In new California commercial financing-related legislation, a pending state bill would mandate specified disclosures for small business lending, while a recently passed ordinance in Los Angeles will require banks doing business with the city to reveal if they use sales goals.
Senate Bill 1235 represents a major development that, if passed in its present form, would have a significant impact on lending and factoring involving small- to medium-sized businesses (SMBs) in California, and potentially encourage copycat legislation in other states.
What happened
While disclosure requirements for consumer borrowers have been in place for decades, including in particular under the federal Truth in Lending Act and Regulation Z, this first-of-its-kind legislation, introduced in February, would extend similar provisions to financing involving SMBs.
Senate Bill 1235 would require "providers" of "commercial financing" to disclose specified information at the time of extending a specific offer of commercial financing to a "recipient" of the offer, such as a full disclosure of the total amount of any fees charged in connection with the commercial financing, the total amount of funds provided and the "estimated annualized cost of capital," which would be similar in nature to the "annual percentage rate" (APR) for consumer-purpose credit.
Other disclosures include the term of the financing (displayed in months or years), the total monthly payment amount owed by the prospective recipient, the total dollar cost, the annualized interest rate (if applicable), a description of the funding and repayment process (including the frequency of payments and the amount of each), a description of prepayment policies (featuring an explanation of whether and how prepayment penalties apply, complete with examples), and any collateral required as a condition of receiving the commercial financing.
Providers would also need to obtain the recipient’s signature on the disclosure prior to consummating the deal. The disclosure could be provided in either paper or electronic form.
"Commercial financing" would include commercial-purpose loans as well as accounts receivable purchase transactions (i.e., factoring), including, potentially, merchant cash advances. It would exclude offers of more than $500,000 and so would primarily apply to SMB transactions.
The bill would apply to providers that consummate or arrange more than five commercial financing transactions during a calendar year but exempt depository institution providers (defined to include specified state and federal financial institutions, such as commercial banks). Accordingly, the bill would primarily impact nondepository institution lenders and factors, including numerous fintech companies involved in extending loans or factoring arrangements to SMBs.
After squeaking by the Senate in May, the measure has already made its way through multiple committees in the Assembly in anticipation of a vote.
The city of Los Angeles also waded into uncharted waters, with the city council amending the Responsible Banking Ordinance to require commercial and investment banks doing business with the city to reveal whether they use sales goals or quotas. Specifically, banks will be required to state whether they set individual or branch-level sales goals or requirements; whether they consider the quantity of an employee’s sales as a basis for decisions about advancement, termination or compensation; and whether policies and training are in place to prevent sales abuses.
The headline-making practice of sales incentives at banks resulted in a warning from the Consumer Financial Protection Bureau under the prior administration, cautioning financial institutions against the practice.
In addition, the amendments mandate that banks disclose their Community Reinvestment Act score, certify that whistleblower protection policies are in place and notify the city of any pending enforcement actions.
L.A. Mayor Eric Garcetti signed the amended ordinance into law in early July. “Every Angeleno should be able to share in the opportunities our city creates, and businesses that partner with the city should be held to the highest ethical standards,” he said in a statement. “The Responsible Banking Ordinance will help us protect consumers and hold businesses accountable for unscrupulous practices.”
To read SB 1235, click here.
Why it matters
Both pieces of legislation are generally the first of their kind, and imitations could follow from other cities or states. The senate bill in particular would be game-changing, opening the door to consumer-type disclosure requirements in connection with commercial-purpose transactions, including accounts receivable purchases. Should the California disclosure requirements for SMB financing pass, the groundbreaking development could have a significant impact on lenders.