On June 9, 2022, the California Office of Administrative Law approved the California Department of Financial Protection and Innovation’s final regulations implementing California’s first-of-its-kind commercial financing disclosure law. The regulations take effect on December 9, 2022, so financers, providers, and brokers subject to the regulations should start preparing to provide compliant disclosures by the effective date.
In previous client alerts, we discussed the California Commercial Financing Disclosure Law enacted in September 2018 (the “Act”), and the first draft regulations issued by the California Department of Business Oversight, predecessor to the California Department of Financial Protection and Innovation (DFPI) in July 2019.
Now, after almost three years and four rounds of amended regulations, the DFPI has issued final regulations (Final Regulations) and set an effective date for the disclosure requirements. This client alert is the first in a series focused on the Final Regulations, discussing what they mean for financers, providers, and brokers of commercial financing transactions in California, as those terms are defined under the Final Regulations, and highlighting some lingering questions. In this client alert, we focus on who and what kinds of commercial financing transactions are covered, the required disclosures, and potential penalties for non-compliance.
Scope – Generally
The Act applies to commercial financing offers of $500,000 or less, and the Final Regulations address how to determine whether a financing offer meets that threshold.
The Act applies broadly not just to commercial loans, but also to commercial open-end credit plans, lease financings, factoring transactions, sales-based financing transactions (e.g., merchant cash advances), and asset-based lending transactions.
The Final Regulations limit coverage to “recipients whose business is principally directed or managed from California.” In determining whether a recipient meets this criterion, a provider may rely on a written representation from the recipient or the business address provided by the recipient in the financing application.
Among others, depository institutions are expressly exempt from the Act. This exemption, though, does not extend to a depository institution’s non-depository subsidiaries or affiliates. The Final Regulations also purport to cover non-depository institutions that enter into agreements with depository institutions to administer an online lending platform for the depository institution (a “Non-Bank Partner”).
Scope – Financers, Providers, and Brokers
The Final Regulations establish obligations for three types of entities: providers, financers, and brokers.
Provider is an entity that extends a specific offer of commercial financing or a Non-Bank Partner.
Financer is a new definition added to the Final Regulations. It is an entity that provides the commercial financing (even if another entity (i.e., the provider) extends the specific offer of commercial financing) or a Non-Bank Partner. Thus, there is overlap between the definitions of “provider” and “financer,” including with respect to a Non-Bank Partner.
Broker includes a person other than the financer, recipient, or recipient’s agent, who, for compensation: 1) participates in the negotiations; 2) advises the recipient about financing options; 3) participates in the preparation of any financing documents; 4) contacts the financer on behalf of the recipient; 5) gathers financing application documentation or delivers documentation to the financer; 6) communicates financing decisions; or 7) obtains the recipient’s signature on financing documents.
In response to comments, the DFPI did not identify any authority for including brokers in the regulations or any source for the expansive definition. Nor did the DFPI provide any substantive response to the point raised by commenters that inclusion of brokers is not necessary to implement the law. The only obligation of brokers under the Final Regulations is to provide disclosures received from the financer or provider to the recipient. Brokers are not responsible for the accuracy of the disclosures, but they may be liable if they make representations concerning the financing.
General Disclosure Requirements
At a high level, the Final Regulations require a provider of financing to:
- Prepare written disclosures that comply with the specific formatting and content requirements, including disclosure of: Funding Provided, Annual Percentage Rate (APR), Finance Charge, Total Payment Amount, Periodic Payment Amount or Monthly Cost, all calculated in accordance with the requirements set forth in the Final Regulations; as well whether there are any prepayment penalties.
- Provide the written disclosures (including in electronic form) to the recipient at the time of extending a Specific Commercial Financing Offer, which includes any time when the terms of an existing commercial financing contract are amended, supplemented, or changed if the changes result in an APR increase and the changes are not made to resolve a recipient’s default; and
- Obtain a signed copy of the disclosures (including by electronic signature) prior to consummation for the transaction.
Potential Penalties for Noncompliance
A violation of the Act by a California Financing Law (CFL) licensee is a violation of the CFL, and CFL licensees are subject to examination and enforcement by the DFPI relating to the disclosure obligations. Neither the Act nor the Final Regulations provide the DFPI authority to enforce violations by non-CFL licensees. Note, though, that in the only provision of the California Consumer Financial Protection Act (CCFPL) that does not concern consumers, the CCFPL authorizes the DFPI to define unfair, deceptive, and abusive acts and practices in connection with the offering of commercial financing to small businesses. Shortly after issuing the Final Regulations, the DFPI issued proposed regulations defining unfair, deceptive, and abusive acts and practices in connection with the offering of commercial financing to small businesses, which the DFPI may rely on to enforce violations of the Final Regulations by non‑CFL licensees.
Moving Toward Compliance
It’s been a long road from enactment of the commercial financing disclosure law to issuance of the Final Regulations. It remains to be seen whether and how well the DFPI met the challenge of creating a standardized disclosure regime for a diverse array of commercial financing products. It also remains to be seen whether the required disclosures will assist small business owners in comparing costs of these varied types of products, as the DFPI intended.
Watch for the rest of our series of client alerts on commercial financing, which will cover: a) the disclosure timing, format, and content requirements in more detail; b) APR and finance charge computation as well as tolerances and safe harbors; c) issues focused on merchant cash advances, including computations and estimation; and d) commercial financing disclosure laws passed or being considered by other states.
 Cal. Fin. Code § 22800(m), (n), and § 22802(a).
 Cal. Code Regs. tit. 10, § 921.
 The Act defines “commercial loan” to exclude loans with a principal amount of less than $5,000; however, other forms of commercial financing below this $5,000 threshold appear to be subject to the Act. See Cal. Fin. Code § 22800(e).
 Cal. Code Regs. tit. 10, § 954.
 Cal. Fin. Code § 22801.
 Cal. Code Regs. tit. 10, § 900(a)(14), (24).
 Cal. Fin. Code § 22800(m), Cal. Code Regs. tit. 10, § 900(a)(24).
 Cal. Code Regs. tit. 10, § 900(a)(14).
 Cal. Code Regs. tit. 10, § 900(a)(8).
 Final Statement of Reasons, Response to Comment 3.6.2, PRO 01/18, at 142.
 Cal. Code Regs. tit. 10, § 952.
 Cal. Fin. Code § 22802(a); Cal. Code Regs. tit. 10, §§ 900(a)(5), 920.
 These specific formatting, content, and delivery requirements will be covered in detail in a separate client alert.
 Cal. Fin. Code §§ 22780.1, 22805.
 Cal. Fin. Code § 90009(e).
 Comments are due on the proposed regulations by August 8, 2022. We will cover these proposed regulations in a separate client alert.