Spurred in part by the pandemic, regulators and lawmakers have increasingly focused on the accessibility and transparency of loans to small and medium-sized businesses. At the federal level, the CFPB is considering a rule requiring detailed reporting on loans to small and medium-sized businesses in service of the Biden administration’s focus on financial inclusion. At the state level, California and New York have led the charge, enacting similar laws requiring providers of a wide range of commercial finance transactions to provide specific information to borrowers before consumption. A number of other states, including Connecticut and Maryland, are also considering commercial finance disclosure laws.
Utah and Virginia, which both passed trade finance laws last quarter, stand out for their innovative approaches. Utah became the first state to require commercial finance providers to register with the state’s financial regulatory agency. Virginia law is narrowly focused on “sales-based financing,” which generally means vendor factoring and cash advances to merchants. Notably, no state is adopting the controversial APR disclosure requirement that has delayed implementation of the California and New York laws.
On March 24, 2022, Utah enacted a law requiring providers of non-mortgage commercial financing transactions up to $1 million, including closed and open loans, factoring, and cash advances merchants to provide accurate information on the cost of credit. . 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 over $1 million, Utah law exempts the following entities and types of transactions: (1) deposit-taking institutions and their subsidiaries and service companies regulated by a federal banking agency; (2) suppliers regulated under the federal Farm Credit Act; (3) approved fund issuers; (4) vendors who complete no more than five covered trade finance transactions in Utah in any 12-month period; (5) transactions secured by real estate; (6) real leases; (7) purchase price obligations; (8) loans of $50,000 or more to a motor vehicle dealership or motor vehicle leasing company (or an affiliate of either); and (9) transactions related to the sale of a product or service that Supplier, its parent company or its “owned and controlled” subsidiary manufactures, licenses or distributes.
The Utah law becomes effective on January 1, 2023 and will apply prospectively to transactions initiated on or before that date. We do not expect the compliance deadline to be extended, as has been the case for similar laws in California and New York, where disclosures will not be required until state financial regulators have published regulations specifying the calculation methods and formats to be used by suppliers. Detailed implementation instructions are a virtual necessity in California and New York, as both require providers to disclose APR, which is essentially an “all-inclusive” cost of credit disclosure that not only includes periodic interest, but most one-time charges. Calculating APR is a complicated business when it comes to products, such as factoring transactions and merchant cash advances, that are structured as sales rather than loans.
Instead, Utah law focuses on a relatively simple set of disclosures for all types of covered transactions. The required disclosures are:
- The total amount of funds to be provided to the company;
- The total amount of funds to be paid to the company, if the amount differs from the funds provided (for example, because the funds were withheld to repay a pre-existing obligation);
- The total amount to be paid to the supplier;
- The total dollar cost of the transaction, calculated as the difference between the total funds provided to the company and the total amount payable to the supplier;
- The payment schedule (including variable payments and how they are calculated);
- Any discount or penalty associated with prepayment; and
- Any amount that the supplier will pay to a broker as part of the transaction.
Although the law requires providers to disclose “in accordance with the [the statute] and the rules issued by [the Department of Financial Institutions]”, it does not require regulation. The law also does not impose detailed formatting requirements for required disclosures, unlike the laws of California and New York.
Virginia’s new law, which goes into effect July 1, 2022, focuses on transactions refunded as a percentage of sales or revenue, in which the amount of the payment depends on the recipient’s sales volume or revenue. The new law also covers transactions which, although reimbursable as a percentage of sales or turnover, involve a fixed payment with a periodic “adjustment” mechanism to align the amount paid with the agreed percentage. This document describes two common repayment structures for merchant cash advance products.
Virginia law exempts transactions over $500,000 and those initiated by depository institutions. In addition, vendors and brokers who do not make more than five Covered Transactions in a twelve month period are not covered.
Covered “sales-based” transaction providers are required to register with the Virginia Bureau of Financial Institutions. With respect to each transaction, providers are also required to provide the following information at the time the borrower receives an offer which, if accepted, binds the provider (known as a specific offer):
- The total financing amount based on sales and the disbursement amount, if different (i.e. due to the deduction of fees);
- The financial burden;
- The total reimbursement amount (the disbursement amount plus finance charges);
- The estimated number of payments (the number of payments expected, based on the expected sales volume, to equal the total refund amount);
- The payment schedule;
- A description of all other potential fees and charges not included in finance charges;
- Prepayment policies;
- Description of collateral or collateral requirements, if any; and
- A statement of whether the supplier will pay a broker under the specific sales-based financing offer and, if so, the amount.
Virginia law specifically requires rulemaking by the state’s financial regulator; however, this does not suspend the effectiveness of the law pending publication of rules.
Interestingly, Virginia law also covers choice of court clauses and arbitration provisions that may be inconvenient for the borrower. The law provides that forum selection clauses designating a place outside of 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. Since the law defines the “beneficiary” of a covered transaction as a company with its principal place of business in the Commonwealth, the law effectively requires that face-to-face disputes and arbitration proceedings arising out of the contract be take place in Virginia.