A California federal district court recently granted the motion for summary judgment filed by the California Department of Financial Protection and Innovation (DFPI) in the lawsuit filed by an advocacy organization seeking to enjoin the DFPI from enforcing its final regulations (Regulations) implementing 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, 2022.

The plaintiff, the Small Business Finance Association (SBFA), alleged in its complaint that the Regulations violate the First Amendment rights of its members.  More specifically, SBFA alleged that the compelled disclosures do not accurately inform customers about the terms of a provider’s products because the disclosures for sales-based financing (SBF) transactions are “literally false” and the disclosures for both SBF transactions and open-end credit (OEC) are misleading because they are inaccurate.  SBFA also alleged 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.

In rejecting the SBFA’s First Amendment claim, the court applied the First Amendment test for compelled commercial speech established by the U.S. Supreme Court in its 1985 decision in Zauderer v Office of Disciplinary Counsel of Supreme Court of Ohio.  According to the district court, to satisfy Zauderer, the DFPI was required to prove that the compelled disclosures are (1) purely factual, (2) noncontroversial, (3) not unduly burdensome, and (4) reasonably related to a substantial governmental interest.  With regard to each of these elements, the court reasoned:

  • For a disclosure to be purely factual, it must be “literally true” and “not misleading.” SBFA alleged the use of the word “fees” in the SBF disclosure that “[t]he cost of this financing is based upon fees charged by the [provider] rather than interest that accrues over time” was false because the cost of an SBF is based on a “discount” and not “fees.”  The word “discount” did not make the disclosure false because operationally, “discounts” are similar to “origination fees.”  SBFA also alleged the use of the word “payment” in the disclosure “Estimated Total Payment Amount” and the word “owe” in the disclosure “[y]our finance charge will not increase if you take longer to pay off what you owe” falsely connote a loan and should be replaced with “remittance” and “due,” respectively.  These are distinctions without a difference.  Making a “payment” means the same as making a “remittance” and an amount “owed” is not different than an amount “due.”  The SBF disclosures are literally true because terms “payment” and “owe” are truthful descriptors within the SBF disclosures.
  • The record did not show that the SBF and OEC disclosures mislead recipients into believing that the products are traditional loans.  Neither are they misleading because the estimated figures for payment, term, and APR vary significantly from actual results.  The disclosures explicitly state that they are based on assumptions, putting any reasonable person on notice that the calculations are based on assumptions and may not perform as estimated.
  • “Objective controversy” exists where a statement “elevates one side of a legitimately unresolved scientific debate.”  SBFA alleged the disclosures are “objectively” controversial because there is a “vigorous debate” in the commercial financing industry whether an “Estimated APR” should be disclosed in connection with an SBF transaction.  The existence of some disagreement about the usefulness of an estimated APR did not render the disclosure controversial for First Amendment purposes.  There was no evidence that the “Estimated APR” term has been expressly rejected by reputable authorities on the matter.  “Subjective controversy” exists where a statement is “fundamentally at odds with [the speaker’s] business.”  The “Estimated APR” disclosure is not subjectively controversial because it is simply a mathematical calculation based on the terms of a contract and the assumptions stated.  The fact that TILA uses a different methodology for calculating the APR in consumer lines of credit does not make the OEC disclosures subjectively controversial.  TILA does not apply to commercial financing and there is no evidence that any authority has rejected the use of the Regulations’ methodology in the commercial financing context.
  • To be unduly burdensome, a compelled disclosure must be so comprehensive that it drowns out the speaker’s own message.  The disclosures required by the Regulations are not unduly burdensome because they do not impede speech and there was no evidence that the costs of compliance would prevent a provider’s commercial speech (i.e. make it uneconomical to offer financing).  Also, nothing in the Regulations prevents providers from making any statement outside of the disclosures.
  • The disclosures are reasonably related to the state’s substantial interest in protecting small businesses from unwittingly entering into unaffordable financing transactions.

In rejecting SBFA’s preemption claim, the court gave a “high level of deference” to the CFPB’s March 2023 determination that TILA does not preempt SB 1235.  TILA provides that it does not preempt state laws “relating to the disclosure of information in connection with credit transactions” except to the extent such laws are “inconsistent with the provisions of [TILA], and then only to the extent of the inconsistency.”  The court cited the Supreme Court’s 1980 decision in Ford Motor Credit Co v Milhollin.  In that case, the Supreme Court deferred to a Federal Reserve Board interpretation of TILA.  The question of what is the appropriate level of judicial deference to agency interpretations (and whether the Supreme Court’s 1984 Chevron decision, which created a framework for judicial review of an agency interpretation, should be overruled) is now before the Supreme Court in two cases.