Commercial Financing Disclosures
Small Business Finance Association v. Clothilde Hewlett
Date: Dec. 4, 2023
Issue: Whether California Department of Financial Protection and Innovation (DFPI) regulations violate the First Amendment and are preempted by the Truth in Lending Act (TILA).
Case Summary: A California federal district court granted DFPI’s motion for summary judgment after the Small Business Finance Association (SBFA) sued to enjoin DFPI from enforcing its final regulations implementing California’s commercial financing disclosure law.
On Sept. 30. 2018, California enacted Senate Bill 1235, which required consumer-like disclosures for commercial financing products, including small business loans and merchant cash advances. The statute requires that offers of commercial financing for $500,000 or less include disclosures of the amount of funds provided, the total dollar cost of financing, the term or estimated term, the method, frequency, and amount of payments, a description of prepayment policies, and the total cost of financing expressed as an annualized rate. On June 9, 2022, DFPI promulgated regulations detailing the required disclosures for close-end loans, open-end lines of credit (OECs), factoring transactions, sales-based financings (SBFs) leases, asset-based lending, and all other financial products.
In SBF transactions, a financer pays a small business an “advance” in exchange for the small business remitting a “payback” from a percentage of the business’s future receipts. The regulations require the financer to disclose the payback amount (called the “estimated total payment amount”); the total cost of financing including fees and discount due at closing (called the “final charge”). The regulations also require the financer to provide explanations that “the cost of this financing is based upon fees charged by [financer]rather than interest over time.”
SBFA sued DFPI seeking to prevent enforcement of the regulations. First, SBFA claimed the compelled disclosures violated its members’ free speech rights under the First Amendment. Second, SBFA claimed TILA preempts the regulations because they mandate the disclosure of APR and finance charges but define and calculate the terms differently than TILA. DFPI moved for summary judgment, arguing: SBFA lacks standing to challenge the regulations; the regulations do not violate the First Amendment under the test for commercial speech established in Zauderer v. Office of Disciplinary Counsel of Supreme Court of Ohio; and TILA does not preempt the regulations.
The court granted DFPI’s motion for summary judgment. First, the court rejected DFPI’s argument that SBFA had standing to sue. According to the court, to establish standing under Article III of the Constitution an association must show: its individual members have standing in their own right; the interests at stake in the litigation are germane to the organization’s purposes; and the case may be litigated without participation by individual members of the association. The court determined SBFA satisfied all requirements and possessed standing.
The court next examined SBFA’s First Amendment claim. The court relied on the First Amendment test for compelled commercial speech established by the U.S. Supreme Court in Zauderer in 1985. To satisfy Zauderer, the court concluded DFPI was required to prove the compelled disclosures were purely factual, noncontroversial, not unduly burdensome, and reasonably related to a substantial governmental interest.
On whether the compelled disclosures were purely factual, the court explained a disclosure must be “literally true” and “not misleading.” SBFA asserted that certain words in the compelled disclosures rendered the disclosures literally false. SBFA argued the word “fees” in the regulation is false because the cost of an SBF is based on a “discount” rather than “fees.” SBFA argued the disclosures for both SBFs and OECs are misleading because they are wildly inaccurate. The court determined, however, the term “fees” is broader in scope than the term “discount,” and using “fees does not render the statement false. For these reasons, the court concluded the SBF disclosures were literally true.
On whether the disclosures are noncontroversial, SBFA alleged the disclosures were “objectively” controversial because there is a “vigorous debate” in the commercial financing industry about whether an “estimated annual percentage rate (APR)” should be disclosed in connection with an SBF transaction. The court concluded the existence of some disagreement about the usefulness of an estimated APR disclosure does not render the disclosure controversial.
On whether the disclosures are unduly burdensome, the court explained a compelled disclosure must be so comprehensive that it drowns out the speaker’s own message. The court concluded the disclosures required by the regulations did not impede speech and there was no evidence the costs of compliance would prevent a provider’s commercial speech. Satisfying all criteria in Zauderer, the court determined that the disclosures did not violate the First Amendment.
Finally, the court examined SBFA’s claim that the Regulations are preempted by TILA. The court relied on Consumer Financial Protection Bureau’s March 2023 determination that TILA does not preempt SB 1235. The court emphasized it would not disturb the agency’s interpretation of TILA unless the interpretation is “demonstrably irrational.”
Bottom Line: There is no indication of whether SBFA will appeal the court’s decision.