California Attorney General Rob Bonta is defending the state’s recently passed small business disclosure law, which requires merchant lenders, factoring firms and some fintech companies to disclose annual percentage rates to borrowers.
Last week, Bonta sent a letter to Rohit Chopra, director of the Consumer Financial Protection Bureau, supporting the agency’s view that the California law — which took effect Dec. 9 — is not preempted by the federal Truth in Lending Act.
California law requires non-banks to disclose the APR, total interest and fees for financing of $500,000 or less.
Bonta sent the letter in response to a preliminary ruling by the CFPB last month that small business disclosure laws in four states — California, New York, Utah and Virginia — did not conflict with TILA, the seminal consumer protection law that created the current consumer disclosure regime. But TILA only governs the disclosure of user information; there are currently no federal disclosure requirements for commercial loans.
State disclosure laws that protect small businesses are a relatively new concept, and only California and New York require lenders to calculate and disclose key terms. The issue is further complicated by the proliferation of short-term, expensive financing options online, made mostly by non-bank institutions for small business borrowers with bad credit. As states have become more active in their efforts to regulate small business lending, lenders have filed lawsuits and floated new legal theories to gut state laws.
Bonta writes in comment letter to the CFPB that California’s disclosure law “was enacted in 2018 to help small businesses navigate a complex trade finance market by enforcing uniform disclosures of certain credit terms in a manner similar to the requirements of TILA, but for commercial transactions not governed by TILA.’
He noted that the law went through four years of public notice and comment with extensive industry input. However, last month a trade group of cash advance firms filed a lawsuit against the California Department of Financial Protection and Innovation in what many saw as a “Hail Mary” to strike down the new law. The New York-based Small Business Finance Association is suing California DFPI Commissioner Clotilde Hewlett, alleging that the disclosure law violates the free speech rights of non-bank lenders by forcing them to describe their products to borrowers “in ways that are false and misleading,” according to the lawsuit.
“The reason for the lawsuit is that there are many reasons why APR disclosure does not work for commercial finance products,” said Steve Dennis, CEO and executive director of the Small Business Finance Association. “What confuses customers is that they don’t understand what APR is, and with shorter term products it skews the calculation.”
Asset-based lenders and factoring firms say calculating APR is a challenge for businesses that pledge working capital receivables. They also argue that state disclosure laws will increase the cost of credit for short-term financing, especially one- or two-week bridge loans for commercial borrowers. Some experts also say the state is imposing yet another disclosure regime with reams of fine print that borrowers never read.
Bonta is urging the CFPB to further articulate that state laws that require more disclosures than federal law are not preempted. He also said that state law should be ignored only when there is an actual conflict with federal law.
“It is vital that businesses and entrepreneurs have the information they need to understand the risks and benefits of borrowing and have the tools available to find the solution that best suits their needs,” said Bonta in a press release.
California’s DFPI said it has tailored the regulations to cover a wide range of financing, from closed-end loans to open-end credit plans, merchant cash advances, asset-based loans, lease financing and factoring transactions. When a commercial financing offer is made, the financier must disclose the total dollar cost of the financing and the total cost of the financing expressed as an annual percentage rate, which means that lenders must disclose any finance charge or estimated finance charge, annual percentage rate or estimated APR, depending on the specific trade finance agreement.
Lenders argue that the regulations will require them to provide information that does not accurately describe the cost of financing. They also argue that the new law prevents lenders from giving prospective customers additional information without risking fines, penalties and additional liability.
“Far from providing accurate information that would allow businesses to compare the terms and costs of different financing options, the disclosures required under the regulations actually require providers to provide inaccurate disclosures,” the suit states.