The California Commercial Financing Disclosure Law (CFDL) became effective on December 9, 2022, four years after Governor Jerry Brown signed the CFDL legislation into law in September 2018. After numerous revisions and comment periods, the Department of Financial Protection and Innovation (DFPI) finalized rules on June 9, 2022, triggering a six-month implementation period.
Announcing the new rules, DFPI Commissioner Clothide Hewlett said: “These first-in-the-nation protections for small business borrowers are a major milestone in financial services oversight in California and a model for other states to follow.”
To date, three other states have followed California’s lead and enacted similar, consumer-like laws for commercial lending – New York (effective August 1, 2023), Utah (effective January 1, 2023) and Virginia (partially effective July 1, 2022). A handful of states, including Connecticut, Maryland, Missouri, North Carolina and New Jersey, are considering their own versions of commercial loan disclosure laws for small business borrowers.
What follows is a brief overview of the California CFDL and some of its associated complexities, along with a look at the key similarities and differences in the laws of New York, Utah, and Virginia.
The California CFDL applies to non-depository financial institutions that provide commercial financing to recipients whose businesses are located in or principally directed from California. Exempted from the law are federal- and state-chartered banks, credit unions and trust companies but not wholly owned subsidiaries of the same. Also exempted are financial technology firms providing technology or support services to a depository institution’s commercial financing program.
However, two conditions must exist for this fintech exemption to apply. The fintech must have no interest in or agreement to acquire an interest in the commercial financing, and the program must not be branded with the fintech’s trademark. Note that this narrow exemption for fintechs may not apply to the type of partnerships many fintechs forge with banks to facilitate financing. It is therefore incumbent upon funding banks to ensure that each non-exempt fintech partner has a compliant program in place to provide the new California disclosures in a timely, accurate and complete manner.
The types of commercial financings covered by the California CFDL include closed- and open-end loans, general factoring, sales-based transactions (e.g., merchant cash advances), lease financing, and asset-based transactions equal to or less than $500,000. A catch-all provision applies to all other commercial financing transactions not falling with the aforementioned classifications.
The California CFDL requires lenders to disclose specific information about the major terms of commercial financing when a detailed offer of credit is made and before loan documents are presented to the borrower to enable comparison with offers from other lenders. It has exacting formatting requirements as to font size, column width, and the representation of numbers and percentages.
The following information must be disclosed in columnar format: (i) total amount of financing and the disbursement amount; (ii) finance charge; (iii) annual percentage rate (APR); (iv) term; and (v) total repayment amount; and (vi) prepayment penalties.
Calculations of APR and finance charge are similar to but not exactly like the federal Truth in Lending Act (TILA) and Regulation Z. An unresolved question exists as to whether lenders can rely on the Official Staff Commentary to Regulation Z, which provides valuable information pertaining to the calculation of finance charge.
New York’s CFDL was signed by Governor Andrew Cuomo on December 23, 2020. On September 14, 2022, the New York Department of Financial Services (NYDFS) issued a notice of proposed rulemaking to mandate that consumer-like disclosures be provided by commercial finance companies to business borrowers when a specific offer of financing is offered for certain commercial transactions of $2.5 million or less – a significantly higher maximum than California’s $500,000.
NYDFS published a final rule on February 1, 2023, with an effective date of August 1, 2023. Banks, credit unions, trust companies and industrial loan companies are exempt, as well as majority-owned subsidiaries of such financial institutions, unlike California that does not exempt subsidiaries of depositories. However, like California, New York’s final rule now limits the CFDL’s scope to transactions where the recipient is principally directed or managed from New York (or is a natural person residing in New York). This is a significant change from New York’s proposed rule, which would have applied to all transactions nationwide whenever the provider was based in New York.
However, an exception applies when the borrower’s state also requires commercial loan disclosures, which as of now is California, Utah, and for sales-based financing transactions Virginia. In that case, the disclosures required by the borrower’s home state would apply. The types of commercial financings specified parallel California’s rule including the broad, catch-all category of “other.”
The specific terms that must be disclosed under New York’s CFDL parallel California but include three additional items: 1) periodic payment amounts; 2) a description of potential fees that can be avoided (e.g., late payment fees, returned payment fees, etc.); and 3) a description of collateral requirements or security interest.
Utah followed California and New York with its Commercial Financing Registration and Disclosure Act, which was signed into law by Governor Spencer Cox on March 23, 2022. As the law’s title proclaims, there is a registration requirement for non-exempt commercial lenders, which is a significant difference from California and New York, which have no registration or licensing requirement.
As of January 1, 2023, commercial financing providers in Utah or providers outside of Utah that offer commercial financing to Utah residents must register annually with the Utah Department of Financial Institutions (DFI) and be registered with the Nationwide Multistate Licensing System and Registry (NMLS). Presumably, the Utah DFI will utilize the NMLS to administer the license application and renewal process.
Utah exempts a wider range of entities and transactions than California and New York – these include subsidiaries of banks, providers of five or fewer commercial financings in any calendar year, Utah-licensed money transmitters, real-estate secured transactions, financings of $50,000 or more to motor vehicle dealers or leasing companies, and commercial transactions over $1 million.
However, the Utah law applies specifically to fintechs that make more than five commercial financing transactions in the state during any calendar year under a written agreement with a depository institution via an online platform.
Interestingly, Utah does not yet require APR or similar rate disclosure but does mandate the disclosure of (i) total funds provided; (ii) total funds disbursed (if less than funds provided); (ii) total amount to be paid to provider; (iv) total dollar cost of transaction; (v) payment manner, amount and frequency; (vi) prepayment penalties; and (vii) funds paid to brokers.
Virginia was the first state to require registration of providers and brokers of sales-based commercial financing when Governor Glenn Younkin signed the state’s registration and disclosure bill into law on April 11, 2022. Mandatory registration with the State Corporation Commission began on November 1, 2022, while the disclosure requirements apply to sales-based transactions entered into after July 1, 2022.
In this context, “sales-based financing” means a transaction that is repaid by the recipient to the provider, over time, as a percentage of sales or revenue, in which the payment amount may increase or decrease according to the volume of sales made or revenue received by the recipient. Sales-based financing also includes a true-up mechanism where the financing is repaid as a fixed payment but provides for a reconciliation process that adjusts the payment to an amount that is a percentage of sales or revenue.
Virginia has a similar de minimis exemption for providers and brokers who enter into five or fewer sales-based financing transactions within a 12-month period or individual sales-based financing transactions of more than $500,000.
Nine specific items must be disclosed: (i) total amount of financing and the disbursement amount if different from the financing amount; (ii) financing charge; (iii) total repayment amount (disbursement amount plus finance change); (iv) estimated number of payments (based on projected sales volume, to equal the total repayment amount); (v) payment amounts (based on projected sales volume); (vi) description of all other potential fees and charges not included in the finance charge; (vii) prepayment information; (viii) description of collateral requirements or security interests; and (ix) declaration of whether provider will pay any compensation directly to broker and the amount of compensation. Additionally, if the recipient elects to prepay or refinance the sales-based financing, updated disclosures are required.
There’s little doubt that more and more states will hop aboard the bandwagon and require commercial financing disclosures for small businesses and/or registration by the non-bank finance companies and fintechs that provide the financing. Even now, there is sufficient divergence of the laws among the four states discussed above to require covered financial institutions to carefully establish state-specific policies, procedures, processes and controls to ensure compliance. Effectively managing these regulatory changes, including adjustments to third-party and vendor oversight programs, will help institutions avoid unexpected, unnecessary and unwanted consequences.
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