Doing Business in California

What you need to know about legislative developments in the nation’s most populous state: A true story of legislative intent and lightning response illustrates the value of ELFA’s state advocacy program.

AT ONCE the nation’s most populous state and largest economy, California is nothing if not a trend-setter. From tea-flavored ice cream to tie-dyed bucket hats, firsts in food and fashion originate in the Golden State as surely as does world-class information technology. 
But California is also known for blazing trails in legislation, and a bill introduced in its state legislature in February 2018 lit fires of concern within ELFA. If made law as written, Senate Bill 1235 (SB 1235) would become the nation’s first legislation requiring the disclosure of interest rates and other information on certain commercial finance products. The law would pertain to all such transactions under $500,000—leases, loans, lines of credit and merchant cash advances included.

“We hope to achieve an exemption [in New York] similar to those in California and New Jersey.”

Scott Riehl, ELFA

A Dangerous Precedent

“The bill exemplified the threat of states taking what have traditionally been consumer protections and bleeding them into commercial transactions,” says Scott Riehl, ELFA’s Vice President of State Government Relations. “Many times, states draft legislation in such a way that protection of consumers is intended but commercial transactions are inadvertently affected. SB 1235 was the first case in which lawmakers actually intended to establish consumer-like protections over commercial transactions.”

Specifically, SB 1235 required the following disclosures on qualifying transactions:

• The total amount of funds provided
• The total dollar cost of the financing
• The term or estimated term
• The method, frequency and amount of payments
• A description of prepayment policies
• The total cost of the financing, expressed as an annualized rate.

If passed, the legislation would not only adversely affect equipment finance companies doing business in California; it might also influence lawmakers in other states to pass similar bills and grow the problem. SB 1235 quickly became ELFA’s hottest state issue.
Eight months of effort followed as members of ELFA’s State Government Relations team traveled repeatedly to California, sought and obtained an audience with the bill’s sponsor, testified before multiple legislative committees on the bill’s potential impact to equipment finance companies, and worked with the sponsor’s staff to make necessary changes. ELFA’s California members played a critical role in developing and advancing alternative legislative provisions. 

“We convinced legislators we were not an industry sector they were trying to protect against,” says Riehl. The bill was subsequently amended to exempt true leases as well as depository banking and made law in September 2018. 

But in several ways, the story was just beginning. The California Department of Business Oversight (DBO) was charged with drafting regulations for enforcement and compliance of SB 1235 and twice asked for comments. ELFA twice responded, both times submitting extensive information and suggestions to address gaps and vagaries still present in the law. Furthermore, legislation similar to SB 1235 was filed in New Jersey and New York. 

Guiding Principles 

ELFA President and CEO Ralph Petta adds helpful perspective. “Underlying ELFA’s position on SB 1235—and any legislation placing consumer-like protections on equipment finance companies—are two principles to which we subscribe,” says Petta. “The first is a level playing field. The law considers you an owner-user if you purchase equipment or use it, and we believe our members should be treated the same as other owner-users. Companies in our industry purchase equipment, but because they are passive finance entities, their users are other people. Yet, equipment finance companies own the equipment and have taken the risk of ownership, so we always want to be sure we’re guided by the same rules that govern other owner-operators.” 

“States, in their zeal to protect consumers, sometimes overreach and apply consumer protections to commercial transactions.”

Ralph Petta, ELFA

The second principle guiding ELFA’s advocacy work is that consumers and businesses are different, and laws pertaining to each should be kept completely separate. “States, in their zeal to protect consumers, sometimes overreach and apply consumer protections to commercial transactions,” says Petta. “There is a dangerous trend by some public policy makers to treat small businesses as consumers. But they are not consumers; instead, they are commercial entities entering into arms-length contracts with equipment finance companies—ELFA members. As such, we believe both parties in these commercial settings are—or should be—sophisticated enough to understand the documents they’re signing and the rights and responsibilities contained in them.”

Causes and Continuing Concerns

Andrew Alper is Vice President and Shareholder of Frandzel Robins Bloom & Csato, L.C., in Los Angeles. He is also a longtime contributor and advisor to ELFA’s state government relations program and was a co-winner of ELFA’s 2019 Edward A. Groobert Award for Legal Excellence. Alper says legislation like SB 1235 often gets its start when constituents bring issues like evergreen clauses to their lawmakers.

“[California] is not an easy place do business…. But it’s a huge economy, and lenders want entrance into the business environment.” 

Andrew Alper, Frandzel Robins Bloom & Csato, L.C. 

“I have seen disputes arise when the lessee has not timely exercised its right to purchase equipment and because of the evergreen clause, the lease term rolls over for a year or other period, causing a dispute between the lessee and lessor,” Alper says. He has also seen contentions by a lessee in which the lessor/lender quoted rates, but because the rates were not specifically disclosed in the lease or loan documents, after signing the documents the lessee/borrower learns that the rates are higher than were represented, and the lessee/borrower and lessor/lender then have a dispute. “The lessee or borrower then involves the state Department of Business Oversight (DBO) and contacts its legislators to ensure that others are not 'hoodwinked' by another lender or lessor,” Alper relates. “The legislator then begins writing a bill, having no concept of provisions in the California version of the Uniform Commercial Code, the business of lending and leasing, or what impact the new law might have on the leasing/financing and lending industry.”

Alper says legislators and courts also blend consumer laws with commercial laws, even though the two types of law are quite different and the protections consumers need are not the same for business and commercial concerns. “Such is the case with SB 1235, where loans under $500,000 are being treated the same way as consumer transactions and contain disclosures that may not be appropriate under the circumstances,” he says, adding, “This is how consumer law is bleeding into the commercial world. In California, I do not see an end to the blurring of these lines.”

“Make sure you are complying with all finance lender laws—the fines can be huge for non-compliance.”

Chris Enbom, AP Equipment Financing

Nor do others at ELFA. Barely a month after SB 1235 was introduced in California, similar legislation was filed in New Jersey. The New Jersey bill not only sought consumer disclosure requirements for loans under $500,000 (sound familiar?); it extended those requirements to brokers and any other third parties involved in the loans. The bill sat quietly in the state Senate until October 2018, when it was amended with a partial exemption for banks that earned it fresh attention. ELFA again sprang into action.

“While at the ELFA Convention, we were alerted of a hearing on the legislation the following Monday,” recalls Riehl. He quickly returned to Washington to plan the association’s response. In the days that followed, ELFA’s Membership and Research divisions, along with the Equipment Leasing & Finance Foundation, teamed to gather and prepare for presentation specific data showing a large presence of ELFA-member companies in New Jersey. More than 70 ELFA-member companies do business in the Garden State, financing nearly $33 billion annually in capital equipment. Armed with this information and more, Riehl flew to Trenton. He summarizes, “ELFA was able to express our concerns in such a way that we were exempted from the legislation before the hearing began.” 

But the movement to place consumer-like protections on commercial transactions continued. A bill introduced in New York in early 2019 sought to allow consumers to cancel contracts with businesses “the same way they entered” those contracts. ELFA, concerned that the legislation too loosely defined “Consumer,” stepped up to offer a more specific definition that would completely exempt ELFA-member commercial contracts. Says Riehl, “We had conversations with lawmakers and are now working with them to make changes to the legislation. We hope to achieve an exemption similar to those in California and New Jersey.”

 

“Lenders and lessors will be required to analyze whether SB 1235 or the CCPA applies on a case-by-case basis.” 

Marshall Goldberg, Glass & Goldberg, A Law Corporation

Additional Complexities

Compliance with SB 1235 won’t be required until final regulations are submitted to and approved by California’s Office of Administrative Law. ELFA estimates mid-2020 as the earliest date this will occur. In the meantime, however, the ELFA Legal Committee’s DBO Work Group stands ready to provide any additional guidance the agency requires. 

Chris Enbom, CEO & Chairman of Bend, Oregon-based AP Equipment Financing, also known as Allegiant Partners, is upset that some equipment finance companies are still disadvantaged against banks, owing to federal pre-emption rules governing many banks. “Banks are not subject to [SB 1235] and have no requirement to disclose rates on commercial transactions,” he says. “We already have a funding disadvantage, and legislation like this presents an increasingly uneven playing field.”

Enbom believes the net result will be less funding for small businesses in California as some companies stop providing non-lease offerings, pull out of the state or “stop funding better credits who are highly rate sensitive and do not see the value in the services independent finance companies provide.”

Alper worries how finance companies will disclose information that until now hasn’t been calculated. “There are still many gaps in SB 1235, such as how annualized interest rates are to be calculated, much less disclosed, for lines of credit or factoring,” he says. “What do you do with transactions that approve a credit line of $2 million, but only advance $400,000? Do you have to make the disclosures or not, since the amount initially advanced is $400,000, but the lender will have to advance more than the $500,000 disclosure limitation?”

How the disclosure laws will pertain to factoring is another concern, since companies that factor invoice their customers on a rolling basis, depending on the amount loaned. Says Alper, “How do you calculate and disclose annualized interest and costs for those types of transactions?” 

Information Privacy Laws

Marshall Goldberg, Partner at Glass & Goldberg, A Law Corporation, in Woodland Hills, California, says information-privacy laws being passed in several states are part of the same trend that produced SB 1235. The California Consumer Privacy Act (CCPA) takes effect Jan. 1, 2020 and restricts how, what and for whom private consumer information can be collected, disclosed and sold by businesses. The legislation became law a mere six days after being introduced in mid-2018 and since then, similar bills have been introduced in 11 states. 

“The CCPA primarily deals with consumers, and a consumer is defined in the CCPA as ‘a natural person who is a California resident,’” says Goldberg. “But businesses must be cautious because a ‘natural person’ may encompass individuals included as part of a business transaction. What happens when a loan or lease is made to a sole proprietor or it includes an individual guarantor?” 

Goldberg says the California legislature temporarily plugged one hole in the CCPA this past September by creating a narrow exemption for “personal information reflecting a written or verbal communication or a transaction between the business and the consumer, where the consumer is a natural person who is acting as an employee, owner, director, officer or contractor of a company, partnership, sole proprietorship, nonprofit or government agency and whose communications or transaction with the business occur solely within the context of the business conducting due diligence regarding, or providing or receiving a product or service to or from such company, partnership, sole proprietorship, nonprofit or government agency.”

But the exemption expires on Jan. 1, 2021 and does not appear to cover angel investors or guarantors. “What happens when an individual family member, perhaps a parent or spouse, executes a guarantee merely to support the lender’s financial requirements of a start up?” Goldberg asks. “That person is not involved in the business on a day-to-day basis; yet as the law is written, the disclosure requirements would apply.” 

As originally drafted, both SB 1235 and the CCPA defined consumers in inexact terms that could be interpreted to include companies having transactions with other businesses. The definition has been amended in SB 1235, but similar vagaries exist in financial disclosure laws introduced in other states. “Many terms aren’t well defined or defined at all,” says Goldberg. Partly as a result, he believes anyone who engages in leasing or lending should assume that all such new laws will apply to them.

“These laws are comprehensive,” Goldberg says. “The European Union’s General Data Protection Regulation (GDPR) is an influence, and we are seeing more privacy laws nationwide. Our industry includes many types of finance companies and funding sources and a multitude of financing alternatives. We are a trillion-dollar industry, and lenders and lessors will be required to analyze whether SB 1235 or the CCPA applies on a case-by-case basis.”

Enbom agrees. “There is a lot of regulation in California, and the regulators do not understand what we do as commercial finance companies,” he says. “On the other hand, the California market is huge, and we will continue to do business there despite the constraints on the market.”

The company that is now AP Equipment Financing was based in California for more than a decade. But Enbom says a desire for growth collided with high costs and subjectivity to increasing financial regulation. In January 2019 the company moved its headquarters to Oregon and retained its license as a California lender. 

To other equipment finance companies doing business in California, Enbom advises, “Make sure you are complying with all finance lender laws—the fines can be huge for non-compliance.” He also suggests staying abreast of other legislative trends, including laws on customer data.

Alper observes that many companies doing business in California currently use equipment finance agreements, which do not disclose interest rates, instead of promissory notes, which do. “I bring this up because SB 1235 is the death knell for equipment finance agreements,” he says. It is one of several changes that companies financing equipment in California may need to make soon. But Alper’s overarching conclusion about the big trend-setting state is much like Enbom’s. “We are very consumer-oriented here,” he says.” It’s not an easy place do business, with high taxes and high costs. But it’s a huge economy, and lenders want entrance into the business environment of one of the largest economies in the world.”