The Center, along with our co-counsel Public Counsel, California Association for Microenterprise Opportunity, the Responsible Business Lending Coalition, and the Office of Kat Taylor, filed an amicus brief in the Central District of California in support of a California Department of Financial Protection and Innovation (DFPI) regulation requiring sales-based financing providers to disclose their APRs and other costs to borrowers, typically small businesses and micro-entrepreneurs.
In recent years, online lending companies have emerged in the financial industry with new financing products, called “sales-based financing,” that are marketed as viable alternatives to traditional loans. These lenders use aggressive and often misleading tactics to target small businesses and entrepreneurs by offering lower requirements for borrowers, quick access to funds, and “creative” financing options that often conceal the high prices of those products. One product, called a Merchant Cash Advance (MCA), provides a fixed sum of cash to small businesses that are repaid from a percentage of the businesses’ sales, plus a “factor rate” fee. If you had to look up what a “factor rate” is, you’re not alone; the terms of these products are novel and purposefully opaque. SBF providers regularly use arcane semantic distinctions and unfamiliar terminology to sell their credit products. In doing so, they conceal universally understood financing metrics like the loans’ Annual Percentage Rate. That lack of transparency makes it extremely difficult for small businesses to compare financing options and can mislead small businesses into accepting higher-priced financing. MCAs have very high costs that can be devastating to small businesses to pay back. One analysis of small business contracts found that the average undisclosed APR charged was 94 percent, and that some APRs exceeded 350 percent. Without an APR disclosure, small businesses simply cannot compare their options. As a San Francisco fitness studio owner described: “They do everything in their power to make sure that you can’t compare A to B.”
To help rein in these predatory practices in the small business lending market, the California Legislature enacted Senate Bill 1235, which among other things authorized the DFPI to issue rules mandating cost disclosures like estimated APR. The DFPI did so in 2021, but shortly thereafter, a trade association of SBF lenders challenged the regulations in federal court as unconstitutional under the First Amendment and preempted by federal law.
The Center’s brief argues that the DFPI’s regulations helpfully address confusion and opacity in the sales-based lending market, while fully comporting with the First Amendment’s requirements for compelled speech. The Regulations simply require providers to make a factually accurate statement of the estimated APR and other costs, using the best information available at the time of the disclosure. This is not difficult for providers to do. Indeed, many providers already calculate and rely on estimates required by the regulations for their own business purposes. Rather than threatening protected speech, the regulations advance First Amendment principles by providing potential borrowers vital information that they need to make informed decisions about financial products. The DFPI’s regulations comport with the Legislature’s goal to rein in an industry that has long preyed on California’s small businesses and entrepreneurs. Small businesses and consumer advocates alike await the Court’s decision on this important issue for transparency in lending.
Center Fellows Nicole Antonuccio ‘24 and Leila Nasrolahi ‘24 provided invaluable research and drafting assistance with the Center’s brief. We’re also proud to share some compliments we received from our amici about the brief:
“As the small business advocates in the room, we are incredibly grateful for your collaboration, your intelligence, your hard work, dedication, and I can go on and on.”
“We obviously could not have mustered the response we have to this challenge without your engagement and expertise.”
“One of the most deeply satisfying compensations of a career working in the public interest is the opportunity to meet, observe, and work for and beside remarkably talented people of great character and intelligence ... like all of you who crafted this fine work.”