Articles by Robert F. Gage, Hudson Cook LLP
North Dakota Law Regulates “Alternative Financing” as a “Loan”
May 30, 2025The state legislature in North Dakota recently passed House Bill 1127. This bill made a simple amendment to a 1970s-era law called the Money Brokers Act (“MBA”).
Despite its name, the MBA is not limited to brokers. It is the primary law regulating consumer and commercial lending in North Dakota. It applies to any person engaged in the act of arranging or providing loans. Such persons are called “money brokers” in the MBA.
This amendment adds a two-sentence definition of the word “loan”. When this amendment takes effect, the MBA will define “loan” as follows:
“Loan” means a contract by which one delivers a sum of money to another and the latter agrees to return at a future time a sum equivalent to that which the person borrowed. This includes alternative financing products as identified by the commissioner through the issuance of an order.
Is this is a big deal? Yes. Here’s why.
Until now, the MBA has always defined the term “money brokering” to include the act of providing “loans” but has never defined the term “loan”. As a result, forms of business financing that are not typically considered loans – such as factoring or revenue-based financing (also sometimes called “merchant cash advance”) would not be subject to the MBA. Adding this new definition of “loan” to the MBA creates significant risk that alternative forms of business financing will become subject to the regulatory burdens impose by MBA.
Those burdens are significant. The MBA requires money brokers to obtain a license from the North Dakota Department of Financial Institutions (“DFI”). The MBA also caps the maximum amount of fees and charges that can be impose by a money broker at a rate of 36% per year.
With this new definition, the North Dakota Department of Financial Institutions (“DFI”) can now issue an order designating any financing product as a loan subject to the MBA. Does the DFI intend to regulate revenue-based financing? That’s unknown at this time. The Commissioner of Financial Institutions provided a memorandum to the legislature stating that the new definition would allow DFI to ensure that North Dakota’s citizens “will have access to new lending products, without sacrificing safeguards”. It is possible that the Commissioner is intending to focus on consumer financing products and not commercial financing. Even if that’s the case, that’s small comfort.
There is still a problem with this law because the first sentence of the definition is simply too broad. It states that a “loan” includes a transaction with the following two features:
1. There is a contract by which a sum of money is delivered to another.
- A typical revenue-based financing is structured as a purchase of a merchant’s future revenue at a discounted purchase price. The purchase price is a sum of money delivered to the merchant.
- Invoice factoring transactions also involve a delivery of funds in the amount of the face value of the invoice minus a discount and/or a reserve.
2. At a future time, the person receiving that money agrees to return an “equivalent” sum.
- In revenue-based financing, the merchant agrees to deliver the purchased amount based on an agreed-upon percentage of the merchant’s revenue stream. Arguably this is a “sum of money” equivalent to the purchase price advanced to the merchant.
- Factoring is a bit more complicated. In recourse factoring, a factoring client sometimes is required to repurchase an invoice from the factor if the invoice is not paid on time. The repurchase price is based on the face value of the invoice. Arguably this is a “sum of money” equivalent to the face value of the invoice minus a discount and/or a reserve.
Even if the DFI does not order that revenue-based financing or factoring are loans, a North Dakota court could take the position that the definition of “loan” is now so broad that these products are already loans under the revised MBA. No DFI order is needed.
If a North Dakota court concludes these products are now subject to regulation under the MBA, including its 36% rate cap, then this opens the door for North Dakota businesses that obtain financing to sue any provider that imposes charges that effectively exceed that rate cap.
It’s not clear whether the North Dakota legislature understands what it just did. This amendment was part of a legislative package that was primarily focused on data security. The addition of the “loan” definition would be difficult to find if you weren’t looking for it. House Bill 1127 passed with almost unanimous support. Did all those legislators understand that this law could drive away products that offer working capital to businesses that badly need liquidity and don’t have access to a bank line of credit? I doubt it.
Does this mean that providers of alternative financing should stop funding in North Dakota? That’s a business decision. We’ll certainly be watching to see if the DFI provides any guidance on any kind of “alternative financing” product it considers to be a loan. But providers of revenue-based financing and factoring should start thinking about whether they might need an MBA license North Dakota and whether they can live with the MBA’s 36% rate cap.
According to the North Dakota legislature’s website, this change in the MBA is likely to take effect on August 1, 2025. That gives you some time to think about whether North Dakota is still a viable market for your financial products.
NY Reminds MCA Industry That Annual Reports are Due April 30 (and how to know if this applies to your organization)
April 11, 2025
On April 10, the New York Department of Financial Services (NYDFS) sent an e-mail alert to remind providers of “sales-based financing” (New York’s term for merchant cash advance) that providers must file a report analyzing the annual percentage rates (or APRs) on transactions completed in New York. The report is required only for providers that use the so-called “opt-in” method of estimating APRs in the disclosures required by the New York Commercial Financing Disclosure Law (CFDL).
If you are currently asking yourself whether your organization uses the “opt-in” method, then there is a good chance that you are and don’t know it. The explanation of the opt-in method, its connection to APR, and the annual filing requirement, are all buried deeply within NYDFS regulations that are difficult to understand, and not very easy to explain. That said, here’s a simplified explanation.
As you may know, the CFDL is a disclosure law that requires providers of sales-based financing (and most other forms of commercial financing) to provide a set of disclosures designed to provide businesses with information about the cost of the financing they are obtaining.
Sales-based financing is a unique financial product because payments are based on a percentage of business revenue. The initial fixed payment is supposed to be a factor of this agreed percentage and the estimated average revenue of the business. Under the NYDFS regulations, there are two permitted methods for estimating this revenue. The first involves looking back at the historic revenue of the business and estimating future revenue based on a review of past revenue. In the NYDFS regulations, this is called the “historical method”. There are rigid rules for using the historical method. For example, the time period for the look-back generally must be no less than four months and no more than 12 months. You must use that period for all transactions in the state. There are a number of exceptions to these general rules. Another requirement is that, once you decide on the look-back period, you must record this decision in an internal document that identifies the effective date of this decision. You must do the same any time you change the look-back period.
The “opt-in method” is essentially any method that does not conform to the rules for the historical method. In other words, unless you are following the rules for the historical method, you are using the opt-in method.
If you are using the opt-in method, then you have to provide a report to NYDFS no later than April 30 of each year. Currently, the report must include the following information covering the period of the preceding calendar year:
- For each transaction, the estimated APRs disclosed to the recipient and actual retrospective APRs of completed transactions.
- The annual mean of all differences between the estimated APRs disclosed to the recipient and actual retrospective APRs of completed transactions, which mean shall be reported both weighted by financing amount, and unweighted.
- A statement of any unusual and extraordinary circumstances impacting the provider’s deviation between estimated and actual APR.
Making this report is not a task for the faint-hearted. A comparison of estimated APR to “actual retrospective” APR requires tracking the performance of all completed transactions in New York for the year and calculating APRs based on the exact date and exact amount of every payment!
Note that the reporting is exclusively focused on APR, not revenue. What does average business revenue have to do with APR? To paraphrase Michael Corleone . . . my answer is this Senator: Nothing.
The NYDFS seems to be under the impression that the estimated APR on a sales-based financing transaction can be manipulated by aggressively interpreting average sales revenue, which would (so the theory goes) lower the initial fixed payment and increase the effective term of the transaction. There are some very good reasons to conclude that this theory is deeply flawed. For example, reducing the payment and lengthening the term would lower the estimated APR. But it will also result in a lower actual retrospective APR. There is nothing manipulative about it. A provider need not manipulate the average revenue estimate to provide a lower payment and longer effective term.
Setting aside the point that it was unnecessary to create rules for estimating average sales revenue, it should be clear that few providers would knowingly put themselves in the position of having to file this annual APR report. How can you ensure that you do not trigger this reporting requirement? Make sure your organization is complying with the rules for the historical method.
