While the consumer finance industry is heavily regulated by federal, state, and local consumer protection laws, commercial loan lenders have mostly remained outside the scope of state credit protection laws.
However, as part of what appears to be a new financial regulatory trend, states have started to focus on commercial lending, leading to the adoption of consumer-like disclosure requirements that impact certain commercial loan origination platforms, including merchant cash advances, small business loans, and factoring.
The federal Truth in Lending Act and Regulation Z, which implements TILA, require that consumers receive meaningful written disclosures about certain key terms relating to consumer credit obligations—e.g., student loans, residential mortgages, or auto loans—before entering into contracts. TILA requires disclosure of the annual percentage rate, finance charge, amount financed, and total number of payments.
California, New York, Utah, and Virginia recently passed new laws and regulations requiring heightened levels of disclosure for commercial loans, similar to those under TILA. The New York Department of Financial Services’ final regulations are effective Aug. 1, 2023.
Similar laws have been proposed in nearly a dozen states and are pending, have failed, or have been withdrawn. These regulatory trends heighten the importance of ongoing state regulatory monitoring and compliance for “providers” of certain commercial financing transactions.
The framework of the state-law disclosure requirements is so similar to TILA’s that it prompted the Consumer Financial Protection Bureau to make a preemption determination on March 28 that, with respect to the state laws, TILA does not preempt state action. The CFPB reasoned that TILA only applies to consumer credit and doesn’t create preemption for commercial financing, to which TILA does not apply.
The CFPB is also considering making determinations for the California, Utah, and Virginia laws and noted that these laws are very similar to New York’s and TILA would not preempt them.
California and New York Requirements
Under the California Commercial Financing Disclosure Law, people providing commercial financing to borrowers “whose business is principally directed or managed from California” are now required to provide borrowers with TILA-like disclosures when a specific offer of commercial financing is extended and to obtain the recipient’s signature on that disclosure before consummating the commercial financing transaction.
The CCFDL contains exemptions, including commercial financings secured by real estate. For transactions less than $500,000, the CCFDL applies to commercial loans, certain commercial open-end plans, factoring, merchant cash advances, and commercial asset-based lending.
Unlike the New York law, which applies to brokers as well as lenders, the CCFDL considers a “provider” to be primarily an entity extending credit, such as a lender/originator, but also includes a nonbank partner in a marketplace lending arrangement that facilitates the arrangement of financing through a financial institution.
The New York law requires that lenders and brokers in a commercial financing transaction of $2.5 million or less make certain TILA-like disclosures and provides a de minimis exemption.
The specific disclosures vary by the type of financing. For closed-end financing, the New York law requires the disclosure of certain information, including the total amount of the commercial financing, financing terms, the APR (calculated largely in accordance with TILA), rate-related fees and charges, repayment amount totals, payment frequency, prepayment terms, and collateral descriptions.
Immediate Impact on Commercial Lenders and Compliance
The California and New York laws outline express requirements for the disclosures, including specific formatting requirements and required information about the policies and procedures for lending and servicing.
When disclosures are provided by a third party, the lender must have policies to ensure that the third party has copies of the compliant disclosure and that the disclosure is provided to the relevant debtors. Noncompliance is subject to criminal penalties in California. New York’s penalty provision is limited to civil remedies.
For commercial lenders, these new regulatory requirements will undoubtedly impose certain operational and ongoing costs, not only for maintaining compliance in states where laws have already been passed but for monitoring the adoption of similar requirements in other states.
Because there is no uniform standard among the adopted disclosure requirements, commercial lenders will need to work closely with outside regulatory counsel to adopt forms that conform to the prescribed requirements on a state-by-state basis.
Regulatory compliance is also important for investors and capital markets. Specialty lending platforms that typically leverage direct lending arrangements or securitizations as a financing source to allow for their continued origination of small business loans, merchant cash advance loans, or any other type of commercial loans should ensure compliance with these new regulatory regimes—or risk defaulting their own facilities or lowering the available capital.
Compliance with the applicable law is part of the standard loan-level eligibility requirements, representations, and covenants for these transactions.
Likewise, investors and underwriters will want to perform appropriate due diligence on the underlying platform’s disclosure forms and compliance monitoring programs to ensure ongoing compliance with the state-law requirements.
As these new regulations for commercial loan disclosure requirements gain momentum, it remains to be seen if states will explore additional ways to regulate commercial lending, for example, by requiring the licensure of originators of commercial loans, which has long been the standard practice in California. The California law generally requires finance lenders and brokers extending consumer and commercial loans to obtain a “finance lenders” license.
Industry participants must continue to monitor federal and state requirements to avoid any potential liability down the road. The need to do so has become more pressing with the current state of heightened regulatory activity.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Tara Castillo is a partner in Alston & Bird’s finance group and chair of its structured and warehouse finance team.
Stephen Ornstein is a partner in Alston & Bird’s financial services and products group and co-leader of the firm’s consumer financial services team.
Maria Merritt is counsel in Alston & Bird’s finance group and a member of the structured and warehouse finance team.
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