Jeffrey S. Paige is the General Counsel of CFG Merchant Solutions. Visit: https://cfgmerchantsolutions.com/
Articles by Jeffrey S. Paige
Legal Complexities in the Revenue-Based Financing Industry: An Analysis of Recent Court Cases
January 6, 2025Jeffrey S. Paige is the General Counsel of CFG Merchant Solutions. Visit: https://cfgmerchantsolutions.com
Navigating the intricate legal landscape of the revenue-based financing industry has become increasingly complex, with recent court cases providing profound insights into the sector’s regulatory dynamics. Amidst legislative shifts, litigation between funders and merchants, and public enforcement actions, three prominent court cases have recently emerged, each offering further guidance into the nuanced legal dynamics governing this innovative sector.
SBFA vs. DFPI: Constitutional Challenges to California’s Regulatory Framework
In the Small Business Finance Association (SBFA) vs. California Department of Financial Protection and Innovation (DFPI), 9th Cir., Case No. 24-50, SBFA challenged the constitutional validity and federal preemption of California’s Commercial Financing Disclosure Law. Central to SBFA’s stance is the contention that the state’s regulatory framework infringes upon the First Amendment rights of its members. SBFA asserts that the regulations compel its members to disseminate inaccurate disclosures to customers, while simultaneously prohibiting any communication that could rectify or clarify purportedly misleading information. Furthermore, SBFA contends that California’s customized interpretation of the Annual Percentage Rate (APR) conflicts with the federal Truth in Lending Act (TILA), potentially causing confusion among merchants. The DFPI moved for summary judgment to dismiss the complaint.
Updates and Nuances: Recent Ruling on SBFA vs. DFPI
On December 4, 2023, the trial level judge ruled in favor of the DFPI, granting their motion for summary judgment and dismissing the case.
First Amendment Argument: The judge disagreed with SBFA, concluding that the disclosures would help small businesses understand the costs and were neither misleading nor unduly burdensome.
Federal Preemption Argument: The judge deferred to the Consumer Financial Protection Bureau (CFPB)‘s authority to resolve preemption issues. In March 2023, the CFPB ruled that the Commercial Financing Disclosure Law (CFDL) does not conflict with TILA.
The SFBA has filed an appeal of the lower court’s grant of summary judgment with the United States Court of Appeals for the Ninth Circuit. On May 28, 2024, SBFA filed their appellate brief setting forth the facts on the record on summary judgment and their specific legal arguments, emphasizing the reversible errors made by the district court, particularly regarding the false and misleading nature of the compelled disclosures, the controversy surrounding the use of APR metrics on products (like receivables-based funding transactions) that APR was not designed to properly describe, and the lack of justification for the regulations. The preemption argument is not being raised on appeal. Following this, on June 6, 2024, the Appellee DFPI’s unopposed motion for an extension of time to file the answering brief was granted. The answering brief of the DFPI is now due on August 30, 2024.
Given these developments, SBFA’s challenge continues to underscore significant constitutional, substantive, and procedural issues within California’s regulatory framework.
The People v. Richmond Capital Group: Uncovering Predatory Practices
In the case of The People v. Richmond Capital Group, 195 N.Y.S.3d 637 (N.Y. Sup. Ct. 2023, unpublished slip copy), allegations of predatory practices have uncovered crucial legal considerations for revenue-based financing providers. Initially filed by the People in 2020, the court ultimately found for the People, holding that the Defendants in that case were “predatory lenders” making thinly disguised loans with usurious interest. The keys to this decision were the reconciliation duty (which was allegedly never performed by the Defendants despite the mandatory contract provisions and requirement that merchants submit bank statements to Defendants on a monthly basis), the fact that the transactions were explicitly based upon fixed repayment amounts with fixed repayment timeframes (as opposed to revenue based funding products, where remittance of the purchased receivables may vary in amount and duration along with the merchant’s revenue stream), contract provisions such as making a few missed payments or declaration of bankruptcy events of default (shifting the risk of loss off of the funder), and the fact that Defendants always referred to their products as loans, and not a bona fide purchase and sale of future receipts. The reprehensible conduct of certain Defendants who harassed, bullied, and made numerous fraudulent statements to their merchant customers certainly did not help their cause. In September 2023 and February 2024, the court issued further decisions addressing accounting and disgorgement of funds, but the core principles related to reconciliation and data remain the same. It’s unclear if Richmond Capital Group appealed any of these rulings.
U.S. Info Group, LLC v. EBF Holdings: Implications for ISO Behavior and Funder Accountability
2023 WL 6198803 (S.D.N.Y., 2003), a case out of the Southern District of New York involving New York law, involves allegations by a Plaintiff against a receivables-based funder similar to those in Richmond Capital, but with a very different set of facts, and a different outcome. U.S. Info Group attempted a civil Racketeer Influenced and Corrupt Organizations Act (RICO) claim against EBF Holdings, alleging that the receivables-based funding transaction at issue was a disguised usurious loan under New York law.
In September 2023, the court dismissed the case entirely on the funder’s motion to dismiss the third amended complaint. The judge ruled that U.S. Info Group failed to adequately allege facts demonstrating a “RICO enterprise” or widespread fraud scheme involving EBF Holdings and their affiliates. In addition, the Court re-iterated the major hallmarks of a true purchase and sale receivables-based funding transaction: (i) that the contract contained a reconciliation provision (and that the funder actually preforms reconciliations where warranted such that the provision is not illusory); (ii) that the risk of non-performance due to bankruptcy or declined revenue of the merchant always rests with the funder; and (iii) that there is no finite, fixed repayment term, which would be typical of a loan.
Legal Recommendations for Funders
Funders should consult with knowledgeable and capable attorneys in this area of law to establish and effectuate clear provisions in their contracts along with steadfast adherence to their contract terms and best practices.
As for the DFPI and California’s disclosure requirements, they remain the law of the land unless the final, unappealable decision of a court states otherwise. Thus, funders should consult with their attorneys to ensure strict compliance with California’s disclosure law and regulations.
In conclusion, the recent legal battles involving the revenue-based financing industry underscore the need for continuous vigilance, genuine commitment to proper contract terms and best practices in servicing those contracts, and adaptation to emerging regulatory paradigms, in order to ensure sustainable growth and legal compliance within this dynamic sector.
Legal Risks: Penalties for Non-Compliance in Revenue-Based Financing
December 11, 2023Jeffrey 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.
