Legal Briefs
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.
ISO Arrested by FBI
October 18, 2023
A merchant processing ISO was arrested by federal agents this week for his alleged role in a business loan fraud scheme. Paul Paredes, who owns J&E Business Consulting LLC in Rochester, NY, allegedly used the identities of his merchant processing clients to obtain business loans for himself.
“Small businesses provide J&E with their financial information, such as the owner’s identifying information, including driver’s license, social security number, and email, as well as bank account information,” the Assistant US Attorney said.
According to the complaint, between May and November 2022, Paredes fraudulently submitted approximately 42 loan applications using the identities of approximately 31 individuals, enabling him to obtain millions of dollars. He used the money to pay off one victim, pay other loan companies, and he used it on personal expenses such as credit cards, travel, and vehicles.
Paredes is also facing a related civil lawsuit over the matter. According to public records, his company has also used and defaulted on several merchant cash advances from as far back as 2016 to as recent as this year.
“Although a comprehensive analysis of all known accounts has not yet been completed, the financial transactions in the [bank] accounts appear to be consistent with Paredes laundering the fraudulent loan proceeds obtained from the lender companies, which are proceeds of a Specified Unlawful Activity, namely wire fraud, in a similar fashion to a ‘Ponzi scheme’ and inconsistent with the operations of a legitimate business enterprise,” an FBI agent said in an affidavit.
NY Appellate Division Rules One Funder’s Contract Crossed Loan Threshold
October 12, 2023While New York’s Appellate Division has previously decided what’s not usury when it comes to MCA transactions, the Second Department has now ruled what is.
On Wednesday, the Court issued its decision in Crystal Springs Capital, Inc v. Big Thicket Coin, LLC et al, a case that had otherwise started out as a routine breach of contract action related to the purchase of future receivables in the New York Supreme Court back in September of 2020. When defendants never appeared, the plaintiff obtained a default judgment eleven months later. That sparked a response from the defendants who then sought to vacate it on several grounds, including by arguing that the underlying agreement was really a criminally usurious loan. The Court rejected the argument for several reasons, citing that the “reconciliation language in the Agreement is nonillusory” and stating plainly that “a merchant cash advance agreement is not a loan and therefore its terms are not usurious.” Vacatur denied. Defendants appealed.
Given the history in New York (1st Dept, 4th Dept, etc.), the case was hardly news, until now.
In the new Decision & Order, the Court said that “the defendants established that the agreement constituted a criminally usurious loan.” In support of that outcome, the Court said that the plaintiff was “under no obligation” to reconcile the payments and that the full uncollected purchased amount plus all fees were due in default even if the business declared bankruptcy. (View contract at issue here)
“Together, these terms established that the agreement was a loan, pursuant to which repayment was absolute, rather than a purchase of future receipts under which repayment was contingent upon the Big Thicket defendants’ actual sales,” the Court said. “The plaintiff does not dispute that the agreement effected an annual interest rate exceeding the criminally usurious threshold of 25%.”
New York’s Fourth Department: Revenue Purchase Agreements Are Not Loans
August 25, 2023A lawsuit brought by Samson MCA LLC against Joseph A. Russo M.D. P.C./IV Therapeutics PLLC, DBA Aspire Med Spa & Joseph Russo & Marco V Beatrice has brought revenue purchase agreements back in to the legal spotlight in New York State. Once again its been affirmed that they’re not loans.
In May 2021, plaintiff Samson MCA sued defendants for breach of contract and won on summary judgment despite defendants’ contentions that the revenue purchase agreements at issue were actually “criminally usurious loans.” Defendant Marco V Beatrice appealed. After a very careful analysis of the agreements, a final decision was issued by the Appellate Division, Fourth Department on August 11, 2023.
“On appeal, [defendant] contends that the agreements are void because they are criminally usurious loans and that the court therefore erred in granting plaintiff’s motion and denying defendants’ cross-motion with respect to him,” the Court stated. “Thus, the central question before us is whether the two agreements were, in fact, revenue purchase agreements or whether they were, instead, loans.”
The Court said that when determining whether a transaction constitutes a loan, courts must determine whether the amount is repayable absolutely or under all circumstances:
“Usually, courts weigh three factors when determining whether repayment is absolute or contingent:
(1) whether there is a reconciliation provision in the agreement;
(2) whether the agreement has a finite term; and
(3) whether there is any recourse should the merchant declare bankruptcy”
Final decision:
Contrary to [defendant’s] contention, plaintiff established as a matter of law that the agreements were revenue purchase agreements rather than loans, and [defendant] failed to raise a triable issue of fact with respect thereto (see Principis Capital, LLC, 201 AD3d at 754). Here, the agreements submitted by plaintiff contained reconciliation provisions requiring the adjustment of the remittance amount upon request based on changes to the entity defendants’ revenues, and had no finite term and no payment schedule. Additionally, as noted, each agreement contained an acknowledgment “that [plaintiff] may never receive the purchased amount in the event that [the entity defendants’ business] does not generate sufficient revenue” and, for the most part, plaintiff did not have recourse in the event that the entity defendants declared bankruptcy (see Streamlined Consultants, Inc. v EBF Holdings LLC, 2022 WL 4368114, *5 [SD NY, Sept. 20, 2022, No. 21-CV-9528 (KMK)]).
We have reviewed [defendant’s] remaining contention and conclude that it does not warrant reversal or modification of the judgment.
The original lawsuit can be found under Index No. 129401/2021 in the New York Supreme Court.
Full decision by the Appellate Division, Fourth Judicial Department can be found here.
Former MBE Capital Partners, LLC CEO Sentenced to 4.5 Years in Prison
July 31, 2023
Rafael Martinez, the former CEO of MBE Capital Partners, LLC, is going to prison. The company was a PPP lender during covid but it was alleged it should not have been!
In March 2022, the DOJ said that “Martinez used false representations and documents to fraudulently obtain the approval of the SBA for his company, MBE Capital Partners, LLC, to be a non-bank lender through the PPP. Martinez then used that approval to obtain approximately $932 million in capital to issue PPP loans and earn over approximately $71 million in lender fees.”
Martinez then spent those funds on himself, purchasing a villa in the Dominican Republic, a Ferrari, and private jets.
He pled guilty to conspiracy to commit wire fraud exactly a year later. Last week he was sentenced to four and a half years in prison.
Celsius Founder Alex Mashinsky is Charged by DOJ, SEC, CFTC
July 13, 2023Crypto platform Celsius founder Alex Mashinsky has been charged by multiple agencies including the US Attorney’s Office for the Southern District for his role in a multibillion dollar fraud and market manipulation schemes. Although he has been referred to as a “crypto lender,” some of the most unusual stories surrounding the alleged fraud have to do with the customers. For instance, in the Celsius bankrupty proceeding, one customer pleaded for their funds back on the basis that they had yolo’d their entire EIDL funds into it.
“I placed my entire EIDL loan, $525,000 in Celsius to earn an APY to help pay back the 3.9% interest on the loan while I was in the process of deciding on if I would keep the EIDL or use it on my business,” the customer wrote. “I deposited these funds a few weeks after the Celsius rules changed on their ‘Earn’ accounts which required a user to be an Accredited Investor, which I was not.”
That victim’s story was publicized 12 months ago. At its peak, Celsius managed $25 billion of customer funds. The company declared bankruptcy in July 2022. Federal charges allege that much of the Celsius business was just a fraud run by Alex Mashinsky and another co-defendant.
The SEC and CFTC have also filed civil charges against Mashinsky.
New York Court of Appeals Dismisses Case That Challenged MCA Legality
June 13, 2023The New York Court of Appeals dismissed AH Wines Inc., et al. v C6 Capital Funding LLC. Its reasoning was brief.
“Appeal dismissed without costs, by the Court sua sponte, upon the ground that the issues presented have become moot,” the order says.
For a more complete understanding of the outcome, please contact an attorney.
Kate Fisher, Chris Murray Recipients of the Greg Nowak Impact Award
June 5, 2023
The Alternative Finance Bar Association selected two recipients for this year’s Greg Nowak Impact Award. They were Katherine C. Fisher, Partner of Hudson Cook, LLP and Christopher R. Murray, Managing Member of Murray Legal, PLLC. Winners are generally selected for their all-around efforts for the legal community both on matters of law and outside of it.
Greg Nowak, who passed away in 2021, was a partner of Troutman Pepper and a beloved founding member of the AFBA. The winner of last year’s award was David A. Picon, a Partner of Proskauer Rose LLP.
