States have introduced a patchwork of new laws over the past two years aimed at protecting small business borrowers. Targeting unregulated financial institutions that provide alternative financing like merchant cash advances and factoring, these laws would require lenders to provide information typically seen in consumer loans.
For example, disclosures at the time of the offer for which borrower acknowledgment is required typically include the total amount of funds provided; the total dollar cost of the financing; the term of the loan; the method, frequency and amount of payments; and the total cost at an annualized rate. While transparency is generally good for both lender and borrower, whether these laws will have the desired effect is another question.
So far, 11 states have passed or introduced commercial loan disclosure bills, while other states have introduced similar bills in various stages of completion.
Lenders currently have no obligations under the laws, as there are no regulatory guidelines in place to implement or enforce them. Regulators have been unable to define how certain disclosure requirements can be applied in practice, particularly with respect to APR disclosures. Although California has proposed regulations five times since 2018, each proposal has drawn substantial comments that lenders will have difficulty implementing the proposed regulations.
Despite the challenges, the large number of pending bills – and the constant reintroduction even where bills have failed – shows that these laws are not going away. It’s not about whether states will find a way to impose increased disclosure requirements and regulation on small business loans; it’s a question of when. As such, non-traditional financial companies must be prepared to adjust their disclosures to meet new requirements.
Why consumer loan regulation is happening now
Merchant cash advances and similar forms of alternative financing have become increasingly popular, and many Internet-based providers are available for small businesses. The pandemic has led state legislatures to focus more on the need for increased regulation and disclosure.
Recognizing that the uncertain economic landscape could encourage lenders to take advantage of small businesses in times of need, a number of state lawmakers want to level the playing field for commercial borrowers.
Few would disagree that borrowers should have transparency with lenders so they can understand the financing available to them and make informed decisions. Yet the laws that have been passed so far have two significant flaws.
First, there is widespread uncertainty about what exactly the disclosure requirements should include, which lenders they affect, and what lenders must do to comply with them. No one, including regulators and credit institutions themselves, seems clear about how these laws will take shape.
Second, and even more worrying, some lenders simply won’t be able to comply with the new disclosure requirements because the lending products they offer don’t comply.
As a result, some lenders may leave states where they cannot comply with disclosure regulations. This, in turn, will lead to less competitive financing in the marketplace and fewer loan products available to small business borrowers, which would ultimately lead to more expensive financing for small businesses – the exact problem that these law are trying to correct.
On the lender side, regulatory risk will increase. For example, New York’s Commercial Financial Disclosure Law (CFDL) provides penalties that include a $2,000 fine for each violation and a $10,000 fine for each willful violation. Additionally, a lender who knowingly violates the CFDL may be liable for restitution or subject to a permanent or preliminary injunction on behalf of a beneficiary affected by the violation.
It remains to be seen if and how states can try to address these unintended consequences through additional regulations or legislation. What is almost certainly assured, however, is that similar laws are likely to hit every state in the months and years to come.
Ideally, lawmakers and regulators will work on the blind spots of these laws and rectify them. In the meantime, state-licensed lenders that lend to small businesses should follow these bills closely. Non-traditional lenders should be aware that they may soon be subject to disclosure requirements unlike what we have seen before in the commercial space.
Stephen J. Grable is a litigation partner at Thompson Coburn Hahn & Hessen LLP.