The Other Shoe Drops: The California DFPI Issues Proposed UDAAP Regulations for Providers of Commercial Financing to Small Businesses and Others

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

Background

Despite its title, the California Consumer Financial Protection Law (CCFPL) contains one 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 connection with the offering of commercial financing or other financial products and services to small businesses, nonprofits, and family farms.[1] It also authorizes the DFPI to promulgate rules requiring data collection and reporting on the provision of commercial financing or other financial products and services.

Pursuant to that authority, on June 24, 2022, the DFPI issued a Notice of Proposed Action Under the California Consumer Financial Protection Law Regarding Commercial Financial Products and Services, along with the text of Proposed Regulations and its Initial Statement of Reasons.

The Department’s UDAAP authority follows California’s first-of-its-kind commercial financing 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 regulations implementing the commercial financing disclosure law, and the regulations will take effect on December 9, 2022 (the “Commercial Financing Disclosure Regulations”).

Scope

The Proposed Regulations would apply to providers of commercial financing or other financial products and services to small businesses, nonprofits, and family farms.

Covered Providers under the CCFPL and the Proposed Regulations are providers of: a) commercial financing, as defined in the commercial financing disclosure law; or b) other financial products or services to covered consumers. It appears that this definition would cover providers and financers, but does not appear to cover brokers as those terms are defined in the Commercial Financing Disclosure Regulations.

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

Covered Consumers similarly would include non-consumers: small businesses, nonprofits, and family farms whose activities are “principally directed or managed from California.”

Small Business would have the same meaning as in California Code of Civil Procedure section 1028.5(c). This provision concerns small businesses that can recover attorney’s fees in litigation between small businesses and state regulatory agencies. It defines small business as a business that is independently owned and operated, not dominant in its field, and below specified maximum thresholds in annual gross receipts or other criteria in various sectors such as general construction, retail trade, and transportation.

The Proposed Regulations also would define Nonprofits and Family Farms.

UDAAP Definitions

The definitions of unfair and deceptive would have two parts. Part one is lifted verbatim from the UDAAP section of the CFPB’s exam manual. The second part is a reference to any practice that is unfair or deceptive under the 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 Dodd-Frank Act Title X (12 U.S.C. § 5531(d)).

UDAAP Enforcement

Although the CCFPL only authorizes the DFPI to define UDAAP for commercial financing to small businesses and other recipients and to require reporting, the Proposed Regulations would specify that it is “unlawful for a Covered Provider to engage” in UDAAP.

The Proposed Regulations also attempt to add remedies for enforcement proceedings beyond those authorized by the CCFPL. The CCFPL provides that the Department may conduct hearings and adjudication proceedings with respect to any “person” to ensure or enforce compliance with any rule the Department imposes under the Law.[2] The term “person” is defined broadly such that it includes Covered Providers as defined in the Proposed Regulations.[3] The CCFPL provides that the DFPI may assess penalties and issue a desist and refrain order. It authorizes “ancillary relief”—meaning contract rescission, refunds, restitution, disgorgement, damages, etc.—only for a violation “with respect to consumer financial products,” as that term is defined in the CCFPL.[4]

Despite the specified limitations in the CCFPL, the Department purports to authorize itself to seek ancillary relief for UDAAP violations under the Proposed Regulations.

Reporting Requirements

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

Initial Takeaways

Throughout the Proposed Regulations, the DFPI conflates consumer and commercial financing. In the Initial Statement of Reasons, the DFPI acknowledges that the legislature was focused on creating “[r]obust consumer protections” and asserts the anticipated benefits of the Proposed Regulations include “an increase in consumer welfare.” Despite the DFPI’s “covered consumer” terminology, though, the Proposed Regulations concern financing to businesses, nonprofits, and family farms, not consumers.

The DFPI copies definitions of UDAAP verbatim from Dodd-Frank Title X, which also concerns consumer financial products and services. The DFPI tries to connect lending to consumers with lending to organizations by claiming these organizations are “managed and operated by individuals and consumers of financial products and services just like individual consumers.” This assertion is not backed up by any analysis or research regarding the thresholds specified in the definition of small businesses in a statutory provision unrelated to commercial lending. It also skips over the corporate form entirely as well as the legal and practical distinctions between business organizations and the individuals who own those organizations.

In addition, the DFPI does not explain why UDAAP definitions that apply to consumer transactions should similarly apply to commercial financing transactions. The DFPI’s broad, general approach reflects an assumption that we know it when we see it. Covered Providers would be left attempting to read the tea leaves, trying to understand the UDAAP framework based on DFPI consent orders.

Covered Providers should consider participating in the rulemaking process, particularly with respect to definitions of covered financing recipients such as Small Businesses that are pulled from statutes unrelated to commercial financing or were created by the DFPI for the Proposed Regulations.

[1] Cal. Fin. Code § 90009(e).

[2] Cal Fin. Code § 90015(a).

[3] Cal Fin. Code § 90005(m).

[4] Cal Fin. Code §§ 90015(e), 90012(b).