Payroll Advance Industry in Regulators’ Crosshairs

Financial Services Law

The payroll advance industry is the subject of a newly announced multistate investigation seeking information to enable regulators to determine whether there is unlawful lending by online companies engaged in this business. Led by the New York Department of Financial Services (DFS), the 11 state regulators (plus Puerto Rico) are investigating whether payroll advance companies collect usurious or otherwise unlawful interest rates, often disguised as fees, tips or monthly memberships.

What happened

Employers have long allowed for payroll advances in which the company essentially advances to one or more of its employees’ wages that have been earned but not yet paid. Businesses have no obligation to make such advances, also known as “early wage access,” but many have done so as a courtesy to employees. To facilitate such advances, a separate, for-profit industry has developed in which employers arrange with such companies to advance funds to their employees on a variety of different terms, ranging from informal tips to service charges that may be relatively high in comparison with the dollar amount of the advance.

Earlier this month, DFS Superintendent Linda A. Lacewell announced an investigation into the payroll advance industry, through which employees gain access to wages that they have earned but not yet received.

The DFS—along with regulators from Connecticut, Illinois, Maryland, New Jersey, North Carolina, Oklahoma, Puerto Rico, South Carolina, South Dakota and Texas—expressed concern about lending terms that potentially are unlawful.

“[S]ome of these firms appear to collect usurious or otherwise unlawful interest rates in the guise of ‘tips,’ monthly membership and/or exorbitant additional fees, and may force improper overdraft charges on vulnerable low-income consumers,” Lacewell said.

The investigation will focus on whether the payroll advance companies are in violation of state banking laws, state usury laws, licensing laws and other applicable laws regulating payday lending, and consumer protection laws.

“High-cost payroll loans are scrutinized closely in New York, and this investigation will help determine whether these payroll advance practices are usurious and harming consumers,” Lacewell said. “We will use all the tools at our disposal, including partnering with peer regulators to safeguard consumers from predatory lending and scams that ensnare families in endless cycles of debt.”

The DFS said it will be sending out letter requests for information to members of the payroll advance industry.

Concerns about usurious interest in the payroll advance industry are not new. Regulators, led by the New York attorney general, conducted a similar investigation last year as to merchant cash advances.

In a related case challenging merchant cash advances, a New York State court held in a 2016 decision in Platinum Rapid Funding Group Ltd. v. VIP Limousine Services, Inc. that a merchant cash advance structured as a purchase of the merchant’s future receivables is not a loan, and thus cannot be found to be usurious. In that case, VIP entered into an agreement with Platinum under which VIP sold its future receivables for an upfront discounted price.

VIP later withdrew consent for Platinum to electronically withdraw funds from its account, arguing that the agreements with Platinum ran afoul of New York usury law.

But the court dismissed this claim, holding that the usury law is applicable only to loans or forbearances, regardless of how onerous a repayment requirement may be. “The Agreement was for the purchase of future receivables in return for an upfront payment,” Judge Jerome C. Murphy wrote. “The repayment was based upon a percentage of daily receipts, and the period over which such payment would take place was indeterminate. Plaintiff took the risk that there could be no daily receipts, and defendants took the risk that, if receipts were substantially greater than anticipated, repayment of the obligation could occur over an abbreviated period, with the sum over and above the amount advanced being more than 25 percent.

“The request for the Court to convert the Agreement to a loan, with interest in excess of 25 percent, would require unwarranted speculation, and would contradict the explicit terms of the sale of future receivables in accordance with the Merchant Agreement.”

To read the opinion in Platinum Rapid Funding Group v. VIP Limousine Services, Inc., click here.

Why it matters

This may be the beginning of the end for the somewhat more deregulated environment in which some payroll advance firms have operated. Like the merchant cash advance industry, the payroll advance industry has been able to achieve relatively high returns from the services they perform. And, although most employees appreciate them as a kinder and gentler version of the payday advance industry, all that could change if regulators conclude that the associated fees are just disguised unlawful interest rates. Regulators may conclude that, unlike the future receivables that merchants purport to “sell,” employee payroll advances are loans that are subject to normal usury limits and consumer protections.