On Thursday, July 23, 2020, the New York State Legislature voted to approve companion bills ( S 5470/A 10118-A), commonly referred to as the “New York State Small Business Truth in Lending Act” (NY TILA). In passing the NY TILA, the State of New York follows in California’s footsteps, which passed its own state Truth in Lending statute in 2018 and, if signed into law by Governor Cuomo, New York would become the second state to enact such a law. Essentially, the NY TILA requires disclosures for small business financing transactions of less than $500,000, similar to those required for consumer borrowers by the Federal Truth in Lending Act (Regulation Z, 12 C.F.R. 1026). What follows is an overview of the NY TILA, including a summary of the types of transactions to which the statute applies, specific disclosure requirements, and the types of lenders and providers covered by or exempt from the provisions of the statute. We will then discuss specific considerations for merchant cash advances (MCAs), an industry which appears to be a focus of the statute and whose satisfaction of certain of the disclosure requirements may prove uniquely problematic.
To what types of transactions does the NY TILA specifically apply?
The NY TILA covers a broad number of commercial (not consumer) transactions, including traditional open-end financings, closed-end financings, equipment loan financing, factoring and sales-based financings. To make it clear that sales-based financing is intended to cover MCAs, that category includes transactions in which a true-up mechanism is used for the recipient of the commercial financing transaction to repay the provider through a reconciliation process that is necessary to adjust fixed payments so that a desired percentage of sales or revenue of the recipient is achieved. Under New York State case law, such a true-up and reconciliation mechanism is a necessary requirement for such transaction to be deemed to be a sale of receivables, rather than a loan secured by receivables, and therefore not subject to New York’s usury laws.
What disclosures must generally be provided under the NY TILA?
Regardless of the type of commercial financing transaction, covered providers must ensure that the specific terms of the commercial financing, including price or amount offered to a recipient (defined in the NY TILA as a “specific offer”), must include the applicable “finance charge” and the “estimated annual percentage rate.” Finance charge is broadly defined as the “cost of financing as a dollar amount” and includes “any charge payable directly or indirectly by the recipient as an incident to or condition of the extension of financing.” The determination of such cost of financing of course varies depending on the form of the commercial financing transaction and the NY TILA does provide some guidance to help providers determine the finance charge. For example, Section 801(e) makes clear that for the purposes of a factoring transaction, “the finance charge includes the discount taken on the face value of the accounts receivable.” The estimated annual percentage rate is to be expressed as a yearly rate, inclusive of any fees and finance charges and calculated in accordance with the federal Truth in Lending Act, based on the estimated term of repayment and the projected periodic payment amounts.
Additional fees, costs and expenses, among other similar items, must also be disclosed upon the making of a specific offer by the provider to the recipient, such as the total amount of the commercial financing, and any fees deducted from the amount disbursed to the recipient. Moreover, providers need to disclose a description of the collateral requirements for the commercial financing transaction, if any.
The amount and description of information required to be disclosed becomes more nuanced and problematic depending on the type of commercial financing transaction. Descriptions may be reasonably simple in a traditional loan transaction. However, providers of sales-based financings (such as providers of MCAs, for example), will need to include calculations of the estimated term of repayment and projected periodic payment amounts. This would require providers of sales-based financings to conduct a historical review of the sales of a recipient to determine the projected amount of sales and the receivables arising therefrom that the provider would purchase, along with the discount and other finance charge from such sale. Even if the payments under a sales-based financing are expected to be variable, the provider must be sure to include, along with the specific offer, a “payment schedule or a description of the method used to calculate the amounts and frequency of payments, and the amount of the average projected payments per month.” See § 803(f)(ii) of the NY TILA.
What lenders or providers are exempt from the disclosure requirements of the NY TILA?
Section 802 of the NY TILA exempts from the requirements of the statute: “financial institutions”; persons acting in an intermediate capacity with regards to the provision of services to an entity otherwise exempt from the NY TILA (such as software licensing companies), support services or other technology service providers; lenders regulated by the Federal Farm Credit Act; lenders in a commercial financing transaction secured by real estate; lessors under a lease, as defined in Section 2-A-103 of the Uniform Commercial Code; persons who make no more than five commercial financing transactions in the State of New York in a twelve-month period; or an individual commercial financing transaction that is greater than $500,000. Thus, the NY TILA includes most non-regulated entities (including finance companies and hedge funds) within its coverage. It should be noted that there are no exemptions for commercial small loan transactions, even where the intent is to bundle them into a substantial financing or securitization transaction.
Specifically, the term “financial institutions” includes most regulated banking or lending institutions, such as banks, trust companies, industrial loan companies, federally chartered savings and loan associations, federal savings banks or federal credit unions, savings and loan associations, savings banks or credit unions, in each case, that is organized or authorized to transact business in the State of New York.
What are the penalties for non-compliance with the NY TILA?
Providers who violate the NY TILA are potentially liable for a civil penalty of up to $2,000 for each individual violation of the NY TILA. This penalty increases to up to $10,000 for each individual violation if the provider is determined to have willfully violated the NY TILA. Furthermore, Section 812(b) states that the superintendent of the New York State Department of Financial Services (the Superintendent) may order additional relief, including a permanent or preliminary injunction on behalf of the recipient affected by the violation.
Specific considerations with regards to providers of sales-based financings such as Merchant Cash Advances
In particular, providers of MCAs should pay particular attention to the terms of Section 803 due to the potential minefield of disclosure requirements involving sales-based financing transactions. Due to the very nature of an MCA, where the timing and amount of the generation and collection of receivables are likely unknown when the transaction is entered into (no less when terms are being offered), compliance with Section 803 presents a challenge which may be extremely difficult, if not nearly impossible, to satisfy. This difficulty is likely inherent in an MCA provider’s very business model. Although a historical analysis of a recipient’s sales history and prior receivables generation may help in determining some of the necessary information for disclosure, such information may not be available for a small business that is new or whose records are less than well maintained and difficult to ascertain given the quick paced timing of the transaction. Section 803 purports to address this problem by allowing providers the use of an “opt-in method” to determine the annual percentage rate and other financing charges, which allows providers to elect the manner in which the provider estimates sales volume for each disclosure. However, this requires providers of MCAs to, on an annual basis, report to the Superintendent the financing charges estimated to the recipient at the time of the specific offer and the amount of financing charges actually incurred. A deviation between the financing charge at the time of the specific offer and the amount of financing charges actually incurred that is determined unreasonable by the Superintendent, could result in the provider being in non-compliance with the NY TILA.
Regardless of whether a sales-based financing provider elects to use the “historical method” instead of the “opt-in method,” the provider still needs to provide notice to the Superintendent of the method it intends to use across all instances of sales-based financings. Furthermore, if the NY TILA is signed into law, providers of MCAs are cautioned against making unilateral changes to their terms, without notice to the recipient, to percentages of periodic debit amounts that may result, or seemingly appear to result, in an increase to the financing charge, such as, for example, those MCA providers using a “daily retrieval rate” or similar mechanism to approximate amounts of the base payments periodically due to achieve the “total repayment amount” (as defined in Section 803(d) of the NY TILA). Although the NY TILA does not address this specific circumstance, the broad discretion granted to the Superintendent due to its level of oversight would dictate that such actions should be avoided by MCA providers, even if only to ensure that there is no appearance of non-compliance. We note that while California adopted a similar law requiring MCA providers to disclose an annual percentage rate, the California legislature, due to the difficulty in determining an annual percentage rate on an MCA transaction, left it up to the Department of Business Oversight to determine how this would be done. To date no regulations have been issued by them on how to do this.
Conclusion
Although the NY TILA is not yet law and it would not be effective until 180 days after being signed into law by Governor Cuomo, providers of commercial financing transactions falling under the auspices of the NY TILA should begin to consider the implications to its business as well as to the forms of documents it presently uses. Providers should work with their professionals to develop specific processes and systems, as well as updated documents, to attempt to ensure compliance with the disclosure requirements of the NY TILA, including determining the best way to ascertain finance charges and estimated annual percentage rates under the mechanisms of the NY TILA, even if the finance charges and estimated annual percentage rates may otherwise seem unascertainable.
