Legal Risks: Penalties for Non-Compliance in Revenue-Based Financing

Jeffrey S. Paige is the General Counsel of CFG Merchant Solutions. Visit: https://cfgmerchantsolutions.com

Staying compliant with disclosure legislation and regulations is paramount for revenue-based financing funders and brokers alike. In states such as California, Virginia, Utah, New York, Georgia, Connecticut, and Florida, there are specific requirements to which commercial financing funders must adhere. Funders and brokers who fail to comply with these requirements could face significant legal and/or financial penalties. Funders and brokers are encouraged to consult their legal counsel to ensure full compliance with all laws and regulations of every state in which they transact business.

California Code of Regulations Title 10, Chapter 3 – California Financing Disclosure Law (Effective December 9, 2022):

Starting on December 9, 2022, commercial financing funders in California are required to provide clients with certain disclosures, including the controversial APR calculation. This became mandatory following the issuance of final regulations by the California Department of Financial Protection and Innovation (DFPI) on June 15th to implement the California Code of Regulations Title 10, Chapter 3. Violations of these disclosure requirements in California can lead to significant penalties, reaching up to $10,000 for willful violations, along with the possibility of imprisonment for licensees who commit violations. To maintain compliance and avoid penalties, consult with your counsel to ensure your disclosures are timely and set forth all required information, including but not limited to:

• Total amount of funds provided
• Total dollar cost of the financing
• Term or estimated term
• Payment details
• Prepayment policies
• Total cost of financing expressed as an annualized rate

Virginia HB1027 – Virginia Financing Disclosure Law (Effective July 1, 2022):

Virginia enacted HB1027, introducing disclosure and registration requirements for sales-based financing funders. Funders conducting business in Virginia are obligated to conform to these regulations, which include but are not limited to:

• Registration: Funders and brokers in revenue-based financing must register with the State Corporation Commission and subsequently renew annually.
• Disclosures: Disclosures for specific financing offers are mandatory, covering total financing amount, finance charges, total repayment amount, estimated payments, payment amounts, and applicable fees.
• Virginia’s Distinction: Unlike California and New York, Virginia does not mandate the disclosure of an annual percentage rate (APR), focusing on the disclosure of the total cost of capital.

Non-compliance with Virginia HB1027, the Virginia Financing Disclosure Law, exposes businesses to substantial penalties. The law empowers the Virginia Attorney General to seek injunctions for violations, in addition to restitution payments, damages, and attorney’s fees for violations.

Utah SB183 – Utah Financing Disclosure Law (Effective January 1, 2023):

Engaging in a commercial financing transaction as a provider in Utah or with a Utah resident has become unlawful unless one is registered with the Utah Department of Financial Institutions (DFI). This registration, akin to California’s process, must be renewed annually through the Nationwide Multistate Licensing System (NMLS). Utah’s unique framework explicitly states that non-compliance does not affect the enforceability of transactions, nor do violations give rise to a private cause of action against the funder. However, civil penalties are not to be underestimated. Violators can face penalties of $500 per violation, not exceeding $20,000 for all violations. For repeat offenders, especially those who receive written notice of prior violations, penalties can escalate to $1,000 per violation, capped at $50,000. To ensure compliance with Utah SB 183 and avoid legal trouble, ensure proper and timely registration and annual renewal. Also, consult with counsel to prepare the required disclosures, which feature (but are not limited to) the total amount of funds provided, the total cost of financing, and any other pertinent material terms and associated costs as required by the regulations.

New York Commercial Financing Disclosure Law (August 1, 2023):

The New York Commercial Financing Disclosure Law (CFDL) mandates standardized disclosures for unregulated financial institutions engaged in commercial financing transactions. Funders failing to comply may face civil penalties, with fines reaching up to $2,000 per violation or $10,000 for intentional violations. In addition, for knowing violations, the Superintendent of the Department of Financial Services can impose restitution payments and/or injunctive relief. Disclosures include, but are not limited to:

• The total amount of funds provided
• The total cost of financing (expressed as an annualized rate)
• A description of the financing product
• Other material terms and fees
• The name and contact information of the funder
• A statement that the borrower has the right to cancel the deal within three business days of receiving the disclosures
• Timing: The disclosure must be given to the borrower when a specific commercial financing offer is made.
• Any portion of the amount financed used to pay unpaid finance charges or fees (referred to in the legislation as “double dipping.”)

Funders should proactively integrate these disclosures to align with New York’s regulatory standards and foster a culture of accuracy and responsibility in commercial financing practices.

Georgia Commercial Financing Disclosure Law (Effective January 1, 2024):

Effective January 1, 2023, Georgia’s Commercial Financing Disclosure Law mandates clear and detailed disclosures for commercial financing funders. The law amends Georgia’s Fair Business Practices Act, applying specifically to providers of commercial loans and accounts receivable purchase transactions under $500,000. Transactions are defined as purchases of accounts receivable or payment intangibles, strategically avoiding loan classification, and notably, no licensing or registration requirements are imposed on funders. Funders failing to comply with these disclosure requirements face potential civil penalties, ranging from $500 to $20,000, with additional penalties for continued non-compliance after notice. Importantly, these penalties do not compromise the enforceability of the transactions, and it is noteworthy that the law does not grant a private right of action.

Disclosure Requirements:

• Providers must disclose key terms: total funding amount, net funds disbursed, total payable, financing cost, payment schedule, and prepayment penalties.
• Unlike California and New York, Georgia’s law does not mandate APR calculation.
• The definition of “Providers” is consistent with Utah’s Commercial Financing Registration and Disclosure Act.
• Covers those engaging in more than five commercial financing transactions in Georgia annually, including online platforms partnering with depository institutions.

Florida Commercial Financing Disclosure Law (Effective July 1, 2023):

Effective from July 1, 2023, commercial financing funders in Florida are mandated to comply with the requirements of the Florida Commercial Financing Disclosure Law.

Florida Law Disclosure Requirements:

Non-compliance with these regulations can result in fines ranging from $500 per incident to an aggregate of $20,000, with possible aggregate penalties up to $50,000 for continued violations after receipt of notice. As with other states, transparency in financial dealings is paramount, and funders should stay updated on regulatory changes to ensure continuous compliance.

Connecticut Financing Disclosure Law (Effective July 1, 2024):

Connecticut sets a clear deadline for funders and brokers to register with the state banking commissioner by October 1, 2024. Additionally, the Connecticut Financing Disclosure law requires funders to disclose:

These regulations apply to entities providing commercial financing, and failure to comply can result in severe civil penalties of up to $100,000. The commissioner additionally holds the authority to enjoin those violating the statute. Understanding and fully complying with these requirements is crucial for funders and brokers that transact business in this state.

The Imperative of Adhering to Evolving Commercial Financing Disclosure Laws

The regulatory frameworks in California, Virginia, Utah, Georgia, New York, Florida, and Connecticut, coupled with impending regulations in other states, underscore a growing regulatory focus on transparency, customer protection, disclosure and equitable financial practices. With revenue-based financing facing heightened scrutiny, the strict compliance with these laws cannot be emphasized enough. Ensuring adherence is not just a best practice but a crucial necessity to avoid potential legal penalties and foster a financial ecosystem built on trust, integrity, and responsible funding practices.

How Many Funders and Brokers Are There?

According to the State of Virginia, there are only 115 total sales-based financing providers lawfully registered to transact with merchants in the state. That includes all funders and brokers combined. The figure seems… low, although there are potential exceptions to the rule.

All MCA funders AND BROKERS were required to register with the state in accordance with the law before November 1, 2022. The initial registration fee is $1,000 and the annual fee is $500, but more importantly applicants must disclose any judgment, Memorandums of Understanding, cease & desist orders, or convictions resulting from a crime or an act of fraud, breach of trust, or money laundering “with respect to that person or any officer, director, manager, operator, or individual who otherwise controls the operations of such provider or broker.”

An automatically updated live list of registered providers can be viewed here.

Regulators Seek to Shore Up Potential Hole in Commercial Financing Disclosure Rules

After a trade association sued the Commissioner of the California Department of Financial Protection and Innovation over its allegedly unlawful disclosure rules, regulators appear to be scrambling to cover their bases. In particular the SBFA, as plaintiff, has argued that California’s prescribed APR formulas are actually preempted by the federal Truth in Lending Act (TILA) and thus irrelevant.

Within 24 hours of the lawsuit becoming public, a federal agency, the CFPB, coincidentally asked the public to comment on whether or not the disclosure law of a separate state (New York) should be preempted by TILA.

“The CFPB is requesting comment on whether it should finalize its preliminary determination that the New York law – as well as potentially similar laws in California, Utah, and Virginia – are not preempted,” the agency said.

It is of the CFPB’s opinion that such state laws are not preempted and it has proposed to codify such in an official ruling. On January 20th the Attorney General for the State of California praised the CFPB for this initiative.

“…if TILA were to preempt the CFDL’s commercial financing disclosures, there would be no required disclosures at all for commercial credit in California, undermining TILA’s purpose in promoting uniform information and eliminating protections for small businesses and entrepreneurs in California,” said AG Rob Bonta.

The disclosure rules in California went into effect on January 1st despite the lawsuit being filed in December. The SBFA did not attempt to obtain a temporary injunction so there was no anticipation of a delay. The only thing that has happened in the case thus far is that California has asked for an extension to answer the lawsuit. The State now has until February 21st to submit it. In the meantime, the comment period for the CFPB’s proposed rule ended on January 20th, which now potentially puts the agency on course to quickly invent a rule to head off the challenge in California and other states.