New York Gov. Andrew Cuomo (D) Dec. 23 signed into law the Small Business Truth in Lending Act, which requires new consumer-type disclosures for commercial financing, including for sales-based financing such as merchant cash advance (MCA) and invoice factoring.
The act, which takes effect June 21, 2021, also delegates regulatory and enforcement authority to the state’s Department of Financial Services (DFS).
New York is the second state to adopt such legislation, preceded by California in 2018.
The act will significantly impact small business financing in New York, mandating federal Truth in Lending Act-like disclosures for commercial transactions, including nontraditional financing arrangements and open-end lines of credit.
Commercial financing providers will have to assess the costs and benefits of compliance versus limiting their financing offerings in New York.
Conversely, financing recipients will obtain additional (if imperfect) disclosures but may have fewer financing options should providers stop offering regulated financing options in New York.
What the Law Requires
The act applies to sales-based—or merchant cash advance—financing, accounts receivable factoring, open-end extensions of credit (including most lines of credit), closed-end extensions of credit (including equipment financing), as well as renewal financing or refinancing.
It exempts financings larger than $500,000, financial institutions and chartered banks, transactions secured by real estate or leases, and providers of only five financing transactions per 12 months.
The act requires financing providers, including brokers, to disclose the following information when extending a financing offer: 1) actual disbursement amount; 2) all financing charges including discounted purchase prices for MCA and factoring; 3) annual percentage rate (APR); 4) total repayment amount; 5) term; 6) payment amounts including average projected payments per month; 7) all other potential fees including draw fees and late payment fees; 8) payoff or refinance costs; and 9) collateral or security requirements.
Because MCA financings are inherently contingent on the recipient’s daily or weekly revenue levels and lack a fixed term, the act permits MCA funders to disclose only an estimated APR based on the recipient’s projected sales, called the “projected sales volume.”
MCA providers may select between two methods of calculating the recipient’s projected sales volume—the historical method or the opt-in method—and must inform the DFS of their selection.
The historical method is based on the financing recipient’s average historical sales during a fixed period. The financing provider, however, must use the same fixed period for all its financing transactions.
The opt-in method allows the provider discretion to determine the projected sales volume for each transaction, but the provider must submit an annual report to the DFS containing all its projected APRs as well as actual APRs of completed transactions. If the DFS determines the deviation between estimated and actual APRs is “unacceptable,” it may require the provider to use the historical method going forward.
The act contains similar detailed disclosure requirements for other financing transactions, including factoring and lines of credit, which providers are encouraged to review with counsel. Of note is the requirement that providers of renewal financing disclose the amount used to pay off the existing financing, including whether and how much of the renewal financing is used to pay unpaid finance charges.
The DFS is authorized to impose civil penalties of $2,000 per violation, $10,000 per “willful” violation, and injunctive relief for “knowing” violations.
Issues Raised by the Law
The act’s treatment of MCA disclosures—particularly its application of fixed-financing metrics (such as APR and a term) to an inherently contingent form of financing—raises several issues.
First, one of the act’s goals is to allow financing recipients to compare financing offers, but an accurate apples-to-apples comparison is nearly impossible when providers may elect between various methods of calculating projected sales volumes and, therefore, APRs and terms.
Second, the provision of an estimated term and APR in an MCA transaction stands in tension with established New York case law against the inclusion of a fixed term, reflecting the sale nature of the transaction.
Third, the record-keeping realities of many small financing recipients is such that the information required for the historical method is often not available or is difficult to determine in the short time-frame of these transactions. Electing the opt-in method, however, could result in the DFS finding that the provider is not in compliance with the act.
Fourth, it remains to be seen how the DFS will define what is an “unacceptable” deviation between estimated and actual APRs for providers electing the opt-in method and whether providers will voluntarily submit annual reports to DFS to take advantage of the opt-in method’s more flexible approach.
Finally, the act is silent about its jurisdictional reach and whether financing recipients have a private right of action to sue.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Mendy Piekarski is a commercial and securities litigation partner with Thompson Hine LLP in New York. He also counsels alternative commercial financing and merchant cash advance companies on various legal and regulatory matters.