It appears likely that California Governor Jerry Brown will sign a bill passed on August 31 by the state's Senate, Senate Bill 1235, which would create consumer-style disclosure requirements for certain commercial loans and other finance products, such as merchant cash advances and factoring transactions.
Notably, the new disclosure requirements would apply to sponsors of bank-model lending programs in addition to companies directly extending certain forms of commercial credit pursuant to California Finance Lender licenses. The requirements would apply whenever the company receiving financing is located in California, even if the company providing the financing is located outside the state. Although the bill contains several ambiguities and potential loopholes created by last-minute amendments, Governor Brown is expected to sign it over industry opposition.
The bill's central feature is a requirement that "providers" make the following disclosures before consummation of a covered transaction and must obtain the recipient’s signature on the disclosure: "(1) the total amount of funds provided; (2) the total dollar cost of the financing; (3) the term or estimated term; (4) the method, frequency, and amount of payments; (5) a description of prepayment policies; and (6) the total cost of the financing expressed as an annualized rate."
Providers "who [offer] commercial financing that is factoring or asset-based lending and that [offer] the recipient an agreement that describes the general terms and conditions" have the option of disclosing the same terms "as an example of a transaction that could occur under the general agreement for a given amount of accounts receivables." The requirement to disclose the annualized rate will sunset on January 1, 2024.
As used in the bill, the term "provider" includes both a "person who extends a specific offer of commercial financing to a recipient," and certain bank-model program sponsors, i.e., "a nondepository institution, which 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 administered by the nondepository institution." "Commercial financing" is defined broadly to include "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." This would appear to include commercial credit cards but not commercial sales finance contracts.
There are exemptions and carve-outs for, among other things, depository institutions, financings of more than $500,000, closed-end loans with a principal amount of less than $5,000, and transactions secured by real property.
Numerous drafting errors in the bill will create substantial uncertainty and difficulty for companies subject to its disclosure requirements. For example, the alternative "possible example" form of disclosure presumably is intended to address the fact that it is impossible to calculate most of the disclosure amounts for a merchant cash advance until the transaction has been fully performed. The Innovative Lending Platform Association, a prominent small business finance trade group, recognized this fact in its model disclosure for merchant cash advances. As drafted, however, the bill would not permit merchant cash advance companies to make the alternative disclosure because it is available only to providers of "commercial financing that is factoring or asset-based lending." Thus, merchant cash advance companies cannot possibly comply with the bill as drafted. In addition, while the bill's definition of "commercial financing" includes open-end credit, the disclosure regime it contemplates is not designed to accommodate commercial open-end credit plans where, for example, the total amount to be lent and the total cost cannot be determined in advance. There are several other significant drafting errors affecting other types of companies.
The bill's requirements are subject to examination and enforcement by the California Department of Business Oversight (DBO). Providers need not comply with the bill until the DBO adopts regulations addressing details such as calculation methods for the items to be disclosed and the time, manner, and format of the disclosures. We do not expect the DBO to propose these regulations until after the next state administration takes office, and presumably the DBO will specify an effective date that allows a reasonable amount of time in which to comply.
Unless industry trade groups can persuade Governor Brown not to sign this poorly drafted bill, many companies offering commercial financing in California will have to choose between challenging the law in court and limiting the financing options they offer in the state. For example, companies may stop offering merchant cash advances and analogous loan products, depriving California merchants of the ability to align their financing obligations with their cash flow. This surely is not the result intended by the bill’s sponsors.
Ballard Spahr's Consumer Financial Services Group is nationally recognized for its guidance in structuring and documenting new consumer financial services products and programs, its experience with the full range of federal and state consumer credit laws, and its skill in litigation defense and avoidance.
The firm's Marketplace Lending Task Force is nationally recognized for counseling Fintech companies in both the consumer and small business spaces. We offer soup-to-nuts guidance, working with startup alternative lenders, long-established market leaders, banks, institutional investors, and others. We document and advise on the structure and strategy of bank, platform, and investor relationships, assist in concluding account servicing arrangements, provide extensive consumer regulatory advice, documentation, and diligence assistance, and help with state licensing. We have been advising clients on the steps involved in obtaining a special purpose national bank charter from the Office of the Comptroller of the Currency.
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