There is a broader trend in financial regulatory developments to implement traditionally consumer-style borrower protections in commercial lending. This is occurring at both the federal and state levels, each of which is discussed below.
Federal: CFPB Finalizes Rulemaking to Regulate Small Business Lending
For the first time since the formal launch of the Consumer Financial Protection Bureau (CFPB) in 2011, the CFPB has recently promulgated a new regulation that enables the agency to expand its reach beyond consumer to business lending.
In 2010, Congress enacted Section 1071 of the Dodd-Frank Act, which had authorized the CFPB to oversee borrower protections by requiring lending entities to report data to the CFPB relating to credit applications of women-owned, minority-owned, or small businesses. Last Thursday, on March 30, 2023, the CFPB issued a final rule amending Regulation B to implement changes to the Equal Credit Opportunity Act. Pursuant to this rule, covered lending entities are now required to collect and report to the CFPB data on applications for credit for small businesses, including those that are owned by women or minorities. The 888-page rule creates our nation’s first comprehensive dataset regarding lending to small businesses. Covered entities are required to comply beginning as early as October 1, 2024. Going forward, the CFPB will issue a supplementary proposal that would, if promulgated, provide additional implementation time for small lenders that have proven success records in serving their local communities under the Community Reinvestment Act and similar state laws.
States Enact New Commercial Loan Disclosure Laws
A growing number of states, including California, Utah, Virginia, and New York, have adopted commercial financial disclosure laws that are modeled after the Truth in Lending Act and Regulation Z. These laws aim to promote transparency and protect small businesses from predatory lending practices through clear and concise disclosure of annual percentage rates, fees, loan term, payment amounts, collateral and security information, prepayment penalties, and other data points. The scope of these laws are broad and go beyond open and closed end financing to cover factoring, lease financing, and other sales based financing arrangements. In addition, Utah and Virginia laws also carry a state registration component. Exemptions vary by state, but include exemptions for bank and bank subsidiary transactions, lease financing, commercial mortgage transactions, and any covered financing over a dollar threshold ranging from $500,000 in California to $2.5 million in New York.
On March 28, 2023, the CFPB issued its determination regarding the preemption of state commercial financial disclosures by the Truth in Lending Act. 88 Fed. Reg. 19214 (Mar. 31, 2023). Its review beginning December 2022 in response to a preemption determination request from trade groups. TILA’s implementing regulation, Regulation Z, authorizes the CFPB to review state laws for impermissible inconsistencies with Regulation Z upon request. 12 CFR § 1026.28. In response to its initial assessment, the CFPB determined on a preliminary basis that New York’s law was not contradictory to the requirements under TILA and Regulation Z. 87 Fed. Reg. 76551 (Dec. 15, 2022). As part of that preliminary determination, the CFPB also requested comment on whether it should finalize that determination and related determinations related to California, Utah, and Virginia law. After receiving fifteen comments, the CFPB finalized its determination. Specifically, TILA targets consumer transactions, not commercial transactions. Accordingly, these state laws are not inconsistent with TILA and thus TILA does not preempt them, according to the CFPB.
With the improvement in rate structures, we have observed an uptick in potential commercial lending activity. Businesses engaged in small business lending, lease financing, factoring, or any form of commercial lending should take heed and consult with counsel to ensure requisite compliance. [Insert any typical verbiage used at Reed Smith to invite them to contact the authors.]