Documentation Matters

by Andrew K. Alper September/October 2008
Most brokers, lenders and lessors have heard horror stories about doing business in California and the requirement of having a Commercial Finance Lenders License. Yes, the horror stories are true although qualifying to obtain the license is not very difficult. The following discussion is a short summary of some of the relevant provisions of the CFFL.

The state of California has enacted its California Finance Lenders Law (CFLL), which requires lenders making loans secured by personal property to obtain a license in accordance with California Financial Code §22000 et. seq. These provisions come into play in a recent case where one lender attempted to use a choice of law clause to avoid the CFLL.

The stated purpose of the CFLL is to 1.) ensure an adequate supply of credit to borrowers in California, 2.) to simply, clarify and modernize the law governing loans made by finance lenders, 3.) to foster competition among finance lenders, 4.) to protect borrowers against unfair practices by some lenders, having due regard for the interest of legitimate and scrupulous lenders, 5.) to permit and encourage the development of fair and economically sound lending practices and 6.) to encourage and foster a sound economic climate in California (See Financial Code, §22001).

Persons regulated by the CFLL are generally “brokers” and “finance lenders.” A finance lender includes persons making both consumer and commercial loans (any stated business loan over $5,000 is considered to be a commercial loan and loans under $5,000 or loans made primarily for personal, family or household use are consumer loans).

The business of making loans may include the lending of money and taking in the name of the lender, or in any other name, in whole or in part, as security for a loan, any contract or obligation involving the forfeiture of rights in personal property (See §22009). Section 22100 is absolutely clear that a “broker” and a “finance lender” must obtain a license from the Commissioner of Corporations. California has enacted enforcement mechanisms to attempt to make it clear that the requirements of the CFLL are matters of fundamental public policy, which cannot be waived by agreement between a lender and a borrower.

Section 22324 states: “Any person who contracts for or negotiates in this state a loan to be made outside the state for the purpose of evading or avoiding the provisions of this division are subject to the provisions of this division.” By expressly preventing parties from avoiding the structure of the CFLL by booking or otherwise making a loan out of state strongly suggests that the CFLL may not be circumvented by a contractual choice of law provision.

Pursuant to §22750, contracts made in willful violation of the CFLL, including, in particular, a violation of the requirement that a lender have a license issued by the commissioner, are void. If the violations are not willful, the lender must nonetheless forfeit any interest or charges obtained on the contract (See §22752). In addition, willful violations of the CFLL are punishable with both civil and criminal penalties and injunctive relief (See §22713, §22753 and §22780).

As stated above, no person shall engage in the business of a finance lender or broker without obtaining a license from the commissioner. Among other requirements such as the maintenance of a balance sheet of more than $25,000, stating the name and address of each business location, submitting a business plan, and requiring a bond, a finance lender is entitled to receive a license upon satisfying the commissioner that no one who has more than a 10% interest in the lender has been convicted of a crime or committed an act of dishonesty or fraud (See §22109).

A licensee is required to make an annual report to the commissioner with records of its transactions so the commissioner can determine whether the licensee is complying with the CFLL and regulations promulgated by the commissioner. The commissioner may revoke or suspend a license whenever, among other matters, the commissioner finds the licensee has violated any provision of this division or any rule or regulation made by the commissioner under and within the authority of the CFLL [See §22714(a)(2)].

The commissioner may make general rules and regulations, prior rates of charge, stated by a licensee, be stated free and clearly in the manner that the commissioner deems necessary to prevent misunderstanding by prospective borrowers. Article 3 of the CFLL §22300 et seq. imposes limitations on the conditions, rate of interest and charges licensees may impose on borrowers. Finally, the commissioner is given the power to suspend or revoke any license if the commissioner finds the licensee has violated any provision of the CFLL [See §22714(a)(2)].

If a lessor enters into leases with nominal purchase options or the lease is otherwise determined to be nothing but a lease intended as security or loans secured by personal property, then the lessor is subject to the CFLL if it is doing business in California. If a lessor is strictly entering into “true leases,” then the lessor is not making loans secured by personal property and it is not subject to the CFLL because the CFLL regulates lenders and brokers of loans, not leases. Similarly, usury is a loan or forbearance of money and true leases are not subject to usury requirements. The problem, however, for the lessor is whether the lessor can ever be assured that every transaction in its portfolio in California is a true lease. Therefore, any lessor, broker or other person engaged in the lending of money secured by personal property or in the equipment leasing industry should, out of an abundance of caution, obtain a license if it is doing business in California.

Lessors that maintain corporate offices outside of California and are not California corporations often contend that because their leases have a “choice of law” clause setting forth that the law of another state controls the transaction, that they should not be governed by the CFLL because California law does not apply to their transaction. This contention was tested recently in the case of Brack v. Omni Loan Company Ltd., (July 16, 2008) 164 Cal. App. 4th 1312. Although the facts of this case involved consumer loans rather than commercial transactions, nevertheless the case is instructive, if not controlling, on the issue as to whether California believes that its public policy for lending in the State of California will trump a choice of law clause.

In Brack v. Omni, Omni was a Nevada corporation engaged in consumer lending in California. It made consumer loans secured by personal property assets of its borrowers. Plaintiff Joshua Brack was a nonresident member of the military stationed at Camp Pendleton in California. Brack applied electronically for a loan from Omni (probably somewhere between $900 to $1,800 but it is not specifically stated in the case) and was directed to complete his loan application at Omni’s Oceanside, CA, office. Brack was not advised until he was presented with the loan agreement the interest rate would be 34.89% per annum. The loan was secured by Brack’s personal property assets and included a $104.63 charge for property insurance and a prepaid finance charge. Like all of Omni’s loans, Brack’s loan agreement contained a choice of law provision, which stated: “You agree that this loan contract is subject to Nevada state law.”

Brack repaid his loan in October 2002, and then in December 2003, Brack filed a class action lawsuit against Omni contending that Omni’s practices violated his rights under a number of laws including the CFLL. Among the allegations, Brack alleged Omni was engaged in the business of a finance lender without obtaining a license from the commissioner and failed to prominently display in its offices a full and accurate schedule of its interest rates and other charges. In response to Brack’s claims, among other contentions, Omni contended that the choice of law provision under which the borrowers agreed the loan would be governed by the law of Nevada and not California meant that Omni did not have to comply with the CFLL.

The trial court found Nevada had a substantial relationship to the loan agreements because Omni was a Nevada corporation and the loans were approved in Nevada. The court determined that California had no fundamental interest in the loan transactions, which would require that its laws be applied in place of the law selected under the terms of the loan agreements. Even though the trial court found that California did not have a fundamental interest in applying its CFLL law, it did find that because the loan agreements were made in California by consumers located in California, the state had a materially greater interest in the loan transactions than Nevada. Notwithstanding that fact, the trial court entered judgment in favor of Omni and Brack appealed.

Enforcement of Choice of Law Clauses
In California, the Supreme Court has adopted the Restatement Second Section 187 Conflicts of Law position as to whether it will enforce a choice of law clause in contracts as set forth in the cases of Nedlloyd Lines B.P. v. Superior Court (1982) 3 Cal. 4th 459, 464-469 and Washington Mutual Bank v. Superior Court (2001) 24 Cal. 4th 906, 914-919. The proper approach to determine whether a choice of law clause is enforceable is for the court first to determine 1.) whether the chosen state has a substantial relationship to the parties or their transactions, or 2.) whether there is any other reasonable basis for the party’s choice of law.

If neither of these tests is met, that is the end of the inquiry and the court need not enforce the parties’ choice of law set forth in their contract. If, however, either test is met, the court must next determine whether the chosen state’s law is contrary to a fundamental policy of California. If there is no such conflict, the court shall enforce the parties’ choice of law. If, however, there is a fundamental conflict with California law, the court must then determine whether California has a materially greater interest than does the chosen state in the determination of the particular issue. If California has a materially greater interest than the chosen state, the choice of law will not be enforced.

In the Brack case, the court found that because Omni was a Nevada corporation, there is a substantial relationship to Nevada such that the choice of Nevada law in the loan agreements was reasonable. Therefore, the court moved on to the second step of the analysis as to whether Nevada’s law conflicted with the fundamental policy of California and, if there was such a conflict, whether California had a materially greater interest in the transactions than Nevada.

The court discussed the CFLL in detail and concluded that the provisions of the CFLL are fundamental, unwaiveable and integrated, and undermine the fundamental policy expressed in the CFFL. The court stated that operation of the CFLL depends in large measure upon private enforcement, licensing and the considerable power a corporation commissioner exercises over licensing. The choice of law provisions in Omni’s loan agreements immunized Omni’s activities in California from an entire regulatory scheme and thereby conflicted with this regulatory scheme in a substantial manner. The court then stated that it would decline to enforce the parties’ contractual choice of law provision only if the interests of the forum state (California) are materially greater than those of the chosen state (Nevada) and the forum state’s interests would be more seriously impaired by enforcement of the parties’ contractual choice of law provision than would the interests of the chosen state by the application of the law of the forum state (See Application Group, Inc. v. Hunter Group, Inc. (1998) 61 Cal. App. 4th 881, 898).

The trial court found that in the broadest sense since California has a materially greater interest in Omni’s loan transactions, the choice of law provision would avoid California’s regulatory interests and would therefore not be enforced. As a result, the court reversed the judgment in favor of Omni with instructions to the trial court allowing Brack to proceed with his lawsuit.

Although the Brack v. Omni case is a consumer loan transaction, the same law should be applied to commercial transactions. In fact, §10106 of the Commercial Code in California invalidates choice of law provisions in consumer leases. This section has no applicability to commercial leases which, as stated in both the California Commercial Code and Uniform Commercial Comments to that section, which remain prima facie valid (See Bremen v. Zapata Off-Shore Co. (1972) 407 U.S. 1). Nevertheless, any broker, lessor or lender doing business in California should obtain a California Finance Lender’s License otherwise contracts could be rendered void, unenforceable and subject to civil and criminal penalties and the broker, lessor or lender cannot rely on a choice of law clause to find a way around enforcement of the CFLL in California.


Andrew K. Alper is a partner with the law firm of Frandzel Robins Bloom & Csato, LC in Los Angeles. Alper has been representing equipment lessors, funding sources and other financial institutions since 1978. His practice emphasizes the representation of equipment lessors and funding sources in all aspects of equipment leasing. Alper obtained his Bachelor of Arts degree in Political Science, magna cum laude, from the University of California at Santa Barbara, and received his Juris Doctor from Loyola Marymount University School of Law making the Dean’s List.

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