoin-like cryptocurrencies. This misplaced characterization has resulted in banks and merchant service providers denying cash credit-line facilities and credit card processing services to all sectors of the barter industry.
One of the key differences that separates barter exchanges from cryptocurrencies is that barter exchanges do not convert or redeem trade dollars for cash. However, many of today’s barter exchange membership agreements have clauses that state that in the event of a member’s default, the exchange can convert the member’s negative trade balance to cash via a court judgment. IRTA has received reports from multiple exchange owners’ that have been denied credit card merchant services solely due the existence of such cash-conversion upon judgment clauses in their member agreements.
Barter exchange cash-conversion clauses are typically found in the termination and/or litigation sections of the membership agreements. The clauses contain language similar to:
Sample of Current Termination Clause Language
“If a member has a negative trade balance, the member has 90 days to pay their account with acceptable products or services. After the 90 days, the Member must pay the barter exchange any remaining balance in cash.
In the event the member’s account is terminated, the barter exchange may, at its sole discretion, utilize the member’s credit card to pay any outstanding balances owed in trade dollars or cash dollars.”
Recommendations for Cash-Conversion Clauses in Membership Agreements
Merchant Service providers are now demanding barter exchanges remove any and all references to cash-conversion rights in the membership agreements, as a pre-condition of providing credit card merchant services. Additionally, legislative bodies are re-writing state financial codes and looking for cash-conversion language that could qualify a barter exchange as a money transmitter.
As a result, IRTA recommends barter organizations remove all references to cash-conversion rights in their barter exchange membership agreements.
IRTA further recommends that any prior cash-conversion termination language be replaced with the following clauses, which effectively retains the exchange’s legal rights in a termination/litigation scenario:
Recommended Cash-Conversion Replacement Clause Language
“If a member has a negative trade balance, the member has 90 days to pay their account with acceptable products or services. After the 90 days, the Member must pay the barter exchange any remaining deficit balance with a payment having an equivalent value. The payment must be acceptable to the barter exchange and have easily determined value.
In the event the member’s account is terminated, the barter exchange retains complete reservation of rights to recover Member’s deficit trade balance in law and equity.”
Background – Lending in a Barter Exchange
Barter exchanges do not lend trade dollars. Rather, lending activity takes place collectively between the exchange members’ themselves. IRTA’s March 3, 2014 Advisory Memo titled “Legal Liability for Trade Dollars in a Barter Exchange” under the Library Tab at www.irta.com, further amplifies this point when it states:
“A barter exchange is not like a commercial bank, which makes commercial loans and is liable for all demand deposits…the legal liability of redemption in goods and services of trade dollars in a barter system lies with the debtor members collectively. A barter exchange may or may not be a debtor member, and is liable only to the extent of its own borrowing. A barter exchange does not extend credit, only the members of the network collectively do.”
It is critical that barter organization member agreements have specific clauses that state that the creditor/debtor relationship is between the members, and that the barter exchange is only acting as a third-party record keeper, pursuant to the authority the members’ grant the exchange in the membership agreement.
Note: The Truth in Lending Act (TILA) of 1968, as amended by the Consumer Financial Protection Bureau pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, (or Dodd-Frank Act), is inapplicable to lending activity between barter exchange members. Regulation Z, contained in TILA, applies to “consumers,” defined as individuals (not businesses). It is designed to promote the informed use of consumer credit, by requiring disclosures about its terms and cost. It is applicable only to certain specified transactions, such as certain credit card transactions, mortgage transactions, home equity loans and private education loans.
Recommendations for Lending Clauses in Membership Agreements
IRTA recommends all barter exchange agreements contain the following clauses so as to clearly establish the lending activity within the exchange takes places specifically between the members themselves, (for further detail, see IRTA’s March 3, 2014 Advisory Memo titled “Legal Liability for Trade Dollars in a Barter Exchange” under the Library Tab at www.irta.com)
Recommended Liability for Trade Dollars Clause Language
“Member acknowledges that trade dollars in the barter system (positive balances) are the liabilities of persons/companies who have spent more than their earnings (negative balances); that there is a creditor/debtor relationship between such persons, and that trade transactions incur the normal business risks associated with any credit transaction. As a general rule, trade dollars are the liabilities of Members who owe the barter system, and not of TE (Trade Exchange), which is solely liable for its own indebtedness. TE is authorized to establish a bad debt reserve fund by charging all accounts on a regular basis an amount in trade dollars to be paid into such a fund. Any positive balances abandoned or surrendered by former members in accordance with the Rules may also be paid into the reserve fund.”
Recommended Trade Dollar Loans Clause Language
“Members grant to TE the right and power to make trade dollar loans to any Member on terms and conditions consistent with Member’s creditworthiness and ability to repay. The exercise of this power shall be at the sole discretion of TE management with regard to principal, interest, terms and conditions, lending policy, and other particulars. TE reserves the right to require exchange member’s to complete a formal loan agreement, request financial statements, credit history and collateral prior to loan approval. TE is under no obligation to extend credit at any time. TE will use its best efforts to ensure timely repayments of principal and interest, appropriate collateralization, and perfection of security interest in all loans.’
Note: IRTA highly recommends the exchange establish a bad debt reserve fund to assure the system will remain a healthy balanced exchange. The enabling clause to fund and create such a bad debt reserve fund should read:
Recommended Bad Debt Reserve Fund Clause Language
“Members agree to establish a trade dollar bad debt reserve fund by paying a __% monthly interest charge on member negative trade balances. This Fee will automatically be deducted from the Members’ account each month. Such trade funds shall be deposited in a bad debt reserve fund to offset losses in the TE system.”
Note: The decision to charge interest on negative balances is discretionary. However, charging interest on negative balances does provide a meaningful trade dollar revenue stream to fund the bad debt reserve account and thereby contribute to the overall financial stability of the exchange, (see IRTA’s October 7, 2014 related Advisory Memo titled “Guidelines & Recommendations for Barter Exchange Deficits” under the Library Tab at www.irta.com).