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California on the Verge of Requiring Commercial Finance Disclosures

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.

Copyright © by Ballard Spahr LLP


About this Author

Kaplinksy, partner, New York, finance

Alan S. Kaplinsky is Co-Practice Leader of the firm's Consumer Financial Services Group, which has more than 115 lawyers. Mr. Kaplinsky devotes his practice exclusively to counseling financial institutions on bank regulatory and transactional matters, particularly consumer financial services law, and defending financial institutions that have been sued by consumers in individual and class action lawsuits and by government enforcement agencies. Visit Mr. Kaplinsky's profile in Wikipedia.

Scott Pearson, Ballard Spahr Law Firm, Los Angeles, Business Litigation Attorney

Scott Pearson focuses his practice on the defense of regulatory enforcement actions and class actions, other complex business litigation, and regulatory compliance counseling. Martindale-Hubbell rates Mr. Pearson "at the highest level of professional excellence." He has been called "a true expert in complex litigation and consumer class actions" and "a no-nonsense bulldog lawyer who is highly respected by his peers and the judiciary."

Prominent companies regularly entrust Mr. Pearson with matters involving bet-the-company exposure or extreme complexity, such as overlapping claims being pursued simultaneously in multiple jurisdictions by federal regulators, state Attorneys General, and class action plaintiffs. He also serves as a trusted strategic business advisor, drawing on more than twenty years of experience. His clients include national banks and other financial services firms, institutional investors, sports and entertainment companies, retailers, and others.

Jeremy T Rosenblum, consumer financial services group, finance partner, Philadelphia, Pennsylvania, Ballard Spahr, UDAAP, TILA

Jeremy T. Rosenblum is Co-Practice Leader of the firm's Consumer Financial Services Group. He has devoted the past 30 years in private practice to representing the consumer financial services industry.

Mr. Rosenblum's practice focuses on federal and state lending and consumer practices laws, with emphasis on the interplay between federal and state laws, joint ventures between banks and nonbank financial services providers, the development and documentation of new financial services products (especially products designed to serve the needs of...

Mark Furletti, Partner, Ballard Spahr

Mark J. Furletti focuses on federal and state consumer lending and payments laws, including those that apply to payment cards, vehicle-secured loans, lines of credit, unsecured loans, and deposit products. He counsels providers of consumer financial services, including banks, on regulatory compliance matters and has successfully represented such providers in class action litigation and government supervisory and enforcement matters. He also regularly counsels purchasers of merchant receivables, companies that specialize in online small business lending and companies that...

Culhane, Ballard, Partner

John L. Culhane, Jr., is known for his work advising on interstate direct and indirect consumer and residential mortgage loan and leasing programs, through both traditional brick-and-mortar facilities and e-commerce. Before joining Ballard Spahr, Mr. Culhane was associate counsel with Mellon Bank, N.A.; associate counsel with Bank of America NT&SA; and senior attorney (section chief) with the National Credit Union Administration, the federal agency regulating federal credit unions.

Mr. Culhane addresses issues involving licensing,...