There’s a compliance totem pole in financing. Consumer lending is at the top as most highly regulated and business lending is near the bottom. There are ordered slots in each spot along the pole. For example, mortgage lending is one of the more highly regulated forms of consumer lending, having a number of additional federal laws to contend with (e.g., Real Estate Settlement Procedures Act, Home Mortgage Disclosure Act, Fair Housing Act), as well as state licensing and compliance on a 50-state basis. High-cost mortgages are at the very top with additional Home Ownership and Equity Protection Act and other compliance.
Although their product is towards the bottom of the pole, business lenders don’t get a regulatory free pass, but their compliance obligations are a fraction of those faced by consumer lenders. A few federal laws and regulations do apply to business lenders making loans to companies (e.g., Equal Credit Opportunity Act, Fair Credit Reporting Act if consumer reports are pulled on principals, Office of Foreign Asset Control rules) with a few more for business loans to sole proprietors (e.g., Servicemembers Civil Relief Act).
State side, a handful or two of states license and regulate business lenders making loans under a certain amount with interest rates over a certain annual percent. For example, New York licenses lenders that make business loans of $50,000 or less with an interest rate greater than 16%. California is one of the only states that flatly licenses and regulates all business lenders without regard to loan size or interest rate.
Merchant cash advances and factoring occupy places on the totem pole below business loans. Companies that offer MCAs and factoring products view their products not as loans - really the other side of the financing coin. Meaning, lenders extend liabilities (loans) and factors and MCA providers purchase assets. Factors buy invoices at a discount, MCA providers buy future receivables at a discount. As you can imagine, there’s a lot of grey area between both sides of the coin. There’s a fair amount of case law that informs how to structure these products for regulatory purposes. An examination of cases is beyond the scope of this Flash. A key thrust of the cases is around recourse - factoring and MCAs must largely be non-recourse in keeping with their characterization as an asset sale.
There’s little regulation around factoring and merchant cash advances. When a bill is introduced that covers these products, the industry takes note.
Such a bill was recently introduced in the California Senate. SB 1235 would require companies offering commercial financing in California to provide transaction disclosures. Commercial financing products covered by this bill would include commercial loans and lines of credit; and commercial accounts receivable financing, factoring and cash advances, all under $5,000.
The bill would require companies offering covered commercial financing to provide a written statement before consummation of the transaction. The statement would include disclosures about the total amount of fees, the amount provided, term length, monthly payment, total dollar cost, collateral required, policies regarding repayment and prepayment, annualized interest rate, and APR. The bill provides that the APR for cash advances would be calculated based on the daily, weekly or monthly delivery of receivables that is assumed as part of the offer. The bill offers no guidance on how to calculate the interest rate for factoring and cash advances and the APR for factoring.
SB 1235 would require the statement be signed by all parties to the transaction and meet certain requirements, including that it be in writing using a specified font size, made in the same language used in transactions discussions or negotiations, and not be vague or misleading.
The bill does not require factors and MCA providers to be licensed.
Check out SB 1235 here.
About the Author
|Mike is one of Goodwin’s 100+ lawyers advising on FinTech matters. Goodwin specializes in FinTech alternative lending and funding products and arrangements, including lending on the blockchain, virtual currency secured loans, income share agreements, factoring, merchant cash advances, and bank partnerships. Mike and other members of Goodwin’s FinTech team will be at LendIt April 9-11 in San Francisco, CA. Contact Mike for a meeting at LendIt.|