California Finance Lender’s License Law: Amendments Create New Issues for Unlicensed Brokers
by Andrew K. Alper May/June 2016
Attorney Andrew Alper reviews recent amendments to the California Finance Lender’s License law, which have created complications for lenders that work with unlicensed brokers. He advises anyone involved in selling, brokering or lending to obtain a license to prevent negative consequences.
Lenders who make loans to California residents must be keenly aware of California laws, especially when loans are referred or brokered by unlicensed persons. Under California law, “finance lenders” making loans in California must obtain a license from the California Department of Business Oversight (formerly the California Department of Corporations) and comply with the licensing and regulatory requirements of the California Finance Lender’s License law (CFLL).
A “finance lender” is broadly defined in California Financial Code §22009 as “any person who is engaged in the business of making consumer loans or making commercial loans.” “Person” is generally defined as any individual or entity. The CFLL is located in California Financial Code §22000 and also under the California Code of Regulations.1 There are various exemptions to the CFLL, such as obtaining a California Finance Lender’s License.2
Besides obtaining a license, other notable exemptions from the CFLL are for U.S. banks, savings and loan associations, industrial banks and credit unions doing business under applicable state or federal banking law, franchisors making loans to franchisees, California licensed real estate brokers making or arranging a loan secured by a lien on real property and venture capital companies under limited circumstances.3
Another important exemption is available for a lender making fewer than five California loans in a 12-month period, provided that these are commercial loans “incidental to the business of the person relying on the exemption.”4 The drafters provided little guidance regarding the “incidental to the business of the person relying on the exemption” language.
Legislative history indicates that the exemption’s intention was to eliminate an unnecessary burden on a business that may not be engaged in the lending business but that may make a few loans in a context unrelated to the lending business. An example is a seller of goods that makes a loan to finance the goods — its main business is selling the goods, not financing. Legislative history also specifically identified bridge loans as lending activity that, when performed by a business that is not typically engaged in lending, would fall within this exemption. The CFLL applies to lenders, not companies that enter into true leases or conditional sale contracts.5 The issue is that leases may not be “true leases” but instead disguised as loans or “leases intended as security.” If the lease is not a true lease, it is a loan subject to the CFLL. An example would be a lease with a $1.00 purchase option. This transaction is not a true lease but a loan subject to the CFLL.
Obtaining a license is not only important for a lender to avoid running afoul of restrictions and penalties under the CFLL but also to exempt the lender from usury. Under the California Constitution Code,6 the general usury rate is the greater of 10% per annum or 5% over the federal discount rate established by the Federal Reserve Bank of San Francisco. For many years, the usury rate has been 10% since the federal discount rate has been below 5%. If a loan is usurious, damages to the lender will include recovery of all interest paid. Such payments will apply toward the principal, and these damages may also be trebled. Attorney’s fees will be awarded in connection with any litigation arising from the usurious transaction if the borrower is the prevailing party.
Recent CFLL Amendments
Issues regarding the CFLL have become a hot bed of discussion throughout the California lending and legal industry because of recent CFLL amendments made with respect to unlicensed brokers. Before the introduction of SB197,7 California law prohibited commercial lenders from paying a fee to any unlicensed individual in exchange for referral of business.8 Many lenders were not aware of the prohibition because it was not in the financial code with the rest of the CFLL. Instead, these rules and regulations are promulgated by state agencies, not by the legislature. This law changed significantly with the recent revisions to the CFLL.
According to Financial Code §22602, a finance lender licensee may pay compensation to an unlicensed person for the referral of one or more prospective borrowers to the licensee when all of the following conditions are met:
The referral by the unlicensed person leads the licensee and the referred prospective borrower to consummate a commercial loan.
The annual percentage rate of the loan contract does not exceed 36%.
Before approving the loan, a licensee must obtain documentation to determine the prospective borrower’s commercial status and to ensure the prospective borrower will have sufficient monthly gross revenue to repay the loan. If the underwriting process reveals inadequate repayment ability, the licensee cannot make a loan.
The licensee maintains records of all compensation paid to the unlicensed person in connection with the borrower referral for at least four years.
Annually, the licensee submits information requested by the commissioner regarding the payment of compensation.
A licensee that pays compensation to an unlicensed person in connection with a referral for a commercial loan will be liable for any misrepresentation made to the borrower in connection with the loan.
The following activities by an unlicensed person are not authorized:
Participating in any loan negotiation.
Counseling or advising the borrower about a loan.
Participating in the preparation of any loan documents, including credit applications.
Contacting a licensee on behalf of a borrower other than to refer the borrower.
Gathering loan documentation from the borrower or delivering the documentation to the licensee.
Communicating lending decisions or inquiries to the borrower.
Participating in establishing any sales literature or marketing materials.
Obtaining the borrower’s signature on documents.
However, these prohibitions do not apply if the unlicensed person meets certain criteria.9
Financial Code §22603 requires a finance lender to provide a prospective borrower who has been referred by an unlicensed person the following written statement (in 10-point type or larger, at the time the licensee receives an application for commercial loan), and the prospective borrower must acknowledge receipt of this statement in writing:
“You have been referred to us by [name of unlicensed person]. If you are approved for the loan, we may pay a fee to [name of unlicensed person] for the successful referral. [Licensee], and not [name of unlicensed person] is the sole party authorized to offer a loan to you. You should insure that you understand any and all offers we may extend to you before agreeing to the loan terms. If you wish to report a complaint about this loan transaction, you may contact the Department of Business Oversight at 1-866-ASK-CORP (1-866-275-2677), or file your complaint online at www.dbo.ca.gov.”
Financial Code §22604 states that no person receiving compensation shall make false, misleading or deceptive statements. If that does happen, any person in the business of soliciting borrowers for a loan to be made by a licensee, not in compliance with §22602, 22603 or 22604 or any other provision of the division, may be ordered to cease and desist from engaging in any business or violating the division.
A Hands Off Approach
As a result of the new law, unlicensed brokers may no longer present applications to borrowers, contact the borrowers, run credit reports or do due diligence for a licensed lender. Essentially, brokers must take a hands-off approach to the transaction after referring the customer. In the past, many brokers actually did substantial due diligence, prepared packages and helped the borrower submit its loan application to the lender. This practice may no longer take place. If the unlicensed broker made any misrepresentations regarding the transactions, these misrepresentations will be attributable to the finance lender.
Most well-written loan or lease documents disclaim all warranties and representations made by suppliers, vendors, brokers or others with respect to the transaction and also disclaim any responsibility with respect to goods or equipment being acquired by the borrower. Such disclaimers and contractual language have long been allowed as a matter of law in the Uniform Commercial Code or otherwise. Now, if the borrower contends that equipment sold as part of the loan transaction was falsely represented, or if the supplier who gets a referral fee and is therefore an unlicensed broker made misrepresentations, there is a legal issue as to whether the provisions of the Financial Code or the Uniform Commercial Code will prevail in litigation where the lender has stated that the supplier, vendor, broker or anyone else is not its agent and cannot bind the lender in making representations regarding the transaction or the equipment and the Financial Code places such liability on the lender.
The scope of this article in the space allotted cannot discuss all of the various permutations and issues with respect to recent changes to the CFLL. As attorneys have been counseling their clients for many years, the bottom line is, if any broker, lender or lessor is doing business in California, it is best that anyone involved in selling, brokering or lending on personal property obtain the license from the Department of Business Oversight to prevent an unintended consequence.
Commencing with 10 C.C.R. §1404
See Financial Code §22002
See California Financial Code §22050, 22063, 22057, 22062
See Financial Code §22050(e)
See Financial Code §22054
Article XV §1
Codified in Financial Code §22602, 22603 and 22604
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