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CDBO releases proposed commercial financing disclosure regulations
On September 11, the California Department of Business Oversight (CDBO) initiated the formal rulemaking process with the Office of Administrative Law (OAL) for the proposed regulations implementing the requirements of the commercial financing disclosures required by SB 1235 (Chapter 1011, Statutes of 2018). In September 2018, California enacted SB 1235, which requires non-bank lenders and other finance companies to provide written consumer-style disclosures for certain commercial transactions, including small business loans and merchant cash advances (covered by InfoBytes here). In July 2019, California released the first draft of the proposed regulations (covered by InfoBytes here) to consider comments prior to initiating the formal rulemaking process with the OAL.
The new proposed regulations, which have been modified since the July 2019 draft, provide general format and content requirements for each disclosure, as well as specific requirements for each type of covered transaction. Additionally, the proposed regulations provide information on calculating the annual percentage rate (APR), including additional details for calculating the APR for factoring transactions, as well as calculating the estimated APR for sales-based financing transactions, among other things. Additional details about the proposed regulations can be found in the CDBO’s initial statement of reasons. Comments on the proposed regulations will be accepted through October 28.
Special Alert: California’s new consumer financial protection law expands UDAAP and enforcement authority
On Monday, August 31, the California Legislature passed Assembly Bill 1864, which enacts the California Consumer Financial Protection Law (CCFPL) and changes the name of the Department of Business Oversight (DBO) to the Department of Financial Protection and Innovation (DFPI).
Key takeaways
- Establishes UDAAP authority for the new DFPI, adding “abusive” to “unfair or deceptive” acts or practices prohibited by California law, and authorizing remedies similar to those provided in the Dodd-Frank Act. The DFPI also has authority to define UDAAPs in connection with the offering or provision of commercial financing (e.g., merchant cash advance, lease financing, factoring) and other financial products or services to small business recipients, nonprofits, and family farms.
Federal legislation would apply TILA to small business financing
On July 30, Congresswoman Nydia Velázquez (D-NY), the Chairwoman of the House Small Business Committee, announced new legislation titled, “Small Business Lending Disclosure and Broker Regulation Act,” which would amend TILA and subject small business financing transactions to APR disclosures. The federal legislation would track similar state legislation enacted in California and currently pending the governor’s signature in New York, covered by InfoBytes here and here. However, unlike both California and New York, the federal legislation does not exempt depository institutions from coverage. Highlights of the TILA amendments include:
- CFPB Oversight. The legislation provides the CFPB with the same authority with respect to small business financing as the Bureau has with respect to consumer financial products and services.
- Coverage. The legislation defines small business financing as, “[a]ny line of credit, closed-end commercial credit, sales-based financing, or other non-equity obligation or alleged obligation of a partnership, corporation, cooperative, association, or other entity that is [$2.5 million] or less,” that is not intended for personal, family, or household purposes.
- Disclosure. The legislation would require disclosure of the following information at the time an offer of credit is made: (i) financing amount; (ii) annual percentage rate (APR); (iii) payment amount; (iv) term; (v) financing charge; (vi) prepayment cost or savings; and (vii) collateral requirements.
- Fee Restriction. The legislation prohibits charging a fee on the outstanding principal balance when refinancing or modifying an existing loan, unless there is a tangible benefit to the small business.
Additionally, the legislation would amend the Consumer Financial Protection Act to create the Office of Broker Registration, which would be responsible for oversight of brokers who “solicit[] and present[] offers of commercial financing on behalf of a third party.” The legislation would, among other things: (i) require commercial brokers to register with the CFPB; (ii) require commercial brokers to provide certain disclosures to small business borrowers; (iii) prohibit the charging of fees if financing is not available or not accepted; and (iv) require the CFPB to collect and publicly publish broker complaints from small businesses. Lastly, the legislation would require each state to establish a small business broker licensing law that includes examinations and enforcement mechanisms.
Relatedly, the FTC recently took action against New York-based merchant cash advance providers and two company executives for allegedly engaging in deceptive practices by misrepresenting the terms of their merchant cash advances (MCAs), using unfair collection practices, making unauthorized withdrawals from consumers’ accounts, and misrepresenting collateral and personal guarantee requirements. See detailed InfoBytes coverage on the complaint here.
FTC charges merchant cash advance provider with deceptive and unfair practices
On August 3, the FTC filed a complaint against two New York-based merchant cash advance providers and two company executives (collectively, “defendants”) for allegedly engaging in deceptive practices by misrepresenting the terms of their merchant cash advances (MCAs), using unfair collection practices, making unauthorized withdrawals from consumers’ accounts, and misrepresenting collateral and personal guarantee requirements. The FTC’s complaint alleges that when marketing and offering MCAs to small business customers, the defendants, among other things, (i) falsely advertised that MCAs do not require collateral or personal guarantees, but when consumers defaulted on their financing agreements, the defendants frequently filed lawsuits against them, including against individual business owners who provided personal guarantees, to collect the unpaid amount; (ii) misrepresented the amount of total financing in the contract that consumers would receive by withholding fees that are deducted from the promised funds; and (iii) made unfair, unauthorized withdrawals from customers’ bank accounts in excess of consumers’ authorization without express informed consent, and routinely continued to debit customers’ bank accounts after the MCAs were fully repaid. According to the FTC, the “unauthorized overpayments have been a typical occurrence for [the defendants’] customers, and have impacted at least thousands of them, in amounts ranging from hundreds to thousands of dollars.”
The FTC seeks a permanent injunction against the defendants, along with monetary relief including “rescission or reformation of contracts, restitution, the refund of monies paid, disgorgement of ill-gotten monies, and other equitable relief.”
FTC charges small-business financing operation with deceptive and unfair practices
On June 10, the FTC filed a complaint against two New York-based small-business financing companies and a related entity and individuals (collectively, “defendants”) for allegedly engaging in deceptive practices by misrepresenting the terms of their merchant cash advances (MCAs), using unfair collection practices, and making unauthorized withdrawals from consumers’ accounts. The FTC’s complaint alleges that the defendants purported “to provide immediate funds in a specific amount in exchange for consumers’ agreement to repay a higher amount from future business revenues” to be “remitted over time through daily debits from consumers’ bank accounts.” However, the defendants allegedly, among other things, (i) made false claims on their websites that their MCAs require “no personal guaranty of collateral from business owners,” when in fact, the contracts included such provisions; (ii) withheld various upfront fees ranging from hundreds to tens of thousands of dollars prior to disbursing funds to consumers (according to the complaint, these fees were either poorly disclosed in the contracts or not disclosed at all); (iii) directed agents to charge higher fees to consumers than permitted by the contracts; (iv) required businesses and their owners to sign confessions of judgment (COJs) as part of their contracts, and unlawfully and unfairly used the COJs to seize consumers’ personal and business assets, including in circumstances where consumers could not make payments due to technical issues outside their control, or in instances not permitted by the defendants’ financing contracts; (v) made threatening calls to borrowers, including threats of physical violence or reputational harm, to compel consumers to make payments; and (vi) made unauthorized withdrawals from consumers’ accounts. The FTC seeks a permanent injunction against the defendants, along with monetary relief including “rescission or reformation of contracts, restitution, the refund of monies paid, disgorgement of ill-gotten monies, and other equitable relief.”
The same day, the FTC published a blog post highlighting the Commission’s ongoing efforts to combat questionable financing practices targeting small businesses. The FTC also held a forum in 2019 on marketplace lending to small businesses, which analyzed the potential for unfair and deceptive marketing, sales, and collection practices in the industry, and released a follow-up staff perspective paper earlier this year (see InfoBytes coverage here and here). In addition, over the past few years, several states have introduced legislation and advisories on MCAs and small business financing (see prior InfoBytes coverage here).
California Department of Business Oversight issues advisory to small businesses with merchant cash advance contracts
On April 6, the California Department of Business Oversight (DBO) issued an advisory to small businesses with merchant cash advance contracts. Small businesses are encouraged to review the terms of their existing financing products to determine whether they may be entitled to relief and report finance companies that fail to honor contractual terms that provide relief. The DBO notes that payments under certain financing arrangements are typically adjustable and may be lowered if the small business is closed as a result of government orders.
FTC paper discusses small business financing issues
On February 26, the FTC released a staff perspective paper covering topics discussed during the Commission’s “Strictly Business” forum on small business financing held in 2019, as well as an online tool for small businesses to submit lending- or financing-related complaints. As previously covered by InfoBytes, the forum heard from members of the small business marketplace who discussed the recent uptick in online loans and alternative financing products, and analyzed the potential for unfair and deceptive marketing, sales, and collection practices in the industry. The staff paper provides an overview of key issues discussed during the forum, as well as enforcement information, recent small business financing marketplace trends, potential benefits and risks of newer online financing products, and consumer protection issues associated with merchant cash advances. Among other things, the staff paper emphasized that “small business finance providers should avoid the sorts of practices that the Commission has alleged to be deceptive” in its enforcement actions involving either small business consumers or individual consumers, such as actions charging lenders with making “misleading claims regarding fees, consumer savings, payment amounts, and interest rates” in connection with personal loans. The staff paper also stressed that finance providers should understand that using marketing intermediaries, such as brokers and lead generators, “does not immunize them from liability under the FTC Act,” and that finance providers “should take steps to ensure that their marketers do not engage in deceptive or other unlawful conduct.” Small business consumers, the staff paper noted, would also likely benefit from more uniform and easily understood financing disclosures in order to compare costs and product features in the small business marketplace.
California DBO releases draft regulations for commercial financing disclosures
In July, the California Department of Business Oversight (DBO) issued a request for comment on draft of regulations implementing the state’s new law on commercial financing disclosures. As previously covered by InfoBytes, in September 2018, the California governor signed SB 1235, which requires non-bank lenders and other finance companies to provide written consumer-style disclosures for certain commercial transactions, including small business loans and merchant cash advances. Most notably, the act requires financing entities subject to the law to disclose in each commercial financing transaction—defined as an “accounts receivable purchase transaction, including factoring, asset-based lending transaction, commercial loan, commercial open-end credit plan, or lease financing transaction intended by the recipient for use primarily for other than personal, family, or household purposes”—the “total cost of the financing expressed as an annualized rate” in a form to be prescribed by the DBO.
The draft regulation provides general format and content requirements for each disclosure, as well as specific requirements for each type of covered transaction. In addition to the detailed information in the draft regulation, the DBO has released model disclosure forms for the six financing types, (i) closed-end transactions; (ii) open-ended credit plans; (iii) general factoring; (iv) sales-based financing; (v) lease financing; and (vi) asset-based lending. Additionally, the draft regulation uses an annual percentage rate (APR) as the annualized rate disclosure (as opposed to the annualized cost of capital, which was considered in the December 2018 request for comments, covered by InfoBytes here). Moreover, the draft regulation provides additional information for calculating the APR for factoring transactions as well as calculating the estimated APR for sales-based financing transactions.
Comments on the draft regulations are due by September 9.
New York legislature introduces bills to protect small businesses, regulate merchant cash advance transactions
On May 1, S5470 was introduced in the New York State Senate and is now sitting with the Committee on Banks, which would establish consumer-style disclosure requirements for certain commercial transactions. Similar to the legislation enacted in California last September, previously covered in InfoBytes here, the bill requires financing entities subject to the law to disclose in each commercial financing transaction “the total cost of the financing, expressed as a dollar cost, including any and all fees, expenses and charges that are to be paid by the recipient and that cannot be avoided by the recipient, including any interest expense.” For open and closed-end commercial financing transactions, the bill requires that the disclosures must include, among other things, (i) the amount financed or the maximum credit line; (ii) the total cost of the financing; (iii) the annual percentage rate; (iv) payment amounts; (v) a description of all other potential fees and charges; and (vi) prepayment charges. The bill sets out analogous, but separate, disclosure requirements for accounts receivable purchase transactions, such as merchant cash advance and factoring transactions.
Importantly, the bill does not apply to (i) financial institutions (defined as a chartered or licensed bank, trust company, industrial loan company, savings and loan association, or federal credit union, authorized to do business in New York); (ii) lenders regulated under the federal Farm Credit Act; (iii) commercial financing transactions secured by real property; (iv) a technology service provider; and (v) a lender who makes no more than one applicable transaction in New York in a 12-month period or any person that makes commercial financing transactions in New York that are incidental to the lender’s business in a 12-month period.
Additionally, the New York legislature is also considering a number of other bills that would affect commercial financing transactions:
- A03637, would amend the state’s banking law to deem asset-based lending transactions (defined as, “a transaction in which advances are made which are contingent on the recipient forwarding payments received from one or more third parties for goods such recipient has supplied or services such recipient has rendered to that third party or parties.”) to be loans for all purposes. On its face, this legislation would subject typical merchant cash advance and factoring transactions, which New York courts have in many recent court cases deemed to be non-loan transactions, to lending law restrictions, which would include potential licensure requirements and usury restrictions.
- A03636, would amend the state’s business law to prohibit the inclusion of a confession of judgment (COJ) in a contract or agreement for a financial product or service provided by an entity regulated by the New York Department of Financial Services for the purpose of consumer or investor protection, which is specifically defined by the bill as: (i) any product or service for which registration or licensing is required or for which the offeror or provider is required to be registered or licensed by state law; (ii) any product or service as to which provisions for consumer or investor protection are specifically set forth for such product or service by state statute or regulation; and (iii) securities, commodities and real property subject to the provisions of article 23A of the general business law. COJs are contractual clauses in which a debtor waives in advance his or her right to be notified of a court hearing, or to present his or her side of the case, which are prohibited under federal law for consumer contracts by the FTC Credit Practices Rule (16 C.F.R. pt. 444). In conjunction with potential licensure required under AO3637 above, the passage of both pieces of legislation in New York could result in the prohibition of COJ clauses in merchant cash advance agreements, a common feature of such agreements and generally permitted under New York law.
- A03638, would extend the majority of the state’s consumer protections with respect to loans made to small businesses (defined by the bill as, a “small business shall be deemed to be one which is resident in this state, independently owned and operated, not dominant in its field and employs one hundred or less persons.”). Specifically, the bill would amend the state’s general obligations law to extend all rights and privileges granted under the title to small businesses and would also amend Section 173 and Section 380-e of the state’s banking law to extend all the rights and privileges granted by the section to small businesses.
Relatedly, the FTC recently held a forum on small business marketplace lending practices, see detailed InfoBytes coverage on the forum here.
FTC holds forum on marketplace lending to small businesses
On May 8, the FTC held a forum with members of the small business marketplace to discuss the recent uptick in online loans and alternative financing products, and to analyze the potential for unfair and deceptive marketing, sales, and collection practices in the industry. Opening “Strictly Business: An FTC Forum on Small Business Financing,” FTC Commissioner Rohit Chopra expressed broad concerns about the state of entrepreneurship in the U.S. and the barriers small businesses face when negotiating contracts. Three panels discussed topics including (i) recent trends in the financing marketplace and small business financing products; (ii) the impact of fintech in online lending; (iii) an examination of the risks and benefits of the merchant cash advance industry; and (iv) consumer protection risks and legislative, self-regulatory, and educational efforts to help better protect borrowers.
During the first panel, several industry members discussed the importance of credit and financing products in meeting the capital needs of small businesses who often experience challenges with funding operations and cash management. While traditional bank lending and Small Business Administration (SBA) loans often require lengthy, costly underwriting standards, several panelists noted that new marketplace financing options have created opportunities for small businesses that previously did not exist. Among other things, panelists emphasized that there is a big difference between consumer credit and business credit, and that online lenders are leveraging underlying business data, credit card receivables data, and fundamental underlying business transaction data to make sure small businesses can sustain and service their debt. Funding time is also critical to small businesses with many choosing online lenders for faster access to funds. The panel discussed the benefits of online financing products, such as moving away from including consumer credit scores in the underwriting process and examining nontraditional data to look at cash flow, but also cautioned that there can be a lack of transparency around terms and pricing.
The second panel discussed the merchant cash-advance (MCA) industry, which they described as providing an unregulated form of financing for small businesses in the form of factoring future receivables. Recently, the industry has been scrutinized for alleged collection abuses and use of confessions of judgment (COJs). COJs, which allow lenders to legally seize borrowers’ bank accounts and other assets without a judge’s review, have led to a flood of questionable legal actions against small businesses, according to Commissioner Chopra. However, one of the panelists noted that the FTC limited the ban on COJs to consumers.
The third panel discussed consumer protection risks as well as products and information available for small business borrowers. A key concern amongst several of the panelists was whether business borrowers are sophisticated enough to understand the various options and if they are able to receive the necessary information to shop between products, such as APRs, total costs, and average monthly payments. The panel also discussed federal and state law, as well as self-regulatory efforts, that offer protections for small business borrowers. All agreed that there has been significant action taken at the state level to try to standardize and harmonize these types of lending practices, and while there was support for a national standard, they cautioned that a weaker national standard should not preempt a stronger state standard. Transparent disclosure standards, consumer protection oriented issues such as privacy and data security, as well as deceptive practices, were also discussed, with panelists agreeing that outreach and consumer education is vital in helping consumers make informed decisions.
Director of the FTC’s Bureau of Consumer Protection, Andrew Smith, closed the forum by emphasizing that the FTC has broad authority under the FTC Act to tackle unfair and deceptive practices, and stating that the Commission is very concerned about reports of unfair and deceptive marketing, sales, and collection practices in the small-business finance market. He stressed that while financial technologies can evolve quickly, the underlying legal protections for small businesses remain the same.