California Finance Lenders Push Legislative Agenda in Response to Growth of Alternative Small Business Finance Industry

On October 10, 2015, California Governor Jerry Brown signed into law SB 197, a bill that allows licensed California finance lenders to pay commissions to unlicensed persons that refer prospective commercial loan borrowers to licensees that offer certain types of lower cost loans. The bill was co-sponsored by Opportunity Fund and the California Association for Micro Enterprise Opportunity. The stated purpose of the bill was to “remove a competitive disadvantage that applies to C[alifornia Finance Lender Law (“CFLL”)] licensees making commercial loans.” As the bill’s legislative background explains,

Existing CFLL regulations prohibit CFLL licensees from paying any compensation to any person or company that is unlicensed, in exchange for the referral of business. This places CFLL licensees who make commercial loans at a competitive disadvantage relative to their direct competitors, who are not required to hold CFLL licenses and are thus not subject to this restriction. Two types of direct competitors that are not required to hold CFLL licenses include merchant advance companies (not required to be licensed under the CFLL, because they are advancing, rather than lending money) and companies that partner with banks (not required to be licensed under the CFLL, because the loans are made under the banks’ charters).

Prior to the passage of SB 197, a CFLL licensee was prohibited from paying a commission to an unlicensed person that referred a potential commercial loan borrower to the licensee. The California Code of Regulation states that “no finance company shall pay any compensation to an unlicensed person or company for soliciting or accepting applications for loans…” 10 CCR § 1451.

The new legislation overrides the regulatory restriction and permits licensees to pay compensation to unlicensed persons if certain conditions are met. A CFLL licensee may pay a commission to an unlicensed person if:

1. The loan made to the borrower does not charge an annual interest rate in excess of 36%.
2. The lender conducts an underwriting and obtains sufficient documentation to ensure that the borrower has the ability to repay the loan.
3. The lender maintains records of all compensation paid to unlicensed persons for at least 4 years.
4. The lender submits annual reports to the California Commissioner of Business Oversight.

While the bill permits an unlicensed person to refer potential borrowers to commercial lenders in exchange for compensation, it limits the activities in which the unlicensed person can engage. Under the new legislation, unlicensed persons that refer borrowers for compensation may not:

1. Participate in any loan negotiation.
2. Counsel a borrower about a loan.
3. Prepare any loan documents, including credit applications.
4. Contact the lender on the borrower’s behalf, other than to refer the borrower.
5. Gather documentation of the borrower or obtain the borrower’s signature.
6. Participate in the development of any sales or marketing materials.

To be clear, the purpose of SB 197 was not to prohibit licensees from paying compensation to unlicensed persons in exchange for borrower referrals (licensees have been prohibited from paying commissions to unlicensed persons since the CFLL was enacted). Instead, the bill allows certain lenders that charge annual rates under 36% to do something that they were previously prohibited from doing, i.e. pay commissions to unlicensed persons for commercial loan referrals.