Spurred in part by the pandemic, regulators and legislators have been increasingly focused on the accessibility and transparency of loans to small-to-medium businesses. On the federal level, the CFPB is considering a rule requiring extensive reporting on loans to small-to-medium businesses in service of the Biden Administration’s emphasis on financial inclusion. At the state level, California and New York led the charge, enacting similar statutes requiring providers of a broad range of commercial financing transactions to provide borrowers with specified pre-consummation disclosures. A number of other states, including Connecticut and Maryland, are also considering commercial financing disclosure statutes.
Utah and Virginia, which both passed laws covering commercial financings last quarter, are notable for their novel approaches. Utah has become the first state to require commercial financing providers to register with the state financial regulatory agency. Virginia’s statute is narrowly focused on “sales-based financing”, which generally means factoring and merchant cash advance providers. Notably, neither state is adopting the controversial requirement to disclose APR that has delayed implementation of the California and New York statutes.
- Utah
On March 24, 2022, Utah enacted a statute requiring providers of non-mortgage commercial financing transactions of $1 million or less, including closed- and open-end loans, factoring, and merchant cash advances, to provide specified cost-of-credit disclosures. Additionally, the new law requires covered providers to register with the Utah Department of Financial Institutions through the National Mortgage Licensing System (NMLS).
In addition to transactions of more than $1 million, the Utah law exempts the following entities and transaction types: (1) depository institutions and their subsidiaries and service corporations that are regulated by a federal banking agency; (2) providers regulated under the federal Farm Credit Act; (3) licensed money transmitters; (4) providers that consummate no more than five covered commercial financing transactions in Utah during any 12-month period; (5) transactions secured by real property; (6) true leases; (7) purchase-money obligations; (8) loans of $50,000 or more to a motor vehicle dealer or motor vehicle rental company (or an affiliate of either); and (9) transactions in connection with the sale of a product or service that the provider, its parent company, or its “owned and controlled” subsidiary manufactures, licenses, or distributes.
Utah’s statute becomes effective on January 1, 2023 and will apply prospectively to transactions originated on or before that date. We do not expect the compliance deadline to be extended, as it has been for similar laws in California and New York, where disclosures will not be required until state financial regulators issue regulations specifying calculation methods and formats for providers to use. Detailed implementation instructions are a virtual necessity in California and New York because both require providers to disclose APR, which is essentially an “all-in” cost of credit disclosure that includes not only periodic interest but most one-time fees. Calculating APR is a complicated undertaking with respect to products, such as factoring transactions and merchant cash advances, which are structured as sales rather than loans.
The Utah statute focuses instead on a relatively straightforward set of disclosures for all covered transaction types. The required disclosures are:
- The total amount of funds to be provided to the business;
- The total amount of funds to be disbursed to the business, if the amount differs from funds provided (i.e., because funds were withheld to pay down a preexisting obligation);
- The total amount to be paid to the provider;
- The total dollar cost of the transaction, calculated as the difference between the total funds provided to the business and the total amount to be paid to the provider;
- The payment schedule (including any variable payments and the method of calculating them);
- Any discounts or penalties associated with prepayment; and
- Any amount the provider will pay to a broker in connection with the transaction.
Although the statute requires providers to make disclosures “in accordance with [the statute] and rules issued by [the Department of Financial Institutions]”, it does not require rulemaking. Nor does the statute impose detailed formatting requirements for required disclosures, unlike the California and New York statutes.
- Virginia
Virginia’s new statute, which becomes effective on July 1, 2022, focuses on transactions repaid as a percentage of sales or revenue, in which the payment amount is dependent upon the recipient’s sales volume or revenue. The new law also covers transactions that, though repayable as a percentage of sales or revenue, carry a fixed payment with a periodic “true up” mechanism to align the amount paid with the agreed-upon percentage. This describes two common repayment structures for merchant cash advance products.
The Virginia statute exempts transactions of more than $500,000 and those originated by depository institutions. Additionally, providers and brokers that enter into no more than five covered transactions in a twelve-month period are not covered.
Providers of covered “sales-based” transactions are required to register with the Virginia Bureau of Financial Institutions. With respect to each transaction, providers are also required to provide the following disclosures at the time the borrower receives a quote that, if accepted, is binding on the provider (called a specific offer):
- The total amount of the sales-based financing, and the disbursement amount, if different (i.e., due to deduction of fees);
- The finance charge;
- The total repayment amount (the disbursement amount plus the finance charge);
- The estimated number of payments (the number of payments expected, based on the projected sales volume, to equal the total repayment amount);
- The payment schedule;
- A description of all other potential fees and charges not included in the finance charge;
- Prepayment policies;
- Description of collateral requirements or security interests, if any; and
- A statement of whether the provider will pay a broker in connection with the specific offer of sales-based financing, and, if so, the amount.
The Virginia statute expressly requires rulemaking by the state’s financial regulator; however, it does not stay effectiveness of the statute pending issuance of rules.
Interestingly, the Virginia statute is also concerned with forum selection clauses and arbitration provisions that are likely to be inconvenient for the borrower. The statute provides that forum selection clauses designating a location outside Virginia are unenforceable. Similarly, arbitration provisions may not require in-person arbitration proceedings in a jurisdiction other than that of the borrower’s principal place of business. Because the statute defines the “recipient” of a covered transaction as a company with a principal place of business in the Commonwealth, the statute effectively requires both litigation and face-to-face arbitration proceedings arising under the contract to occur in Virginia.
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