Update and Summary for NEFA Members and Friends
This article was prepared especially for NEFA Members, as a courtesy, by fellow NEFA Members:
Frandzel Robins Bloom & Csato, LC
Glass & Goldberg, ALC
NATIONAL EQUIPMENT FINANCE ASSOCIATION'S QUICK GLANCE AT ISSUES FOR BROKERS, LENDERS AND REFERRAL SOURCES UNDER THE CALIFORNIA FINANCE LENDER'S LAW
The purpose of this Article is to give Brokers, Lessors, referral sources and Funding Sources a quick highlight package as to what they can and cannot do to comply with California Finance Lenders Law (“CFLL”) when brokering, referring or making commercial loans in California. This Article is necessary because of the enactment of SB197 (now codified in California as Financial Code sections 22602 and 22603), effective January 1, 2016, and the confusion it has caused in the leasing and financing industries.
Commercial Loans. Any person engaged in the business of making consumer or commercial loans must be licensed in California. Generally, a consumer loan is a loan of which the proceeds of which are intended by the borrower for use primarily for personal, family or household purposes. For purposes of determining whether the loan is a consumer loan, the lender may rely on any written statement of intended purposes signed by the borrower and the lender is not required to ascertain if the proceeds of the loan are used in accordance with the statement of intended purposes. However, any commercial loan of less than $5,000 is also defined to be a consumer loan.
Usury Law. The usury law in California applies to loans or forbearance agreements with respect to a loan. For any written business loan, the rate of interest may not exceed the higher of (a) 10% or (b) 5% plus the rate prevailing on the 25th day of the month preceding the earlier of (i) the date of execution of the contract to make the loan or forbearance, or (ii) the date of making the loan or forbearance established by the Federal Reserve Bank of San Francisco on advances to member banks under Sections 13 and 13a of the Federal Reserve Act as now in effect or hereafter from time to time amended. Loans or forbearances in excess of that rate are usurious.
Exemptions from Requirement of a California Finance Lenders License (“License”). Although obtaining a License exempts a lender from California's usury law, the fact that a loan is exempt from usury does not eliminate the requirement of a lender to have a Lenders License. Each branch office must have a separate Lenders License. Certain lenders are exempt from having a Lenders License. For example, any person making 5 or fewer commercial loans in a 12-month period, as long as the loans are “incidental” to the business of the person relying on the exemption, is an exempt lender. Unfortunately, the legislative history of the Financial Code does not discuss in any detail what “incidental” means and therefore what is or is not incidental at this point is open for interpretation. Banks and savings and loans are exempt from California usury law and of the requirements of the CFLL law. Bank subsidiaries are also exempt if the subsidiary is making commercial loans. Loans made by a franchisor to a franchisee would not apply to wholesale lending arms of franchisors and are exempt. Conditional sales contracts are also exempt from the CFLL. If a loan when originally made does not violate the provisions of the CFLL, California Code of Regulations (“CCRs”) or California's usury law, a successor or assignee of the lender is also protected either by the exemption or because the transaction is not subject to the CFLL or because it is not usurious. However, the assignment cannot be a sham transaction in an attempt to evade the California usury law. True leases are not subject to the requirements of the CFLL because they are neither a loan nor a forbearance of money and therefore not subject to the CFLL and are not subject to California usury law.
Penalties for Violating CFLL. In the event that a lender is not licensed under the CFLL, then the consequences include injunctions and civil penalties; the surrender of a Lenders License (which is interesting because of the broker or lender never had a Lenders License how could they surrender it?); if the violation is willful, punishment by a fine of not more than $10,000, by imprisonment in a county jail for not more than one year or for by both that fine and imprisonment. There are also special penalties in connection with consumer loans. Unlike commercial contracts which cannot be declared void in the event of a violation, if the loan is a consumer loan, a contract can be declared void.
Brokering Loans. A finance broker licensed under the CFLL may only broker loans to, and collect brokerage commissions or referral fees from, other licensed lenders, without the consent of the California Department of Business Oversight (“DBO”). Without the DBO consent, the finance broker licensed under the CFLL may not broker loans to and collect brokerage commissions from other types of lenders who are not licensed such as credit unions and banks even though such lenders are exempt from the CFLL.
New Loan on Payment of Broker or Referral Fees. Prior to January 1, 2016, commercial lenders with Licenses were prohibited from paying a fee to any person in exchange for a referral of business. Effective January 1, 2016, the California Legislature enacted new statutes authorizing state licensed commercial lenders to pay referral fees for commercial loans to unlicensed persons including brokers and dealers. The term “referral” means either the introduction of the borrower and the finance lender or the delivery to the finance lenders of the borrower's contact information. The purpose of the new law was intended to protect borrowers by ensuring that they are not steered to loans with unfavorable terms by unlicensed persons’ referral or based entirely on the compensation they generate, and not on the extent to which the loan makes sense for the borrower being referred. The new law was allegedly designed to eliminate the possibility that referral fees paid to unlicensed individuals would result in predatory lending. Now unlicensed brokers can be paid referral fees or commissions but the new law is very restrictive.
Unlicensed persons may not:
- Participate in loan negotiations.
- Counsel or advise the borrower about a loan.
- Participate in the preparation of any loan documents.
- Contact the lender on behalf of the borrower beyond the initial referral.
- Obtain loan documentation from the borrower or deliver that documentation to the lender.
- Communicate lending decisions or inquiries to the borrower.
- Participate in creating sales literature or marketing materials.
- Obtain the borrower's signature on loan documents.
- Make a misleading statement or omit material information in any form, including advertisements for prospective borrower about the terms of the loan.
- Engage in any acts that violate California Business and Professions Code.
- Commit an act that constitutes fraud or dishonest dealings.
- Fail to safeguard a prospective borrower's personally identifiable information.
The new law only allows for the payment of a referral fee once a loan has been approved and requires that all loans involving the payment of a referral fee adhere to the best practices for commercial lending, including:
- Verification of borrower's commercial status;
- The loan's annual percentage rate does not exceed 36%;
- The loan's minimum term is one year;
- The lender performs vigorous underwriting to ensure the borrower's financial support the repayment of the loan and maintains records for at least 4 years.
- Submit information requested by Commissioner regarding the compensation.
The new law also requires that the lender must provide the borrower with a written statement detailing the referral arrangements in 10-point font or larger, at the time the licensee receives an application for a commercial loan, and requires the borrower to acknowledge receipt of the following statement in writing:
“You have been referred to use by [Name of Unlicensed Person]. If you are approved for the loan, we may pay a fee to 'Name of Unlicensed Person] for the successful referral. [Licensee], and not [Name of Unlicensed Person] is the sole party authorized to offer a loan to you. You should ensure that you understand any loan offer we may extend to you before agreeing to the loan terms. If you wish to report a complaint about this loan transaction, you may contact the Department of Business Oversight at 1-866-ASK-CORP 1-866-ASK CORP FREE (1-866-275-2677 1-866-275-2677 FREE), or file your complaint online at www.dbo.ca.gov.”
Exemptions from Prohibitions to Obtain Broker's or Referral fees. The prohibitions set forth above do not apply if the unlicensed person meets one or more of the following criteria:
- Is exempt from licensure under this provision.
- Is exempt from federal income taxes under Section 501(c)(2) of the Internal Revenue Code.
- Is a business assistance organization recognized by the United States Small Business Administration.
- Is engaged in 5 or fewer commercial loans in a 12-month period made by persons licensed under the CFLL.
Note that there is a difference on this exemption that the 5 or fewer commercial loans do not have to be "incidental" to the business of the lender like the exemption discussed above.
In addition, a licensee that pays compensation to a person that is not licensed is liable for any misrepresentation made to that borrower in connection with that loan. Presumably, even though most loan documents disclaim any and all warranties and representations of all persons and entities that are not the lender and disclaim any agency relationship between any other party and the lender, it remains to be seen whether an unlicensed broker representation will result in a lender being liable to the borrower notwithstanding such contractual provisions which are enforceable.
Application of Another State's Choice of Law in Loan Documents. If the lender and the borrower have a choice of law clause in their loan contract indicating that another state's law applies to the contract and, therefore the prohibitions under the CFLL or California usury law are not applicable, what will a Court do with respect to enforcement of the choice of law clause? Will it nevertheless apply California law? Although choice of law clauses are generally enforceable as a matter of law so long as they bear a reasonable relation to the state and also to another state or nation, the choice of law clause is probably not enforceable. The CFLL was enacted primarily to protect the citizens of California from fraudulent and unconscionable conduct of those in the lending business and therefore the State's public policy would in all likelihood prevail and the choice of law clause will not be enforceable as to the use of another State's law.
NEFA Executive Director
Direct Phone: 847-380-5052 (Eastern Time)