California has again upped the ante on commercial lending compliance duties.
The Golden State has recently adopted a new law requiring certain lenders and intermediaries to provide special disclosures to commercial loan customers in connection with certain types of commercial finance arrangements.
The new California Commercial Financing Disclosures law is intended to provide “truth in lending” type of disclosures for small business loan borrowers. Its requirements will be in addition to requirements under existing California law that mandate licensing for certain commercial lenders and requirements under the controversial new California privacy law that may also impact certain commercial loan arrangements, such as business loans backed by personal guarantees.
The following is a brief “question and answer” summary regarding the California Commercial Financing Disclosures law.
What types of loans does the law apply to?
The law is directed at offers of “commercial financing” of $500,000 or less made to a recipient who intends to use it primarily for purposes other than personal, family or household purposes.
“Commercial financing” includes:
- Accounts receivable purchase transactions,
- Asset-based lending transactions,
- Commercial loans,
- Commercial open-end credit plans, and
- Lease financing transactions.
Each of these types of transactions is expressly defined in the law, and the definitions create certain carve-outs. For example:
- The definition of “commercial loan” excludes any loan with a principal amount of less than $5,000.
- The definition of “lease financing” only applies if the lease includes a purchase option that creates a security interest under California law.
The law allows a “provider” (i.e., a lender or lender intermediary subject to the law) to rely on a written statement of intended purposes signed by the recipient to determine whether or not financing is being offered for personal, family or household purposes. Also, the law does not require the provider to ascertain that the proceeds of the financing are, in fact, used in accordance with such a statement of intended purposes.
What types of transactions are exempt from the law?
The following types of transactions are exempt from the law’s requirements:
- A commercial financing transaction secured by real property, and
- A commercial financing transaction in which the recipient is a dealer, as defined in California’s Vehicle Code law, or an affiliate of such a dealer, or a vehicle rental company, or an affiliate of such a company, and the transaction is pursuant to a specific commercial financing offer or commercial open-end credit plan of at least $50,000, including any commercial loan made pursuant to such a commercial financing transaction.
What types of lenders and intermediaries qualify as ‘providers’ that are subject to the law?
The law applies to any “provider.” A provider is a party, such as a lender, that extends a specific offer of commercial financing covered by the law.
However, a “provider” can also be an intermediary. The law expressly includes within the definition of “provider” any nondepository institution that enters into a written agreement with a depository institution (such as a state or federally chartered bank) to arrange for the extension of commercial financing by the depository institution to a recipient of the offer via an online lending platform administered by the nondepository institution. So, even if a bank is exempt from the law (see below), at least some of its service providers may not be exempt. The law is not clear regarding whether other types of intermediaries would be subject to the law, such as loan brokers or agents operating from physical offices or via the mail – rather than an online platform – to make offers on behalf of lenders.
The term “specific offer” indicates that the law would not be triggered by general advertising of financing products by any type of provider.
What types of lenders and other ‘providers’ are exempt from the law?
The following “providers” are exempt from the law’s requirements:
- A depository institution, such as a state or federally chartered bank, savings association or credit union “authorized to transact business” in California;
- A lender regulated under the federal Farm Credit Act;
- Any person who makes no more than one commercial financing transaction “in California” in a 12-month period; and
- Any person who makes five or fewer commercial financing transactions “in California” in a 12-month period that are “incidental to the business of the person relying upon the exemption.”
The law does not explain how an out-of-state state-chartered depository institution without a California branch could meet the requirement of being “authorized to conduct business” in California to qualify for the exemption. Also, the law does not expressly extend the depository institution exemption to subsidiaries or affiliates of depository institutions.
In the de minimus exceptions listed above under items 3 and 4:
- The references to making transactions “in California” may refer to the borrower’s physical location — rather than the provider’s location — being in California, based on the law’s applicability to online platform offers by providers; and
- The phrase “incidental to the business of the person relying upon the exemption” appears to target sellers of goods or services that may occasionally provide financing for customers.
If the law applies, what does a provider have to do?
If the law applies, the provider must disclose the following information (as applicable) to the borrower at the time a specific offer of commercial financing is extended, and must obtain the borrower’s signature on the disclosure prior to consummating the commercial financing:
- The total amount of funds provided,
- The total dollar cost of the financing,
- The term or estimated term,
- The method, frequency, and amount of payments,
- A description of prepayment policies, and
- The total cost of the financing expressed as an annualized rate.
There are alternate disclosure options for a provider who offers factoring or asset-based lending and that offers the recipient an agreement that describes the general terms and conditions of the commercial financing transaction that will occur under the agreement.
The requirement for a disclosure of the total cost as an annualized rate has a “sunset” provision, so that it will remain in effect only until January 1, 2024, unless further legislation is adopted to extend it.
When do providers have to start complying?
Although the law was approved by the Governor on September 30, 2018, providers will not have to comply with its requirements until the California Commissioner of Business Oversight adopts regulations implementing the law.
The rulemaking process is now in the initial stages. Preliminary comments on potential rule topics were due January 22, 2019, and proposed rule language has not yet been released. Due to the lengthy rulemaking procedures involved, the rules are unlikely to be finalized for several months, and accordingly, the compliance date for the new law is not likely to be until late in 2019 at the earliest.