California Governor Jerry Brown recently signed two bills into law that will provide Finance Lender licensees with greater flexibility in the ways in which they can obtain loan leads. One bill broadens the category of people who may refer commercial loan customers to licensees, and the other expands the role of a finder for certain unsecured loans. Both bills take effect in January 2016.
Senate Bill 197
Commercial lenders making loans to California residents are required to be licensed under California’s Finance Lender Law (“FLL”). Recently enacted legislation will provide these lenders with greater flexibility in obtaining commercial loan customers.
An existing FLL regulation prohibits FLL licensees from paying compensation to an unlicensed person or company “for soliciting or accepting applications for loans.” Two commercial financing sources are not subject to this prohibition because they are not required to obtain an FLL license: (a) merchant cash advance companies and (b) lenders that affiliate with banks to make loans under the banks’ charters. According to small business experts, this placed FLL licensees at a disadvantage, because “referrals are the single most efficient way for commercial lenders to acquire small business customers.”
The legislature was also concerned about negative effects the referral fee prohibition was having on small businesses. It found that “companies that are not subject to the [FLL] often offer less favorable terms to small businesses than [FLL] licensees, but small business borrowers never learn about these more favorable loans because the [FLL] licensees cannot compensate entities to refer business to them.”
Senate Bill 197 (“SB-197”), signed by Governor Brown on October 10, 2015, removes the referral fee prohibition, subject to certain limitations. SB-197 permits an FLL licensee to “pay compensation to a person that is not [an FLL licensee] in connection with the referral of one or more prospective borrowers to the licensee” if:
- the referral leads to a commercial loan, as that term is defined in the FLL,
- the commercial loan’s APR does not exceed 36%, and
- the licensee obtains documents to verify the borrower’s commercial status and its ability to repay the loan (and maintains required records).
SB-197 attempts to differentiate the activities that constitute a mere “referral” (and thus fall within its allowance for payment of a fee) and those that do not. Referral means “either the introduction of the borrower and the finance lender or the delivery to the finance lender of the borrower’s contact information.” However, SB-197 provides a long list of activities it does not authorize, including: participating in loan negotiations; counselling or advising the borrower about the loan; participating in preparation of the loan documents; and gathering loan documents from the borrower or delivering the documentation to the licensee. SB-197 also explicitly carves out additional categories for which a referral fee may not be paid. The fee may not be paid to (a) an unlicensed person with respect to a residential mortgage loan or (b) a person required to be licensed as a real estate broker, unless that person is so licensed. Because a real estate broker license is required to broker loans secured directly or indirectly by real estate, SB 197 is effectively limited to loans that are not mortgage loans.
SB-197 also introduces provisions regarding disclosures, liability, and prohibited acts in connection with referrals.
Senate Bill 235
In 2010, California established a small-dollar loan pilot program (the “Program”) for unsecured loans ranging from $300 to $2,500. The Program was intended to provide an alternative to payday loans. FLL licensees approved to participate in the Program are permitted to receive charges of up to 36%.
The Program permits licensed FLL lenders to use a finder, defined as “an entity that, at the finder’s physical location for business, brings a licensee and a prospective borrower together for the purpose of negotiating a loan contract.” Under current law, however, there are myriad activities in which a finder may not engage, although current law is silent as to whether a finder may or may not service a loan. Under the Program, a finder may be compensated up to $45 per loan for the first 40 loans originated each month and $40 for any subsequent loans originated during that month.
Senate Bill 235 (“SB-235”) was sponsored by a participant in the Program that wanted to use finders so the participant could offer small loan products to more borrowers. According to a Senate Report issued in connection with SB-235, the participant ran into two hurdles when attempting to use finders. First, the participant sought to give borrowers “the freedom to decide how and from whom they wish to receive their loan proceeds and how and to whom they wish to make their periodic payments.” Other supporters agreed, noting that many underbanked borrowers who took loans under the Program are accustomed to paying their bills in cash and in person. Second, the participant sought greater flexibility in compensating its finders.
SB-235, signed by Governor Brown on October 5, 2015, seeks to address the participant’s concerns. The most significant change under SB-235 permits certain finders to “disburs[e] loan proceeds to a borrower, if this method of disbursement is acceptable to the borrower”; “receiv[e] loan payment or payments from the borrower, if this method of payment is acceptable to the borrower”; and “provid[e] any notice or disclosure required to be provided to the borrower by the licensee,” subject to certain limited exceptions. To engage in these activities, however, the finder must be licensed as an FLL, a commercial bank, a money transmitter (or its agent), a check seller, a credit union, an escrow agent, an industrial loan company, a pawnbroker, a deferred deposit transaction licensee, a residential mortgage lender, an insurance licensee, an accountant, or as a federally regulated bank, thrift, or credit union. Finders that disburse proceeds or receive loan payments are required to provide the borrowers with receipts and to maintain records of all disbursements made and payments received.
SB-235 also increases the compensation a finder may receive to $65 per loan, plus $2 per payment received by the finder on behalf of the licensee for the duration of the loan. However, a licensee may not pay a finder compensation based on the principal amount of the loan, and the total compensation a licensee may pay a finder over the life of a loan may not exceed “the sum of the origination fee and interest charges paid by the borrower in connection with the loan.” A licensee is prohibited from passing onto the consumer, directly or indirectly, any fee or compensation paid to a finder.
An FLL-licensed lender that uses a finder will be required to submit certain information to the Department of Business Oversight regarding the finder and the performance of the loans referred by the finder.