In a recent decision, a federal district court for the Central District of California denied a motion to dismiss filed by the Commissioner of the California Department of Financial Protection and Innovation (DFPI) finding that California’s recently adopted Commercial Financing Disclosures Law (CFDL) may violate the plaintiff’s First Amendment rights or be preempted by the Truth in Lending Act (TILA).
As discussed here, the CFDL applies to commercial financing, where the funds are “intended by the recipient for use primarily for other than personal, family, or household purposes.” The stated purpose of the CFDL is to assist small businesses in making informed decisions about the potential costs of various commercial financing options. The industries subject to the regulation include, among others, traditional installment loans and open-end credit, factoring, and merchant cash advances (MCAs). Under the CFDL, providers are required to disclose metrics such as the amount of funding the small business will receive, the APR calculated for the transaction, a payment amount (if applicable), the term, details related to prepayment policies, and (for products without a monthly payment) an average monthly cost.
The plaintiff in Small Business Financial Association (SBFA) v. Hewlett, is a trade association of small business finance companies. Its members offer a variety of small business financing products, including MCAs and open-end financing products. The SBFA claims the CFDL presents a significant problem for its members, namely they require the use of uniform terms for very different products. The SBFA filed suit alleging: 1) the CFDL compels commercial speech in a manner that violates the First Amendment; and 2) the CFDL is preempted in part by TILA. The Commissioner of the DFPI moved to dismiss the SBFA’s claims. The court denied the motion.
As for the SBFA’s First Amendment claim, the court found that the CFDL compels disclosures that do not accurately inform consumers about the terms of the products offered by the SBFA’s members. Specifically, they misleadingly indicate that MCAs and open-end credit products function like traditional closed-end loans. The Commissioner argued that the disclosures are not misleading because they “clearly disclose they are based on estimates and assumptions … and do not purport to be anything other than estimates.” But the court found that whether a small business customer would be misled is a factual question not to be decided at this stage of the pleadings. Instead, [the SBFA] has plausibly alleged that the [CFDL] compel[s] speech that is not purely factual, which is sufficient for its First Amendment claim to survive dismissal.”
The SBFA’s second claim is that because the CFDL defines the terms APR and finance charge differently than TILA, the law is preempted. The Commissioner countered that the CFDL is not preempted because it only applies to commercial rather than consumer finance. The court agreed that the CFDL is not subject to express preemption because the disclosures apply to a separate type of financial transaction. However, the court found that the CFDL may be subject to conflict preemption based on the potential confusion caused by the use of identical terms to describe different concepts for consumer credit and small business finance. The court discussed that “[S]mall business owners often finance their businesses through a combination of commercial finance products and consumer finance products available to them individually … [T]hese customers are likely to be confused by the [CFDL’s] failure to define ‘APR’ and ‘finance charge’ in a way that TILA does, thereby frustrating TILA’s purpose: to ‘avoid the uninformed use of credit.'”
The regulatory environment for small business finance continues to rapidly evolve. Just last week, the Consumer Financial Protection Bureau (CFPB) issued its final rule for implementing Section 1071 (discussed here), and its determination that the CFDL is not preempted by TILA (discussed here). Also, multiple states have disclosure regulations for commercial financing transactions either enacted (see discussions on New York and Utah) or proposed (see discussions on Missouri, Illinois, Florida, and Connecticut). Whether the Hewlett court will ultimately find that the CFDL violates the First Amendment or is preempted will impact the ever-changing regulatory environment both in California and in these other states that have passed or considered similar requirements.