Bloomberg Law
Square and PayPal face cost disclosures for small business loans

Not Just Cookies, a growing wholesale and e-commerce bakery in Chicago. Company founder and baked goods enthusiast Johnathon Bush is opening more locations in Chicago and soon New York to get its brownies, cookies and pies out faster to customers hungry for desserts.

But expanding his business didn’t come without growing pains when in 2019, Bush took two cash advances from merchants to help pay payrolls and pay rent for the brick-and-mortar store he was in. he operated at the time.

“You are under enormous pressure because you have people depending on you. So you’re in really bad shape and you’re desperate” while exploring funding options, Bush said. A broker referred him to merchant cash advance companies even though he would have qualified for lower-cost options, Bush said.

The funds were delivered quickly, but came with significant fees on top of the funding rate which were not well disclosed, he said. He also felt misled about the interest rate he was initially offered, which didn’t seem to match the amount the company took from his accounts daily.

“There was no transparency,” Bush said.

De facto national standards

Soon, merchant cash advance companies as well as prominent fintech lenders like PayPal Inc. and Lending Club Corp. could be required by state authorities to provide much more transparency to small business borrowers.

Regulators in California and New York have proposed requirements for online lenders to disclose the cost of financing demanded by small business borrowers, such as interest rates and fees. Lawmakers in Connecticut, New Jersey and North Carolina introduced similar legislation.

Once in place, potentially as early as January 1, 2022 in New York, the state rules could create de facto national standards that small business borrowers have not had access to due to a loophole in federal law.

Better disclosures and more transparency would help contractors avoid the financing that accompanies the kind of aggressive and costly reimbursement that Bush experienced as soon as he took the lead.

“It will probably save a lot of small businesses,” he said.

recovery phase

Proponents of state regulatory efforts say the need for better disclosures is ripe as small businesses struggle to get back on their feet after the Covid-19 pandemic.

“The hope is that the standard can make it easier for small businesses to get out of the hole they were in and not fall back into lending they didn’t fully understand,” said Armen Meyer, head of public policy at Lending. Club.

According to estimates by the Responsible Business Lending Coalition, state funding disclosure laws could save California small businesses $2.9 billion and New York small businesses $1.75 billion a year. The group includes online lenders Funding Circle and Lending Club, as well as community development lenders and small business organizations.

As two of the largest U.S. markets to act first on the issue, regulations in California and New York “will set a benchmark for disclosure practices for all potential borrowers,” said Jonathan Pompan. , Co-Chair of Venable LLP’s Consumer Financial Services Practice. Group.

“At the federal level, the focus has been on consumer borrowing, not small business,” Pompan said. This has left a void for many commercial borrowers, many of whom are individuals and minorities. “There is no small business protection office,” he said.

Online lenders have become an important source of financing for many small businesses. They were the third most common source of financing for small businesses over the past five years, according to a report 2021 of the Federal Reserve.

According to the report, commercial borrowers with medium or high credit risk were more likely to turn to online lenders for financing than low-risk borrowers. According to the report, black-owned businesses said availability of credit would be their toughest challenge coming out of the pandemic.

The Responsible Business Lending Coalition has been lobbying state governments for several years to bring more transparency to the market through standardized disclosures.

Its vision is inspired by the Truth in Lending Act, a federal law that requires the use of annual percentage rate and other cost disclosures for consumer loans. No similar federal law exists for small business borrowers.

“It creates market information symmetry for borrowers versus comparison stores, which then forces lenders to compete on price,” said Ryan Metcalf, U.S. head of public policy and regulatory affairs. of Funding Circle and spokesperson for the coalition.

“Today, that doesn’t exist. There is no single metric for borrowers to compare products, terms and prices, and these disclosures using the annual percentage rate are the way to do that,” Metcalf said.

Accurate look?

Some financial service providers, including PayPal, Square Inc., and Stripe, as well as cash advance companies, are concerned that their products may be disadvantaged, whether real or perceived, based on the disclosure parameters that states want to set up.

According to the companies, financing products that are repaid at variable rates, based on metrics such as a merchant’s sales volume, can be difficult to predict at the time of financing. An annual or monthly measurement does not accurately reflect the true cost of their funding, they say.

Others say that requiring both interest rates and fees to be expressed in a single APR statement would mislead borrowers about the cost of capital. Financial Innovation Now, a trade group representing Inc., Intuit Inc. and Apple Inc., as well as PayPal, Square and Stripe, demand The California Department of Financial Protection and Innovation will allow companies to disclose rates and fees separately.

Otherwise, APR disclosures “will bear no relation to the true cost of credit” and could make comparison shopping “a confusing experience”, the group said.

Without provisions that take into account their different business models, the California and New York rules will not be considered a national standard for a segment of the commercial lending industry, said Katherine Fisher, co-chair of the financing practice group. businesses of Hudson Cook LLP.

“I hope state legislatures don’t wholesale adopt the New York and California models, and instead consider which disclosures are likely to be the most accurate and useful for small businesses,” he said. she declared.

State provisions

New York’s proposed draft rules, released Sept. 21, would require disclosures for funding under $2.5 million. It also provides methods for calculating finance charges and APR. The disclosure requirements would take effect on January 1, 2022, under New York law.

California’s rules took more than a year to implement, but the lending community expects that state to come up with its own regulations soon to keep pace with New York.

Disclosures would be required for any funding below $500,000. They also propose requiring lenders to calculate and provide an APR or other metrics to display financing costs.

Federal efforts

Meanwhile, the Consumer Financial Protection Bureau is emerging as a potential player in small business finance disclosure.

Rohit Chopra, who was confirmed as the CFPB’s new director earlier this month, is widely seen as an aggressive enforcer of consumer loan laws and the agency’s sweeping Dodd-Frank Act powers against unfair and deceptive acts and practices.

Chopra took on online commercial lenders as a Democratic member of the Federal Trade Commission. As Commissioner, he call for the FTC to “examine” the trade claims of certain merchant cash advance providers who operated more like installment lenders, which are subject to federal anti-discrimination laws and the Equal Opportunity Act credit.

The CFPB is already developing ways to measure the equity of small business loans and has embarked on a data collection effort to better understand the financing terms that women and minority small business borrowers receive.

“The open question then is what’s next and how will this data be used by decision makers and the office itself,” Venable’s Pompan said.

The RBLC hopes that the California and New York regulations will serve as models for the CFPB’s eventual small business loan disclosure requirements.

“It’s a natural extension of what commercial borrowers should expect and what lenders should do,” Meyer said.


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