New York State introduced new regulations that will affect commercial finance providers. Stephen Whelan discusses the disclosure to borrowers that will begin in 2022 and a bill regarding licensing requirements that was introduced to the New York Senate while providing updates on two court decisions that may impact the industry.
Stephen T. Whelan, Partner, Blank Rome LLP
The new year is only a few months old, and already the Empire State has greeted the equipment finance industry with several measures which could aggravate the conduct of business.
Commercial Finance Disclosure
Commencing Jan. 1, 2022, every non-exempt lender (including persons who present “specific offers”) in a “commercial finance” transaction must disclose to the borrower, at the time that the financing is offered to the borrower:
The amount of the financing
The net proceeds, after payment of fees, and a listing of those fees
The aggregate dollar finance charge, based on the maximum amount of the financing
The estimated annual percentage rate implicit in the financing, including fees and finance charges
The term of the financing and the total amount payable during the life of the loan
The periodic payment amount and any charge for prepayment
A description of any collateral which the lender would require
The new law requires that borrowers sign off (wet ink or electronically) on the disclosure before a lender can even process the application, but the disclosure need not be signed simultaneously with the application. The Superintendent of the State Department of Financial Services is authorized to issue regulations specifying how the disclosure is to be made so that borrowers more readily can compare competing proposals. On Feb. 15, 2021, the state legislature and governor approved amendments, including a section extending the effective date to Jan. 1, 2022.
Exempt from these requirements are federal or state banks and savings and loan associations, real estate mortgage loans, regulated farm credit lenders and lessors under a true lease as defined in Uniform Commercial Code Article 2A, so non-true leases would not be exempt. Also exempt are loans for personal, family or household purposes, so-called isolated transactions (not more than five loans within any 12-month period), any commercial financing transaction for a vehicle dealer or rental vehicle company (or any of their affiliates), and any loan in excess of $2.5 million.
The good news is the Equipment Leasing and Finance Association, after months of negotiations with the legislature, obtained the true lease exemption. The bad news is the law applies the disclosure requirements to any “individual commercial financing transaction” up to $2.5 million. In any case, because borrowers must sign off on the disclosure before a lender is permitted to commence processing the financing application, the law necessarily will increase the turnaround time for the application and approval process. This will place commercial lenders at a competitive disadvantage to regulated financial institutions and to any financier offering a loan or non-true lease to borrowers.
Got a License?
On Jan. 6, 2021, Senate Bill 1061 (and its companion, Assembly Bill 1420) was introduced, containing the clear requirement that any non-exempt entity making or soliciting a “commercial finance product” (CFP) to businesses located in New York first obtain a license. Such products include “any advance of funds to a business for its capital needs,” including loans or lines of credit for the purchase of accounts receivable, revenues, intangibles “or other actual or perceived assets.” It is likely that “advance of funds” would cover a lessor that buys equipment from a vendor and then leases the equipment to a business located in New York.
Unlike the Commercial Finance Disclosure Act, the license law would apply to “any leasing transaction where any funds are provided to the business or commercial enterprise … in the amount of [$500,000] or less” and to those “marketing [CFP] for providers of [CFP and] receiving any compensation from a provider of [CFP] based on the value of the [CFP] provided in exchange for a referral of small business or its owner.” That language suggests that if a lawyer were to refer a client to a lender, or refer a client lender to a prospective borrower, and the lawyer was compensated based on the amount of the loan, then the lawyer would be required to obtain a license.
More significantly, the bill contains a few references to “small business,” but its scope repeatedly covers leases (true and non-true) to all “businesses located in New York state.” The license application would have to list “all of the locations at which the applicant seeks to conduct” the licensed business. And if a licensee wished to open another location — or even change its address — to conduct the licensed business, it would have to notify the superintendent and pay an investigation fee. The request can be denied if the “new location … is not in the public interest.” The language of the bill does not limit “locations” only to those in New York.
The bill contains more examples of overbreadth. To receive a license, applicants must demonstrate that their “financial responsibility, experience, character and general fitness … command the confidence of the community … that the business will be operated honestly, fairly and efficiently,” and that it has liquid assets of at least $50,000 “at each specified location.”
There would be exemptions: Anyone who “makes or solicits five or fewer commercial financing products within any 12-month period,” and regulated institutions such as banks, insurance companies and federal credit unions, along with “any transaction that is intended to be a purchase of the ownership, in whole or in part, of a business or commercial enterprise.” As with the Disclosure Act, the exemptions would place commercial lenders at a competitive disadvantage to regulated financial institutions.
And there would be requirements. “No licensee shall take any instrument in which blanks are left to be filled in after execution.” It is likely that equipment lessors receive signed documents in which blanks are to be completed later several times every year. This section of the bill also is ambiguous: Does it apply only to loans to small businesses? Only to loans of $500,000 or below? Or to any instrument received by a licensee, regardless of the amount of the transaction?
What if a licensee wanted to be acquired by another leasing company, or even sell a large minority stake to a third party? The bill would prohibit any such “change of control” unless the proposed acquirer received the prior approval of the superintendent. “Control” would include the “power to direct … the management and policies of a licensee, whether through the ownership of voting stock … or otherwise” (emphasis added). The bill would presume “control” to exist if a person held 10% or more of the “voting stock” of a licensee. So, if five people each owned 20% of a licensee, none of them could sell their interest unless the state approved.
As with the Disclosure Act described above, the ELFA has been aggressively working to educate policymakers regarding the industry’s legitimate concerns and desired exemptions.
More Bad News
In April 2016, the New York State Attorney General sued Northern Leasing Systems, its affiliates and two Northern executives, “alleging that they were engaged in repeated and persistent fraud in that they tricked individuals, many of whom were small business owners, into entering into unconscionable equipment finance leases (EFLs) for credit card processing equipment.”
In June 2020, the trial court — based solely on affidavits and without any trial or evidentiary hearing — rescinded all Northern Leasing equipment finance leases “obtained by fraud or misrepresentation,” vacated thousands of default judgments which Northern Leasing had obtained in New York City courts and ordered Northern Leasing to cease operations and be dissolved.
Northern Leasing appealed this trial court judgment. On Feb. 11, 2021, the Appellate Division of the New York State Supreme Court issued a unanimous decision, affirming the trial court’s decision (including the dissolution order) and denying the Northern Leasing defendants the opportunity to examine the complaining lessees and conduct a traditional trial or evidentiary hearing.
The Appellate Division opinion noted that the EFLs “contain hidden [emphasis added], one-sided onerous terms, including a ‘no-cancellation provision’ and an automatic month-to-month renewal provision [and that Northern made] it exceedingly difficult for individuals to cancel an EFL or return the unwanted equipment.”
Northern argued that it was the independent sales organizations (ISOs) which had caused hundreds of lessee complaints, but the court stressed that Northern “trained the ISO representatives, provided them with specific lease forms, offered detailed instructions and materials … and paid commissions for each lease solicited from a customer.” The court also observed that Northern failed to “oversee the ISOs and to assess any meaningful penalty against them for presenting a fraudulent” equipment finance lease. The decision concluded that “neither additional discovery nor a trial” was required because Northern’s “knowledge of the [ISOs’] actions and failure to act inculpated them, which is the determining factor.”
Some observers have dismissed these two court decisions as outliers. But others fret that the decisions warn that some measure of supervision is necessary by lessors that use third parties to originate their equipment finance contracts to avoid being tarnished by any of an originators’ bad business. Concern also arises from the Appellate Division’s mentioning that the leases were non-cancelable and automatically renewed unless the lessee timely returned the equipment at lease expiration. These criticisms of many business practices merit attention from the equipment finance industry.
Stephen T. Whelan is a partner in the New York office of law firm Blank Rome LLP. He can be reached at email@example.com.
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