In 2018, California became the first state to pass a commercial finance disclosure law (CDL) requiring certain commercial finance companies to make consumer-style disclosures to financing recipients. The CDL was the catalyst for the passage of similar laws in Utah, Virginia, and New York, and the introduction of commercial disclosure legislation in many other states, including Connecticut, Mississippi, Missouri, New Jersey, North Carolina, and Pennsylvania. After years of regulatory delays, revisions, and comment periods, the California Department of Financial Protection and Innovation (DFPI) finally released its final regulations implementing the CDL on June 9, 2022. The DFPI commissioner announced his expectation that California’s regulations will become “a model for other states to follow” and, if the last few years are any indication, they likely will be.
California’s CDL regulations are extensive, particularly for an industry that has gone largely unregulated up until now, and most commercial finance companies will be starting their compliance program buildouts at square one. This is even more true for providers of alternative commercial financing because a critical component of that business model is being able to offer faster and more flexible alternatives to traditional commercial financing — something these providers have thus far been able to do in part because they operate free of the overhead costs associated with the burdensome “cost of credit” disclosures required of consumer finance providers.
While compliance with California’s CDL, and the many laws like it that will take effect in the coming months and years, is a formidable undertaking, it is not an impossible one with proper guidance. However, if commercial finance providers fail to take immediate steps to build out and maintain sufficient compliance programs, they are likely to face an uphill battle to maintain business as usual.
Here’s what you need you to know about California’s final regulations, which are set to take effect on December 9, 2022.
Who will be required to comply with California’s CDL?
The CDL applies to providers of commercial financing of $500,000 or less to recipients whose businesses are principally directed or managed in California. “Provider” also includes non-bank partners (e.g., fintechs) that facilitate financing through a financial institution. Although the law identifies six categories of commercial financing transactions that will be subject to the new regulations — factoring agreements, open- and closed-end commercial loans, open-end credit plans, sales-based financing, lease financing, and asset-based financing — it also contains a catch-all provision designed to encompass any commercial financing transaction that does not fit squarely within those six categories.
The law exempts depository institutions, real estate-secured commercial financings, providers who make no more than one commercial financing transaction in California per year, and providers who make no more than five commercial financing transactions in California per year that are incidental to the provider’s business, among others.
What information must be disclosed?
Providers will be required to make significant “cost of credit” disclosures, including but certainly not limited to:
- Total amount financed;
- Itemization of amount financed;
- Annual percentage rate (APR);
- Total and itemized finance charges;
- The method, frequency, and terms for payments on both fixed and variable rate financing;
- Average monthly cost of financing for products with no monthly payment;
- Estimated financing term of the proposed transaction; and
- Loan prepayment terms.
The APR disclosure, which was the subject of much industry opposition, represents a significant blow to alternative commercial finance companies who traditionally offer shorter term financing and do not use an APR.
Disclosure content is not the only concern. The regulations strictly govern disclosure format as well, dictating everything from font sizes to the specific number of rows and columns that must be included in certain tables, and provide no form disclosures.
When must the disclosures be made?
The CDL disclosures are not a one-and-done obligation. Initial disclosures must be made at the time a specific commercial financing offer is quoted to a recipient, unless multiple products are offered, in which case the disclosure requirements attach when the recipient selects an offer.
However, if the terms of the parties’ financing contract are amended, supplemented, or changed for any reason other than to resolve a recipient’s default and the new or modified terms will result in an APR increase, an entirely new set of disclosures is required before the recipient agrees to the same. This renewed disclosure obligation attaches even if the same terms were disclosed previously. Subject to certain limitations, disclosures are also required each time a draw occurs on an open-end credit plan.
What is the penalty for noncompliance?
There are both criminal and civil methods of enforcement. A willful violation of California’s CDL is a crime, punishable by a fine not to exceed $10,000, jail time not to exceed one year, or both. On the civil side, the DFPI commissioner can file suit — or request that the California attorney general file suit — to enjoin the provider from violating the CDL or permanently bar them from conducting business in California.
A civil court can also order the violating provider to pay restitution or other damages to recipients of financing, disgorge any monetary gains obtained as a result of the violations, and assess a $2,500 fine for each willful violation.
With a December 2022 implementation date, commercial finance companies should start working now to implement policies, procedures, and processes in order to comply with the CDL. Because commercial finance companies have primarily operated free from regulation until now, many lack not only the experience but the infrastructure to create and implement a compliance program. This is especially true for fintechs, non-bank commercial lenders, and finance companies that do not have experience complying with consumer-style disclosure regulations.
Bradley will host an online webinar titled “California’s New Commercial Disclosure Law: Preparing for Compliance” on Wednesday, July 13, 2022 at 1:00 p.m. CT. During this free event, Bradley lawyers Alex McFall and Christopher Friedman will discuss some of the issues facing commercial lenders, fintechs, factors, MCA companies, and others in the space as they start preparing to comply with California’s new law. You can register to attend here.