Regulation

CFPB Reverses Course: Now Proposes to Remove Merchant Cash Advances from Section 1071 Rule

The CFPB has come back with a new proposal on how to roll out its section 1071 rules. Inside the 198 pages, the agency opines at length on merchant cash advances and reverses its previous opinions. It now believes they should not be subject to the rules.

The CFPB believes that at the onset of data collection under section 1071 the rule should focus on core, generally applicable, lending products that are most likely to be foundational to small businesses’ formation and operation—loans, lines of credit, and credit cards—before determining whether to expand the scope of the rule to include more niche or specialty lending products. The CFPB therefore proposes to exclude MCAs, agricultural lending, and small dollar loans from the definition of covered credit transaction to better ensure the smooth operation of the initial period of data collection, while minimizing disruptions and regulatory complexity in the credit markets subject to section 1071.

Current § 1002.104(a) defines a “covered credit transaction” as “an extension of business credit that is not an excluded transaction under paragraph (b) of this section.” Section 1002.104(b)(1)-(6) enumerates six types of transactions that are excluded from covered credit extensions. The Bureau proposes adding MCAs to the list of excluded transactions in § 1002.104(b). Proposed § 1002.104(b)(7) would exclude MCAs, which it would define as an agreement under which a small business receives a lump-sum payment in exchange for the right to receive a percentage of the small business’s future sales or income up to a ceiling amount. Consistent with this proposed new exclusion, the CFPB proposes deleting several references to MCAs, and the related term sales-based financing, in commentary.

In the 2023 final rule, the CFPB explained its belief that the statutory term “credit” in ECOA is intentionally broad so as to include a wide variety of products without specifically identifying any particular product by name, such that all credit products should be included in the rule unless the CFPB specifically excluded them and concluded that “credit” encompasses MCAs. It further explained that MCAs should not be understood to constitute factoring within the meaning of the existing commentary to Regulation B subpart A or the definition in existing comment 104(b)-1, because factoring involves entities selling an existing legal right to payment from a third party, while no such contemporaneous right exists in an MCA. The CFPB also noted its understanding that, as a practical matter, MCAs are underwritten and function like a typical loan (i.e., underwriting of the recipient of the funds; repayment that functionally comes from the recipient’s own accounts rather than from a third party; repayment of the advance itself plus additional amounts akin to interest; and, at least for some subset of MCAs, repayment in regular intervals over a predictable period of time), although it also implicitly acknowledged practical differences between MCAs and conventional loans by including numerous provisions intended to capture MCA-specific data.

This proposal reconsiders the CFPB’s previous conclusions, as illustrated in existing comment 104(a)(1)-1, which does not exclude MCAs from the definition of “covered credit transactions” under § 1002.104(a), for several independent reasons. First, the CFPB believes that at the onset of the data collection under section 1071 the focus should be on core lenders and products before the CFPB considers expanding the scope of the rule. MCAs are structured differently from traditional lending products; traditional lending concepts like “interest rate” do not fit the way that MCAs are priced. As a result, it is not clear that data collection on MCA transactions under section 1071 would yield information that advances section 1071’s statutory purposes to the extent that some or many such transactions do not constitute credit. The CFPB believes it would advance the purposes of section 1071 at this time to exclude MCAs from the definition of covered credit transaction, and to focus on ensuring the smooth operation of data collection as to core lending products and providers most likely to be foundational to small businesses’ formation and operation.

Second, the CFPB believes it erred in prematurely determining that collection of data on MCA transactions would serve section 1071’s statutory purposes by concluding that all MCAs constitute credit. The 2023 final rule’s one-size-fits-all approach also does not take into account the varied terms and features of MCAs across the market that may be relevant to whether the products meet the definition of “credit” under ECOA, nor did it account for the fact that MCAs are relatively new products whose features and practices may be evolving, including in response to State regulation. Moreover, while some State courts have analyzed whether some MCAs meet State law definitions of “debt” or “credit,” there is a dearth of case law analyzing whether MCAs meet ECOA’s definition of “credit.”

Excluding MCAs from the definition of “covered credit transaction” would be consistent with the way the CFPB has already treated leases, which also present close questions as to whether they meet the definition of “credit” under ECOA. In the 2023 final rule’s analysis of leases, the CFPB acknowledged that some lease transactions could constitute “credit.” But rather than include all lease transactions in the 2023 final rule to ensure coverage of those leases that did actually constitute credit and credit disguised as leases, the CFPB determined that it would be able to monitor the market for such products without including them in the 2023 final rule. The CFPB proposes taking a similar approach to MCA transactions as it did to leases.

Further, the CFPB believes that the 2023 final rule’s coverage of MCAs does not take into account State law developments addressing sales-based financing. Several States have legislation and/or regulations in place addressing the MCA market and requiring providers to disclose terms such as the total cost of capital and the financing rate. Such laws provide key protections for users of MCAs and may shape MCA terms and practices in ways that bear on the question of whether they meet ECOA’s definition of “credit.” While the 2023 final rule referenced these pieces of State legislation, it did not consider the extent to which the evolving landscape under State law rendered premature a determination that including MCAs in the definition of “covered credit transaction” for purposes of mandating data collection furthered section 1071’s statutory purposes. The CFPB believes that it would be advantageous to observe how State laws address MCAs before the CFPB decides how, and whether, to collect data regarding MCAs pursuant to section 1071.

Finally, while the final rule cited concerns about high costs and predatory practices in the MCA market, those concerns may be addressed by Federal and State law enforcement agencies through their respective enforcement authorities.

The CFPB believes that taking into account the factors listed above, the relative novelty and evolving landscape of the MCA industry and the ongoing changes at the State level concerning the regulation of MCAs, that excluding MCA transactions from coverage under the rule at this time is necessary and appropriate to carry out the purposes of section 1071.

As explained above, MCAs differ in kind from traditional lending products, such that collecting data on MCA transactions under Section 1071 may not produce information that is comparable to data collected on other types of transactions. And because MCAs have not generally been regulated as credit, many smaller MCA providers may lack the infrastructure needed to manage compliance with regulatory requirements associated with making extensions of credit. Taken together, requiring MCAs to be reported could lead to data quality issues, which would not advance the purposes of section 1071.

The CFPB will continue to monitor developments in the markets for MCAs and other sales-based financing to determine whether over time a subset might be appropriately included in the definition of “covered credit transaction” for purposes of data collection.

The CFPB seeks comment on this proposed revision to the rule. It also seeks comment on topics including, but not limited to, the extent to which MCAs differ from or resemble traditional lending products; the diversity of MCA terms and practices and how they impact whether MCAs, or a subset of MCAs, meet the definition of “credit” under ECOA; whether certain types of MCAs are more or less appropriate for exclusion; and suggestions for how the 2023 final rule could be modified with respect to MCAs if the CFPB ultimately does not exclude them. The CFPB further seeks comment on alternative definitions to the one proposed in
§ 1002.104(b)(7).