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New York enacts commercial lending disclosure requirements
On December 23, the New York governor signed S5470, which establishes consumer-style disclosure requirements for certain commercial transactions. For open and closed-end commercial financing transactions, the legislation requires that the disclosures 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. Violations are subject to a civil penalty no greater than $2,000 per violation. Notably, the legislation exempts (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) technology service providers; (v) lenders who make no more than five applicable transactions in New York in a 12-month period; and (vi) any individual commercial financing transaction over $500,000. The legislation is effective 180 days after enactment.
As previously covered by InfoBytes, California is currently finalizing proposed regulations implementing the requirements of the commercial financing disclosures required by SB 1235 (Chapter 1011, Statutes of 2018), which was enacted in September 2018. The California Department of Financial Protection and Innovation previously signaled its intent to finalize the regulations by January 2021.
New Jersey charges MCA provider with deceptive practices
On December 8, the New Jersey attorney general announced an action against a merchant cash advance provider, its parent company, and six other associated entities (collectively, “defendants”) alleging the defendants violated the New Jersey Consumer Fraud Act (CFA) and the General Advertising Regulations through the marketing and transacting of their merchant cash advance (MCA) product. (The defendants are currently facing similar allegations from the FTC, covered by InfoBytes here.) According to the complaint, the defendants engaged in “unconscionable business practices, deceived consumers, and/or made false or misleading statements” by marketing and advertising an MCA product, which was allegedly structured as a short-term, high-cost loan. New Jersey argues that the MCA contracts contain terms that “eliminate the distinctions between loans (with fixed regular payments over a defined term) and legitimate MCAs (with variable payments tied to actual receivables and an undefined term).” New Jersey asserts that traditionally, MCA’s do not have a finite repayment term and thus, the fixed repayment period was the equivalent of a loan to its customers. Moreover, the agreements’ “fixed daily payments extracted from Consumers’ accounts have little to no relation to the businesses’ receivables.” Additionally, New Jersey asserts that the defendants allegedly engaged in unconscionable collection practices, including requiring consumers to sign, in their individual capacity and on behalf of their business, an Affidavit of Confessions of Judgment to obtain the MCA, which would allow judgment against both the Consumer’s business assets and personal assets in the event of a purported default. New Jersey is seeking a permanent injunction, civil penalties, restitution, and disgorgement.
Notably, the New Jersey complaint follows a recent enforcement action against a merchant cash advance provider in California (covered by InfoBytes here), where the California Department of Financial Protection and Innovation (DFPI) found, in apparent contrast to the New Jersey action, that MCA agreements with an indefinite repayment period, among other things, operate as a loan equivalent by, placing the “risk of repayment on the merchant by leaving the repayment period open until fully repaid (with fees and interest).”
California DFPI issues MCA enforcement action covering future receivables
On November 12, the California Department of Financial Protection and Innovation (DFPI) issued a consent order with a commercial financing company, resolving allegations that the company’s merchant cash advance (MCA) product was structured as a lending transaction and offered to California merchants without first obtaining a license as required by the California Financing Law (CFL). According to the DFPI, the MCA agreements in question provide the company with “broad authority to declare ‘default’ on its merchants and when doing so may use extensive recourse allowed under its [a]greement,” including in the event of insufficient funds requiring the full funding amount to be repaid, which DFPI argues, “does not put the risk of the ‘purchase’ of receivables on [the financing company]’s shoulders, but rather the risk of repayment on the merchant’s shoulders, just like a loan.” Moreover, the agreements provide for an indefinite repayment period, placing the “risk of repayment on the merchant by leaving the repayment period open until fully repaid (with fees and interest).” The consent order distinguishes between outstanding and future receivables, noting that under California law, commercial financiers purchasing a share of a merchant’s outstanding receivables without recourse (e.g., factoring), is generally not considered lending, but there is no similar recognition by the legislature or courts with respect to future receivables.
The consent order requires the company to (i) desist from lending in California unless and until licensed under the CFL; (ii) refund fees or payments collected from California merchants in excess of the 10 percent state interest rate cap for non-CFL licensees; and (iii) pay $20,000 to the DFPI to cover the cost of the investigation.
Merchant cash advance providers move to dismiss FTC allegations of deceptive and unfair conduct
On October 23, defendants in an FTC lawsuit filed a reply brief in support of their motion to dismiss allegations claiming they misrepresented the terms of their merchant cash advances (MCA), used unfair collection practices, made unauthorized withdrawals from consumer accounts, and misrepresented collateral and personal guarantee requirements in advertisements. As previously covered by InfoBytes, the FTC filed a complaint in August against the defendants—two New York-based merchant cash advance providers and two company executives—alleging deceptive and unfair conduct in violation of Section 5 of the FTC Act. Earlier in October, the defendants filed a motion to dismiss, arguing, among other things, that the FTC “lack[ed] the statutory authority to bring its claims in federal court” under Section 13(b) of the FTC Act because “none of the challenged conduct, to the extent it even occurred or was actionable, is plausibly alleged to be ongoing or ‘about to’ occur.” The FTC countered that it “need only allege” that it had “reason to believe Defendants are violating or are about to violate” Section 5 in order to file suit in federal district court. The FTC further contended that it had also alleged facts sufficient for individual liability.
The defendants responded to the FTC’s opposition to dismissal, arguing, among other things, that even if the FTC invoked the statutory authority under Section 13(b) to have the court hear its claims, the claims fail for other reasons, including that the complaint fails to state a claim under Section 5 by (i) only providing “fragments of advertisements without necessary context”; (ii) ignoring “the express fee disclosures in the MCA agreement” that outline the fees to be paid by a merchant; and (iii) ignoring the fact that “so-called ‘unauthorized’ ACH withdrawals were “explicitly authorized under the MCA agreement.” The defendants further argued that the individual liability claims should also be dismissed because the FTC failed to sufficiently allege that the individual defendants directly participated in or had authority over the alleged conduct.
CFPB outlines plan to disclose data on small-business lending
On September 15, the CFPB released its “Outline of Proposals Under Consideration and Alternatives Considered” (Outline) for implementing the requirements of Section 1071 of the Dodd-Frank Act, which instructs the Bureau to collect and disclose data on lending to women and minority-owned small businesses. The detailed Outline describes the proposals under consideration and discusses other relevant laws, the regulatory process, and potential economic impacts. The Bureau also released a high-level summary of the Outline. Highlights of the proposals include:
- Scope. The Bureau is considering proposing that the data collection and reporting requirements would apply only to applications for credit by a small business. Financial institutions would not be required to collect and report data for women- and minority-owned businesses that are not considered “small,” as defined by the Small Business Act and the Small Business Administration’s (SBA) implementing regulations.
- Covered Lenders. The Bureau is considering proposing a broad definition of “financial institution” that would apply to a variety of entities engaged in small business lending, but is also considering proposing exemptions based on either a size-based (examples include $100 million or $200 million in assets), or activity-based threshold (examples range from 25 loans or $2.5 million to 100 loans or $10 million), or both.
- Covered Products. The Bureau is considering proposing exemptions from the definition of “credit” to include consumer-designated credit, leases, factoring, trade credit, and merchant cash advances.
- Application. Because an “application” would trigger requirements under Section 1071, the Bureau is considering proposing a definition that is largely consistent with Regulation B; however, the Bureau is also considering “clarifying circumstances,” such as inquiries/prequalifications, that would not be reportable.
- Data Points. The Bureau is considering a range of data points for collection, including, in addition to the mandatory data points required by Section 1071, “discretionary data points” to aid in fulfilling the purposes of Section 1071: “pricing, time in business, North American Industry Classification System (NAICS) code, and number of employees.”
- Privacy. The Bureau is considering using a “balancing test” for public disclosure of the data. Specifically, data “would be modified or deleted if its disclosure in unmodified form would pose risks to privacy interests that are not justified by the benefits of public disclosure.”
Additionally, the Bureau will convene a panel, as required by the Small Business Regulatory Enforcement Fairness Act (SBREFA), in October 2020 to “consult small entities regarding the potential impact of the proposals under consideration.” Feedback on the proposals is due no later than December 14.
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).