Revenue Based Finance Coalition (RBFC), a trade group whose members include non-banks that provide sales-based financing to businesses, filed a lawsuit last week against the CFPB in a Florida federal district court challenging the CFPB’s final small business lending rule implementing Section 1071 of Dodd-Frank. The core argument made by RBFC is that because sales-based financing does not constitute “credit” within the meaning of the Equal Credit Opportunity Act (ECOA) and Regulation B, the CFPB did not have the authority to regulate sales-based financing as “credit” under the Rule.
Section 1071 imposes certain data collection and reporting requirements for “any application to a financial institution for credit for women-owned, minority-owned, or small business.” (emphasis added). The Rule defines the “covered credit transactions” that are subject to the Rule’s requirements to mean “an extension of business credit that is not an excluded transaction [as set forth in the Rule.]” The Rule also provides that “credit” for purposes of what is a “covered credit transaction” has the same meaning as the term “credit” in Regulation B (which implements the Equal Credit Opportunity Act (ECOA)). The ECOA defines “credit” to mean “the right granted by a creditor to a debtor to defer payment of debt or to incur debts and defer its payment or to purchase property or services and defer payment therefor.” Regulation B defines “credit” to mean “the right granted by a creditor to an applicant to defer payment of a debt, incur debt and defer its payment, or purchase property or services and defer payment therefor.”
In its background discussion of the Rule, the CFPB stated:
[T]he Bureau is not specifically defining sales-based financing in the rule because the Bureau believes these products are covered by the definition of ‘‘credit’’ in [Regulation B]. However, based on its review of typical merchant cash advance arrangements and its expertise with respect to the nature of credit transactions, the Bureau believes the term ‘‘credit’’ encompasses merchant cash advances and other type of sales-based financing. As a result, the Bureau believes that merchant cash advances and other sales-based financing are covered by the definition of ‘‘credit’’ in [Regulation B]. The Bureau does not believe it is necessary to specifically define merchant cash advances or sales-based financing because the broad definition of ‘‘credit’’ in ECOA and Regulation B—includes credit products covered by the rule unless the Bureau specifically excludes them.
In its complaint, RBFC alleges that sales-based financing does not qualify as “credit” within the meaning of the ECOA or Regulation B and the data and reporting requirements in Section 1071 only apply to applications for “credit.” According to RBFC:
- By its plain terms, ECOA’s definition of “credit” only applies where a right to “defer” payment of a payment obligation exists and sales-based financing “involves a substantially contemporaneous exchange of value—i.e., rights to a percentage of revenue generated by a business’s sale of goods and services in exchange for the sales-based financing provider’s lump sum payment.”
- ECOA’s definition of “credit” repeatedly uses the term “debt” to describe the payment obligation that has been deferred. Even if sales-based financing does involve deferred payment obligations, it does not involve “debt.” Sales-based financing transactions do not create “debt” because they impose no unconditional obligation to repay and no liability where future receipts do not materialize in the ordinary course of business.
- Sales-based financing functions like nonrecourse factoring arrangements, which are not subject to the ECOA. The Regulation B Commentary provides “[f]actoring refers to a purchase of accounts receivable, and thus is not subject to the Act or regulation.”
- Section 1071 only applies in the context of “small business loan data collection” and repeatedly uses “loan” in a manner that informs the meaning of “credit.” Sales-based financing transactions are not “loans” because the provider bears the risk of business failure, and there are no interest rates or finite payment timelines. (RBFC notes that the CFPB acknowledged in its discussion of the Rule that sales-based financing is generally not covered under state lending laws.)
In challenging the Rule, RBFC makes the following claims under the Administrative Procedure Act (APA);
- Because sales-based financing does not qualify as “credit” within the meaning of the ECOA or Regulation B, the CFPB lacked the statutory authority to regulate sales-based financing as “credit” under the Rule. The court should declare the Rule invalid and set it aside to the extent it purports to apply to sales-based financing pursuant to the APA which provides that a court “shall…hold unlawful and set aside agency action [that is] in excess of statutory jurisdiction, authority, or limitations, or short of statutory right.”
- The Rule is arbitrary and capricious because the CFPB (1) made sales-based financing subject to the Rule to level the playing field between sales-based financing providers and their competitors that provide cash flow financing to small businesses in the form of credit, a factor which Congress did not intend the CFPB to consider, (2) failed to adequately consider costs and benefits, and (3) failed to respond to many of the comments submitted by RBFC on the CFPB’s proposed rule. The court should declare the Rule invalid and set it aside to the extent it purports to apply to sales-based financing pursuant to the APA which provides that a court “shall…hold unlawful and set aside agency action [that is] arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.”
The complaint also includes a claim that the Rule should be held unlawful and set aside because the CFPB’s funding mechanism violates the Appropriations Clause of the U.S. Constitution. While the U.S. Court of Appeals for the Fifth Circuit held in CFSA v. CFPB that the CFPB funding mechanism violates the Appropriations Clause, and the matter is now under review by the U.S. Supreme Court, the Florida federal district court is in the jurisdiction of the U.S. Court of Appeals for the Eleventh Circuit and, thus, is not bound by the Fifth Circuit’s decision.
The Rule is also being challenged in two other cases filed in federal district courts, one in Kentucky, and one in Texas. The Kentucky and Texas lawsuits include claims that the Rule is invalid because the CFPB’s funding structure is unconstitutional based on the Fifth Circuit’s ruling and because portions of the Rule also violate various APA requirements. The Kentucky lawsuit also includes a First Amendment claim.
Both the Kentucky and Texas courts issued rulings that preliminarily enjoin the CFPB from implementing and enforcing the Rule. The preliminary injunction in the Texas case initially was limited to the plaintiffs and their members, while the preliminary injunction in the Kentucky case was not so limited. The preliminary injunction in the Texas case was later extended to apply on a nationwide basis. The court’s order in the Texas case (1) stays all deadlines for compliance with the Rule for the plaintiffs and their members, parties that intervened in the lawsuit after the initial ruling and their members, and all covered financial institutions until after the Supreme Court’s decision in the CFSA v. CFPB, and (2) requires the CFPB, if the Supreme Court rules that its funding is constitutional, to extend the deadlines for compliance with the Rule to compensate for the period stayed. The court’s order in the Kentucky case does not provide for such an extension of the compliance deadlines.