The Other Shoe Falls: California DFPI Releases Proposed UDAAP Regulations for Commercial Finance Providers to Small Businesses and Others

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Two weeks after issuing its commercial funding disclosure rule, the California Department of Financial Protection and Innovation issued a Notice of Proposed Action with a proposed rule that (1) would extend its UDAAP authority to providers commercial financing coverage to small businesses and other entities, and (2) impose annual reporting requirements on covered providers. Comments on the draft regulations are expected by August 8, 2022.

Background

Despite its title, the California Consumer Financial Protection Law (CCFPL) contains a provision regarding commercial financing. It authorizes the Department of Financial Protection and Innovation (DFPI or Department) to define Unfair, Deceptive and Abusive Acts and Practices (UDAAP) in relation to the provision of trade finance or other financial products and services to small businesses, associations and families. farms. It also authorizes the DFPI to promulgate rules requiring data collection and data reporting on the provision of trade finance or other financial products and services.

Pursuant to this authority, on June 24, 2022, the DFPI published a notice of proposed action under the California Consumer Financial Protection Act regarding commercial financial products and services, together with the text of the proposed rule and its initial statement of reasons.

The Department’s UDAAP authority follows California’s first commercial finance disclosure law. As we discuss in our first in a series of Client Alerts, on June 9, 2022, the California Office of Administrative Law approved the DFPI’s final rule implementing the Commercial Finance Disclosure Act, and the rule will come into effect. effective December 9, 2022 (the “Commercial Finance Disclosure Regulations”).

Scope

The proposed regulations would apply to providers of trade finance or other financial products and services to small businesses, not-for-profit organizations and family farms.

Suppliers Covered under the CCFPL and the Draft Regulations, are providers of: (a) trade finance, as defined in the Trade Finance Disclosure Act; or b) other covered consumer financial products or services. It appears that this definition would cover suppliers and funders, but does not appear to cover brokers as those terms are defined in the Trade Finance Disclosure Regulations.

In one of a few odd definitions, the DFPI would define “financial products or services” as having the same meaning as that term in the CCFPL, except that “consumer” in the proposed Regulations would mean the opposite of “consumer”: more specifically, the term “consumer” would include corporations, partnerships and all other legal or commercial organizations or entities.

Consumers covered likewise would include non-consumers: small businesses, non-profit organizations, and family farms whose operations are “primarily directed or managed from California.”

Small business would have the same meaning as in Section 1028.5(c) of the California Code of Civil Procedure. This provision relates to small businesses that can recover attorneys’ fees in disputes between small businesses and state regulators. It defines a small business as an independently owned and operated business, not dominant in its field and below specified maximum annual gross revenue thresholds or other criteria in various industries such as general construction, retail and transport.

The draft regulations would also define Non-profit organizations and Family farms.

UDAAP definitions

The definitions of unfair and deceptive would have two parts. The first part is taken verbatim from the UDAAP section of the CFPB examination manual. The second part refers to any unfair or deceptive practice under California Unfair Competition Law, Business & Professions Code Section 17200.

The definition of abusive is lifted verbatim from the CCFPL, which the California Legislature lifted directly from Title X of the Dodd-Frank Act (12 USC § 5531(d)).

Application of the UDAAP

Although the CCFPL only authorizes the DFPI to define the UDAAP for commercial financing of small businesses and other recipients and to require reporting, the draft regulations would specify that it is “unlawful for a covered provider of get involved” in the UDAAP.

The proposed rule also attempts to add remedies for enforcement proceedings beyond those permitted by the CCFPL. The CCFPL provides that the Department may conduct hearings and arbitration proceedings with respect to any “person” to ensure or enforce any rule that the Department imposes under the law. The term “person” is broadly defined to include Covered Providers as defined in the Proposed Regulations. The CCFPL provides that the DFPI may impose sanctions and issue a cease and desist order. It only allows for “incidental relief” – i.e. termination of contract, refunds, restitution, restitution, damages, etc. – only for a violation “concerning consumer financial products”, as this term is defined in the CCFPL.

Notwithstanding the limitations specified in the CCFPL, the Department purports to have the authority to seek collateral relief for violations of the LDAAP under the Proposed Regulations.

Reporting requirements

The proposed Regulations would also require Covered Suppliers to file annual reports identifying: (a) contact information; b) the total number and dollar amount of transactions with Covered Consumers; c) number of transactions with covered consumers by amount financed and type of trade finance or other financial product or service; and (d) the minimum, maximum, average and median total cost of financing by transaction type, calculated in accordance with trade finance disclosure regulations. The proposed regulations would clarify that transactions reported by CFL licensees under the CFL would not have to report the same information to the Department under the proposed regulations.

First takeaway

Throughout the draft regulations, the DFPI confuses consumer finance with commercial finance. In the initial explanatory memorandum, the DFPI recognizes that the legislator endeavored to create “[r]obstinate consumer protections” and states that the anticipated benefits of the proposed settlement include “an increase consumer well-being.” Despite the DFPI’s “covered consumer” terminology, the draft regulations relate to the financing of businesses, non-profit organizations and family farms, not consumers.

The DFPI verbatim copies the UDAAP definitions of Dodd-Frank Title X, which also pertains consumer financial products and services. The DFPI attempts to link consumer lending to lending to organizations by stating that these organizations are “managed and operated by individuals and consumers of financial products and services, just like individual consumers”. This assertion is not supported by any analysis or research regarding the thresholds specified in the definition of small business in any statutory provision unrelated to commercial lending. It also entirely ignores the form of business as well as the legal and practical distinctions between business organizations and the people who own those organizations.

Further, the DFPI does not explain why UDAAP definitions that apply to consumer transactions should apply equally to trade finance transactions. The broad and general approach of the DFPI reflects an assumption that we know it when we see it. Covered providers would attempt to read the tea leaves, trying to understand the UDAAP framework based on DFPI consent orders.

Covered providers should consider participating in the rule-making process, particularly with respect to definitions of covered finance recipients such as small businesses that are extracted from statutes unrelated to commercial finance or that have been created by the DFPI for the draft regulation.

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