California’s New Commercial Financing Disclosure Legislation
Introduction
On August 31, 2018, the California State Senate passed novel legislation, Senate Bill 1235, which requires new disclosures for certain commercial financing, such as loans, factoring transactions, and, potentially, merchant cash advances (MCAs). California Governor Jerry Brown has until September 30 to sign this legislation, and it appears likely that he will.
Senate Bill 1235 represents a major development that would have a significant impact on commercial financing for small- to medium-sized businesses in California. It is the first such legislation of its kind in the nation and may potentially encourage similar legislation in other states.
While disclosure obligations for consumer loans have long existed, including the federal Truth in Lending Act and Regulation Z, Senate Bill 1235 would be the first to require similar disclosure obligations for commercial financing.
The Legislation
The legislation’s key requirement is that “providers” of “commercial financing” disclose the following information at the time of extending an offer of commercial financing to a financing “recipient”:
- 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 (similar to an “annual percentage rate”, or APR). This particular requirement will sunset on January 1, 2024.
Providers would also need to obtain the financing recipient’s signature on these disclosures prior to closing the financing.
These disclosure requirements apply to recipient companies located in California, regardless of the financing provider’s location.
The legislation defines “commercial financing” as commercial loans and accounts receivable purchase transactions (i.e., factoring), including, presumably, merchant cash advances.
The legislation includes several exemptions: (1) for depository institutions, (2) financings of more than $500,000, (3) closed-end loans with a principal amount of less than $5,000, and (4) transactions secured by real estate.
The legislation tasks the California Department of Business Oversight (DBO) with developing regulations to clarify certain disclosure details, such as calculation methods, and the time, manner, and format of the disclosure. Providers are not required to comply with the legislation until the DBO issues the regulations, which is not expected until 2019. The DBO will likely specify an effective date that allows providers with adequate time to come into compliance.
The legislation leaves open several questions. Firstly, and critically for MCA providers, it allows an alternative method of disclosing the annualized rate—permitting, instead of the actual annualized rate, the disclosure of “an example of a transaction that could occur under the general agreement.” This “example” option is presumably intended to address the impossibility of calculating the disclosure amounts for a merchant cash advance until the transaction has concluded. MCA companies, however, would presumably not be permitted to utilize the alternative “example” disclosure because, as written, the legislation makes this option available only to providers of “factoring or asset-based lending,” but fails to mention MCAs (defined as “accounts receivable purchase transaction[s]” in the legislation).
In addition, while the legislation provides that its requirements are subject to DBO examination and enforcement, it fails to address whether private recipients of commercial funding have a private right to sue to enforce the legislation.
Conclusion
Should the legislation pass, it would have a significant impact on commercial financing in California, mandating consumer-type disclosures for commercial transactions, including accounts receivable purchases. Companies providing commercial financing would have to choose between compliance with the legislation, challenging the law in court, or limiting the financing options they offer in California. Conversely, companies receiving commercial financing would indeed see enhanced disclosures but might also find fewer financing options available to them should providers stop offering regulated financing options in California.
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