TILA for Business Loans and Purchases of Receivables? Factors, MCAs, Fintechs and Commercial Lenders Subject to New CA TILA-Like Disclosure Rules
California enacts a first-of-its-kind legislation imposing disclosure requirements on commercial purpose loans similar to those that the federal Truth in Lending Act (“TILA”) and Regulation Z impose on consumer purpose loans. And it extends those provisions to factoring, merchant cash advances and other types of arrangements that involve assignments of accounts and receivables.
On September 30, 2018, California Governor Jerry Brown signed S.B. 1235 into law, which will amend the California Financing Law (“CFL”) to require certain providers of “commercial financing” to disclose information to a recipient at the time of extending a commercial financing offer that is $500,000 or less and to obtain the recipient’s signature on the disclosure before consummating the commercial financing transaction. S.B. 1235 does not create new licensing obligations. Rather, it imposes new disclosure requirements on those who fall within S.B. 1235’s coverage, including both those who are licensed under the CFL and those who are not required to obtain a CFL license.
This change will impact a broad range of non-bank fintech companies offering smaller balance commercial loans. In fact, one purpose of the bill was to require disclosures in so-called bank partnership arrangements, when a commercial finance provider works through an online platform.
While the disclosures vary slightly depending on the type of commercial financing involved, a provider would generally need to disclose the following information: (i) total amount of funds provided; (ii) total dollar cost of the financing; (iii) term or estimated term; (iv) method, frequency and amounts of payments; (v) description of prepayment policies; and (vi) total cost of the financing expressed as an annualized rate. Because the law covers commercial open-end credit plans, accounts receivable transactions and certain lease financing transactions, alternative disclosures for factoring or asset-based lending are provided.
The law will have a significant impact on providers beyond traditional commercial lenders, as it broadly defines “commercial financing” to include accounts receivable purchase transactions, including merchant cash advances, factoring, asset-based lending transactions, commercial loans, commercial open-end credit plans and lease financing transactions intended by the recipient for use primarily for other than personal, family or household purposes.1 Leasing financing is narrowly defined to exclude traditional leasing transactions but captures those lease transactions with a purchase option that creates a security interest in the goods leased.2
Because the law broadly defines commercial financing to include factoring,3 asset-based lending transactions4 and accounts receivable purchase transactions,5 providers offering merchant cash advances or other more traditional factoring arrangements will need to make the same types of disclosures as traditional commercial lenders. While the law is intended to allow recipients to compare various types of commercial financing in a manner similar to how consumers can using TILA’s APR, it remains uncertain whether the annualized rate disclosure will enable meaningful comparisons across different types of commercial financing arrangements.
There are a number of exemptions from these new requirements, some of which mirror existing exemptions from the CFL’s general licensing requirement. The law expressly excludes the following entities: (i) a depository institution (e.g., a bank, credit union or savings association), (ii) a lender regulated under the federal Farm Credit Act, (iii) a commercial financing transaction secured by real property, (iv) a commercial financing transaction in which the recipient is a motor vehicle dealer or a vehicle leasing company or an affiliate of that company and the transaction exceeds $50,000 (v) a person who makes no more than one commercial financing transaction in California in a 12-month period and (vi) a person who makes five or fewer commercial financing transactions in California in a 12-month period if lending is incidental to the business of the person relying on the exemption.
Portions of the law are scheduled to sunset on January 1, 2024, at which time providers will not need to deliver the annualized rate disclosure for traditional financing or for factoring and asset-based lending transactions.
While depository institutions are excluded from the CFL, a provider includes a non-depository institution that enters into a written agreement with a depository institution to arrange for the extension of commercial financing by the depository institution to a recipient via an online lending platform. This would include those commercial lending platforms that originate their loans or merchant cash advances through a bank partner arrangement. Therefore, fintech companies operating commercial lending platforms would be required to comply with this law, regardless of whether they relied on a bank partner arrangement or would not be subject to CFL licensing.
The law requires the Commissioner of the DBO (“Commissioner”) to adopt regulations covering the following points: (i) definitions, contents or methods for each of the disclosure items; (ii) requirements concerning the time, manner and format of the applicable disclosures; and (iii) the annualized rate disclosure. The regulations regarding the annualized rate disclosure must include the following: (a) a determination of the appropriate method to express the annualized rate disclosure and the types of fees included in the disclosure; (b) when providers may be permitted to disclose an estimated annualized rate and how the estimate must be calculated and the accuracy requirements and tolerance allowances for the annualized rate disclosures; and (c) the time, manner and format of the disclosures.
A violation of S.B. 1235’s provisions constitutes a violation of the CFL. Potential penalties for those violations include cease and desist orders, license suspensions or revocations (for those who are licensed under the CFL), and civil penalties of $2,500 per willful violation. In addition, there are penalties of up to $10,000 or imprisonment in a county jail for not more than one year or both. These penalties should be imposed only on the provider that failed to make the required disclosures to the borrower, such as the person who extended a specific offer of commercial financing or an online lending platform that facilitated the offer.
While the law is effective January 1, 2019, a provider is not required to comply with the disclosure requirements until final regulations are adopted by the Commissioner and become effective. This will likely delay the compliance date until the summer of 2019. It is possible the current Commissioner will retire in early 2019, following the November 2018 elections. If that were to occur, the DBO might not act to implement regulations until a new Commissioner takes office. Regardless, the DBO may specify a date by which companies are required to comply. If this is the case, the compliance date might carry over into 2020.
1 Cal. Fin. Code § 22800(d)(1).
2 The California Department of Business Oversight (“DBO”), which licenses commercial lenders in California, has historically treated finance leases as loans that are subject to the DBO’s purview.
3 “Factoring” means “as an accounts receivable purchase transaction that includes an agreement to purchase, transfer, or sell a legally enforceable claim for payment held by a recipient for goods the recipient has supplied or services the recipient has rendered that have been ordered but for which payment has not yet been made.” Cal. Fin. Code § 22800(i).
4 “Asset-based lending transaction” means “a transaction in which advances are made from time to time contingent on a recipient forwarding payments received from one or more third parties for goods the recipient has supplied or services the recipient has rendered to that third party or parties.” Cal. Fin. Code § 22800(c).
5 “Accounts receivable purchase transaction” means “a transaction as part of an agreement requiring a recipient to forward or otherwise sell to the provider all or a portion of accounts, payment intangibles, or cash receipts that are owed to the recipient or are collected by the recipient during a specified period or in a specified amount.” Cal. Fin. Code § 22800(b).
