On December 2, a non-profit advocacy organization filed a lawsuit in a California federal district court seeking to enjoin the California Department of Financial Protection and Innovation (DFPI) from enforcing the final regulations (Regulations) issued by the DFPI to implement California’s commercial financing disclosure law.  SB 1235, which was signed into law in 2018, requires consumer-like disclosures to be made for certain commercial financing products, including small business loans and merchant cash advances.  The Regulations became effective on December 9. 

The plaintiff is the Small Business Finance Association (SBFA) whose mission, as described in the complaint, “is to educate policymakers and regulators about the technology-driven platforms emerging in the small business finance market.”  The complaint describes SBFA’s members as “technology-driven financial services companies specifically focused on providing efficient and responsible capital to small and medium-sized businesses across America.”

SBFA alleges in the complaint that the Regulations violate the First Amendment rights of its members.  According to SBFA, despite the differences between traditional loans and sales-based financing (SBF) transactions, the disclosures mandated by the Regulations erroneously assume that SBF transactions operate like traditional loans.  As a result, the mandated disclosures compel SBFA’s members to describe their SBF transactions in ways that misstate the costs and features of the financing.  SBFA alleges that (1) in addition to compelling inaccurate and misleading speech, the Regulations prohibit commercial free speech by not permitting modifications to the disclosure form and prohibiting a provider from clarifying required information that is misleading or inaccurate or providing additional information except in limited circumstances that are not sufficient to correct false and misleading statements required by the Regulations, and (2) the compelled disclosure of inaccurate or misleading information is not limited to SBF transactions but also extends to open-end financing.

In addition to its First Amendment claim, SBFA claims that the Regulations are preempted by the Truth in Lending Act (TILA) because they mandate disclosure of the “APR” and “finance charge” but define and calculate those terms differently than TILA.  SBFA alleges that the fact that the Regulations apply to commercial and not consumer transactions does not preclude their preemption by TILA. It alleges that:

  • Permitting the terms APR and finance charge to be used for products not covered by TILA when they are defined differently than under TILA would frustrate TILA’s purpose of ensuring uniformity because APR and finance charge would no longer be reliably consistent terms and consumers would stop relying on them.
  • Because small business owners often finance their businesses through a combination of commercial and consumer finance products, they routinely compare products subject to TILA with products that are not subject to TILA.  As a result, a state law mandating disclosure of two key TILA terms for non-TILA products but defining or calculating those terms differently from TILA will create significant confusion for consumers considering TILA products.

As the DFPI will undoubtedly highlight when it responds to SBFA’s complaint, the CFPB has preliminarily determined that California’s financing disclosure law is not preempted by TILA.  Last week, the CFPB issued a notice of its intention to make a determination that the TILA does not preempt the commercial financing disclosure laws of four states, including California.  Although the notice was issued in response to a trade association’s request for a preemption determination as to New York’s commercial financing disclosure law, the CFPB, on its own motion, also addressed the California, Utah, and Virginia laws.

After giving its preliminary conclusion that TILA does not preempt the New York law, the CFPB stated that it was also considering making determinations whether TILA preempts the California, Utah, and Virginia disclosure requirements.  It indicated that it has conducted a preliminary review of those laws “which are similar in relevant aspects to the [New York law] because they do not apply to consumer credit transactions that are within the scope of TILA.”  The CFPB stated that, based on the similar coverage of these state laws, its preliminary conclusion was that they also are not preempted by TILA.  In its preemption analysis, the CFPB considered, and rejected, many of the same arguments advanced by SBFA in support of its preemption claim.