The Center filed an amicus brief in the Ninth Circuit Court of Appeals in support of a California Department of Financial Protection and Innovation (DFPI) regulation requiring sales-based financing providers to disclose their APRs, finance charges, and loan terms to borrowers – typically small businesses and solo entrepreneurs.
The Center’s brief notes that in recent years online lending companies have been providing new “sales-based financing” products that are marketed as 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 the products. One product, the “Merchant Cash Advance” (MCA), provides a fixed sum of cash to small businesses that is 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 purposely opaque. Small business financing (SBF) providers regularly use arcane semantic distinctions and unfamiliar terminology to sell their credit products. They generally do not reveal, on the other hand, universally understood financing metrics like the loans’ Annual Percentage Rate. That lack of transparency makes it 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. Last year, the district court ruled against the trade association and dismissed the case shortly before trial (read about that victory here!), and the lenders appealed to the Ninth Circuit.
The Center’s brief argues that the DFPI’s regulations address confusion and opacity in the sales-based lending market, requiring routine informational disclosures that fully comport 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 relevant product terms, 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 “apples-to-apples” comparisons of and informed decisions about financial products. The DFPI’s regulations comport with the Legislature’s goal of bringing clarity and guardrails to an industry that has for too long preyed on California’s small businesses and entrepreneurs.
The Center is pleased to have been joined on the brief by fellow amici California Association for Microenterprise Opportunity (CAMEO), Consumer Federation of California, FreeFrom, Housing & Economic Rights Advocates, the Office of Kat Taylor, Microenterprise Collaborative of Inland Southern California, Public Counsel, Public Good Law Center, Public Law Center, and Rise Economy. These organizations worked to create the California Department of Financial Protection & Innovation and continue to support the Department in its efforts to safeguard California’s most vulnerable consumers as well as the small, unsophisticated businesses that make up the great majority of SBF customers.