On December 30, 2019, the California Department of Business Oversight (DBO) announced two actions regarding companies offering unregulated, point-of-sale financing to California residents.  In the first action,  the DBO denied the application of Sezzle Inc. for a lender’s license under the California Financing Law (CFL).  According to the DBO in its Statement of Issues, license denial was warranted because Sezzle had engaged in unlicensed point-of-sale lending.  In a parallel second action, the DBO issued a legal opinion advising another, unnamed company that its point-of-sale products also constitute “loans” and require a CFL license to be offered in California.

We question both actions.  As to the Sezzle license denial, our criticisms include but are not limited to the following:

• The DBO found that Sezzle’s customers and merchants do not enter into contracts with each other that are assigned to Sezzle.  There are two problems with this finding: (1) if the finding is correct, it would justify by itself the conclusion that the transactions are loans rather than credit sales (and avoid the need for further analysis), and (2) for residents of California and three other states, the Sezzle User Agreement (at least in its current form) provides that the credit will be through retail installment contracts assigned by Sezzle’s merchants to Sezzle.  Thus, as a factual matter the DBO’s finding is open to question.
• The DBO stated that at least one Sezzle merchant allows Sezzle financings in amounts as low as $35 and that, on these financings, the effective APR would be approximately 600% if Sezzle charged all applicable fees.  In fact, the User Agreement provided, consistent with Sezzle’s advertising, that consumers making payments on time would be charged no interest and no fees—not effective triple-digit APRs.  We note that this is not a case involving hidden merchant upcharges on credit transactions.  Indeed, the DBO explicitly acknowledged that Sezzle prohibits its merchants from charging a higher credit sale price.  Accordingly, this product appears to be consumer-friendly and not unfair, deceptive or abusive in any way.
• In light of the absence of a clear violation of law or any apparent consumer harm, the denial of a CFL license seems unduly harsh.

We think the legal opinion is equally flawed.  It points to a number of “relevant factors” in determining whether a transaction is a credit sale or a loan but fails to provide a cogent explanation why these factors mandate characterization of the transactions as loans under California law:

• The intent of the parties: The opinion says a relevant factor is whether the parties intended the arrangement to be a loan and cites Milana v. Credit Disc. Co., 27 Cal. 2d 335 (1945).  Milana did not involve a credit sale to a consumer and instead involved a purchase of receivables where the seller had to repurchase from the buyer any receivables that went into default and had to unconditionally guaranty that the buyer would collect all of the receivables it purchased.  The transaction in Milana clearly evidenced an attempt to evade usury laws.  However, the DBO apparently thought this factor militated in favor of loan classification despite its acknowledgement that the “products are not presented to customers at checkout as loans.”
• Whether the merchant and third party are closely related or have a preexisting relationship: The DBO cites Glaire v. La Lanne-Paris Health Spa, 12 Cal. 3d 915 (1974) for the assertion that a close relationship between the finance company and its merchants, memorialized by a contract that exists before the customer begins a purchase, is indicative of a loan rather than a credit sale.  Glaire seems inapposite since it involved two interlocking corporations with common ownership and control and a situation where there were few “cash sales” and the vast majority of the transactions were financed before being sold at a substantial undisclosed discount.  Regarding this factor, the DBO fails to address that (1) the leading California and most recent recharacterization case included in its opinion, Boerner v. Colwell Co., 21 Cal.3d 37 (1978), refused to recharacterize credit sales as loans despite the existence of a close preexisting relationship between the seller and the finance company and (2) virtually all credit sale financing programs involve such relationships.
• Whether the third party assumes the contract at the point of sale or later: The DBO suggests that the seller’s discounted sale of credit sale contracts at the point of sale is indicative of transactions properly classified as loans.  However, Glaire, the sole case the DBO cites in support of this conclusion, was inapposite for the reasons discussed above.  Additionally, the DBO’s attempt to distinguish Boerner “because the question in that case was whether the usury laws applied” (i.e., whether the transaction was a loan or a credit sale) is weak.  Boerner contemplated transactions with contemporaneous assignments to the company underwriting the credit and nonetheless found them to be credit sales rather than loans.
• Whether the third party underwrites the transaction in the manner of underwriting a loan: The DBO states that when a third party provides the contract and evaluates the creditworthiness of the customer, such conduct indicates the transaction is a loan.  It only cites a 1946 Attorney General Opinion but acknowledges that the California Supreme Court subsequently reached a contrary result in Boerner.
• Whether the transaction would be regulated under another law: Finally, the DBO states that the application of another statutory scheme to the transactions would be a factor weighing in favor of finding the transactions to fall outside the CFL.  We take some comfort that the new DBO guidance is likely limited to transactions that would not otherwise be subject to California credit sale laws.  However, we note that, once again, the DBO position is in tension with Boerner, where the California Supreme Court did not find it significant that the subject transactions were exempt from both California credit sale and usury laws.  Rather than using the unregulated nature of the conduct as a justification for treating the transactions as loans subject to California usury laws, the Court concluded that that the Legislature is free to regulate in this area if it wishes.  The DBO also fails to acknowledge that the California Supreme Court held similarly in an even more recent case. Sw. Concrete Prods. v. Gosh Constr. Corp., 51 Cal. 3d 701, 707 (1990) (“[The transaction] is exempt from the usury laws because it was a bona fide credit sale.  This is true regardless of whether the Unruh Act applies to the transaction.”)

In summary, the DBO has gone out of its way to classify as loans consumer-friendly transactions structured as credit sales.  In doing so, it has injected unnecessary uncertainty into a previously settled area of the law.  We hope that the DBO will reconsider its actions or that Sezzle will appeal and overturn the DBO’s license denial.