Scott Chait,
Vice President and Counsel, Americas Division,
Sumitomo Mitsui Banking Corporation
The dominoes are beginning to fall. Late last year California and Virginia became the first states in the nation to implement commercial finance disclosure laws, with Utah following in January. Now it’s New York’s turn, with its version to take effect as of Aug. 1, 2023. In addition, legislation has been introduced and is active in at least nine other states. These laws require providers of commercial financing to provide prospective recipients detailed up-front information about the financing being offered — the kind of disclosures that have been more traditionally limited to the consumer lending arena, particularly as governed by the federal Truth and Lending Act.
New York’s Commercial Finance Disclosure Law (the CFDL),1 along with the rules and regulations promulgated by the Department of Financial Services (the regulations),2 applies to commercial financings of up to $2.5 million which are offered to recipients whose businesses are principally directed or managed from New York. Among other exemptions, the law exempts true leases and financial institutions as well as their majority owned subsidiaries. The CFDL in many ways duplicates the California law, but with a few key differences. On the other hand, the Virginia law largely applies to sales-based financings, such as merchant cash advances, which are not common to the equipment finance industry, and the Utah law provides significant exemptions for many of our industry’s typical transactions, such as purchase money obligations and true leases.
This article will provide a high-level overview of the CFDL and regulations by addressing the following key questions: Who is a “provider”? Who is a “recipient”? What is a “commercial financing”? What must be disclosed and when? Are there exemptions from compliance?
PROVIDER, RECIPIENT ANDSPECIFIC OFFER
A provider is the party who makes a specific offer of commercial financing. The term includes financers, brokers (also defined terms in the regulations) and other third parties extending an offer on behalf of another. In other words, a provider is not limited to the party actually providing the funding.
A recipient is the expected primary borrower (or seller of accounts receivable) who has applied for and received a specific offer of commercial financing. This includes authorized representatives of such party, but a broker cannot be a recipient.
An offer is only considered to be a “specific offer” if: 1) the communication is in writing; 2) it communicates a payment or financing amount and any rate, price or cost of financing in connection with a commercial financing; 3) it is based upon information from or about the recipient that informs the provider’s quote (such as financial or credit information, but not name, address or general interest in the financing) and 4) the offer, if accepted by the recipient, would be binding upon the provider. Mere discussion of interest rates and financing amounts is not enough to require disclosure of the APR.
If the provider simultaneously provides the recipient multiple options (i.e., multiple amounts, rates, prices or costs) representing different specific commercial finance offers, then “at the time of extending a specific offer” occurs when the recipient selects an option.
If a provider allows a recipient to select from multiple options or customize an offer, the provider must only provide disclosure for the specific offer the recipient elects to pursue.
COMMERCIAL FINANCING
Generally speaking, the CFDL applies to any commercial financing, which is very broadly construed to mean a non-consumer financing (i.e., intended by the recipient to be used for purposes other than personal, family or household use), for an amount of $2.5 million or less, and in the form of loans, lines of credit, open-ended credit plans, asset-based lending transactions, accounts receivables purchase transactions (including factoring), lease financings transactions (i.e., non-true leases) and other forms of financing. The regulations and the CFDL specifically define many of these terms, but suffice it to say, the catch-all “other forms” of financing means the CFDL will broadly apply to most transactions (unless otherwise exempt, as discussed below).
To determine if a transaction is a commercial financing, a provider may rely upon a recipient’s statement of intended purpose. The provider is not required to independently confirm that the proceeds are, in fact, used in accordance with such intended purpose.
The CFDL is not limited to originations. For non-default workouts, refinancings, restructures, and changes in terms, disclosures must be made. On the other hand, for default workouts, disclosures do not have to be made.
An interesting open question is whether buy/sell syndication transactions — as are typical in the equipment finance industry — are included in the definition of commercial financings? While there are arguments both ways (beyond the scope of — and space allotted for — this article), a provider may nonetheless wish to take the conservative approach and give disclosure to its seller. Of course, whether that’s practical remains to be seen. Ultimately, absent further direction from legislatures, regulators or the courts, providers will have to weigh the risks of non-compliance against business exigencies and market practice.
WHAT MUST BE DISCLOSED?
While the CFDL and regulations provide more granular specificity as to what information must be disclosed based on the transaction type, in general a provider must disclose the following: 1) total amount of the financing; 2) finance charge; 3) APR (but excluding avoidable fees in that calculation); 4) repayment amount (i.e., the disbursement plus the finance charge); 5) term; 6) payment amounts; 7) description of other fees and charges; 8) prepayment information; 9) a description of the collateral with security interests listed; and 10) certain information specific to renewal financing.
Brokers’ fees must be disclosed in writing, which can be separate from the disclosure statement. As far as other third parties, such as dealers, suppliers and manufacturers, the CFDL generally requires a description of other potential fees and charges and when the amount financed is greater than the recipient funds (the definition of which expressly excludes funds paid to other parties, including brokers), the disclosures must include, among other things, amounts paid by the financer to others on the recipient’s behalf, which includes (but is not limited to) a recipient’s supplier.
Also, when the amount financed is greater than the net amount given directly to the recipient, a separate disclosure must be provided entitled “Itemization of Amount Financed.” Unlike the disclosure statement itself, which, as discussed below, must be signed, the itemization does not have to be signed and may include an explanation of any assumptions used to make the itemizations. Otherwise, while additional information may be disclosed to the recipient, it may not be disclosed as part of the required disclosure statement.
In addition, there are specific requirements for making estimates and assumptions and for disclosing adjustable rates, multiple payment options and for when the balance would be due upon demand.
The regulations also allow for certain errors and tolerances in calculations and allow providers to disregard the effects of certain factors in making calculations, such as: payments must be collected in whole cents, scheduled payment dates not being on a business day, months having different number of days and leap years.
The recipient must sign the disclosure prior to consummating the financing. Brokers may not sign on behalf of recipient and electronic signatures and transmissions of the signed disclosures are valid, even if the financing agreement is signed
by other means. The regulations make clear that such electronic signatures must be in compliance with the Electronic Signatures and Records Act and the recipient must be able to receive an automatic date stamp upon submission and obtain a copy of the signed disclosure in a format that the recipient may save indefinitely for future reference. A format that the recipient may save indefinitely includes hard copies and electronic documents.
If the financing transaction is not consummated, no signature is required. If multiple disclosures are provided during the negotiation, the provider need only obtain the recipient’s signature on the final disclosure which corresponds to the consummated transaction.
WHEN MUST DISCLOSURES BE MADE?
The disclosure statement must be made in a stand-alone, separate document at the time a specific financing offer is extended to the recipient. The regulations proscribe — in extreme detail — the specific contents required in the disclosure statement. But, other than the Itemization of Amount Financed, no actual statutory form of disclosure is provided. Rather, it is incumbent upon providers (and their counsel) to parse the regulations to develop their own forms.
“At the time [an offer is] extend[ed]” can have several meanings, including: 1) when a specific offer is quoted to the recipient; 2) any time the terms of a consummated financing contract are amended, supplemented or changed, prior to the recipient agreeing to the changes (e.g., non-default workouts, refinancings and restructures — whether documented or not), and where
any of the foregoing would result in an increase to the finance charge or APR; 3) when a specific offer is quoted to the recipient in writing in connection with each draw on an open-end financing agreement if certain factors are met; and 4) (arguably) when there is a change in terms prior to consummation but after the initial disclosure.
Another open question involves providing estimated disclosures. While, as mentioned above, a provider is allowed under certain circumstances to give estimated disclosures, unfortunately, the CFDL and regulations do not address whether an additional follow-up disclosure is required if the estimated information changes prior to closing. Therefore, a conservative approach may be to issue an additional disclosure if there is a change.
ARE THERE EXEMPTIONS FROM COMPLIANCE?
Banks and other specifically identified financial institutions are exempt from compliance. In a significant departure from the California law, the CFDL also exempts certain subsidiaries of financial institutions, namely any entity “of which a majority of the voting power of the voting equity securities or equity interest is owned, directly or indirectly, by a financial institution.” There is nothing in the CFDL or regulations addressing whether a financial institution must be named in the financing documents to avail itself of this exemption. However, co-branding could negatively affect the availability of the exemption.
The CFDL also exempts true leases and transactions over $2.5 million. This means the aggregate amount that a recipient may receive under a commercial financing agreement — not the amount of any particular advance under such agreement (however, when a commercial financing is not exempt, each advance requires the giving of disclosure). Also exempt are providers who make no more than five commercial financing transactions in New York in a 12-month period.
Finally, the CFDL includes several additional exemptions, including: commercial financings secured by real property; commercial financings in which the recipient is a motor vehicle dealer or a rental vehicle company (each, as defined under New York law), or in which the recipient is or an affiliate of such a company; commercial financings involving a technology service provider that only provides software and support services to an exempt entity under the CFDL for use in such exempt entity’s commercial financing program (and the service provider owns no interest in the financing extended); and commercial financings in which the lender is regulated under the federal Farm Credit Act.
RECORD RETENTION, REPORTING AND PENALTIES
The provider must retain a copy of the disclosure for four years, along with evidence of transmission to the recipient. Only financers — not brokers — must comply with the record retention requirements If a specific offer is being transmitted to the recipient through a broker, the financer must either transmit the disclosures directly to the recipient or provide the broker with a copy of compliant disclosures (and the broker must transmit the disclosures to the recipient — unaltered and before s/he communicates a specific offer to the recipient). In addition, the provider must retain on file for four years written evidence (including time of transmission) that the broker transmitted the disclosures to the recipient and develop procedures reasonably designed to ensure that recipients receive the disclosures. While the broker is obligated to transmit the disclosures without alteration, the broker is not required to review for accuracy and has no liability if the disclosures are non compliant; but nothing in the CFDL limits broker liability for (mis) representations made regarding the financing.
On or before April 30th of every year (starting in 2025), each provider who has used the opt-in method of calculating estimated APR (as described in section 600.9 of the regulations), must report to the DFS superintendent certain information specified under section 600.22 of the regulations.
Providers will be subject to civil penalties for each violation in an amount of up to $2,000 (or, if the violation was willful, up to $10,000). If a provider knowingly violates the law or regulations, the Department of Financial Services superintendent may order additional relief, including restitution or a preliminary injunction on behalf of any recipient affected by
the violation. •
FOONOTES
ABOUT THE AUTHOR: Scott Chait is an attorney with Sumitomo Mitsui Banking Corporation. The views expressed in this article belong solely to the author, and do not necessarily represent the views or position of SMBC or any other person. This article is for general informational purposes only and is not intended and should not be taken as legal advice.
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