lessors and finance companies face a web of state and federal laws applicable to various aspects of their business activities. In particular, determining whether a company requires a license can be tricky given the various statutory triggers and permutations of licensable activities varying across state laws. In an effort to help companies better understand the implications of state licensing laws, this article provides an overview of licensing considerations and trends in state enforcement activity with respect to equipment finance.
Licensing Considerations, Generally
The applicability of state licensing laws may depend on multiple factors, including transaction structures, business entity types and whether the activities are appropriately classified as “commercial” or another type of non-consumer transaction. Although the myriad of rules can be cumbersome to navigate, licensure can also carry ancillary benefits. For example, depending on the state, obtaining the requisite license may permit a company to avoid adhering to the state usury laws. On the other hand, failure to obtain the requisite license may have adverse consequences, such as cease and desist orders, fines and other settlement agreements. In addition, a company may have difficulty enforcing contracts with counterparties and could open itself up to its own contractual liability, which may trigger repurchase or indemnification obligations if the lack of licensure is deemed a breach of contractual representations and warranties.
In the majority of states, non-banks making commercial loans or bargain-purchase leases do not trigger licensure. A notable example of the minority of states that do require licensing is California, where a person engaged in making more than one commercial loan in a 12-month period must obtain a finance lender license. Under the California Financing Law (“CFL”), a commercial loan is defined as a loan with a principal amount of $5,000 or more, or any loan under an open-end credit program, whether secured or unsecured, the proceeds of which are intended by the borrower for use primarily for other than personal, family or household purposes. However, “non-loan” transactions, including bona fide leases, automobile sales finance contracts and retail installment sales, are not subject to the CFL.
Overall, more than 20 other states potentially have licensure requirements for commercial loans based on various state licensing triggers. These triggers include, among others, borrower status (e.g., sole proprietor or legal entity), collateral type (e.g., commercial real property, residential real property, personal property, etc.), loan amount, interest rate, agricultural use, and lender’s state of organization and headquarters location. While licensure in California as a finance lender exempts the licensee from California’s usury limitations, in some states, usury laws may apply regardless of licensure. Additionally, while national bank subsidiaries have historically escaped state licensing laws, the Dodd-Frank Act largely rolled back federal preemption as it applied to subsidiaries and affiliates of federally-regulated banks and savings associations, and at minimum now requires a state-by-state analysis. For example, in the consumer lending context, some states, such as Massachusetts and Pennsylvania, still provide a licensing exemption for bank subsidiaries. Other state consumer lending statutes, such as those in New Jersey and Virginia, exempt banks from licensure, but explicitly state that bank subsidiaries are not exempt. Still other states, such as Delaware and West Virginia, do not explicitly address licensing exemptions for bank subsidiaries. In California, the CFL provides that bank subsidiaries are not exempt from licensure in the context of consumer lending, but bank subsidiaries may make commercial loans without licensure.
Motor Vehicle Dealers and Lessors
Several states require licensure for commercial motor vehicle lessors or dealers. For example, in Mississippi, it is unlawful for a motor vehicle lessor to represent and to offer for lease any new motor vehicle in Mississippi without first obtaining a new motor vehicle dealer license, or to lease or offer to lease a new motor vehicle from an unlicensed location. Except in the motor vehicle context, “true leases” are typically not subject to licensure. However, to the extent that a true lease were to be re-characterized as a lease intended as a security, a different outcome could result. Many states also have laws regulating the financing of personal property. These laws may apply to “retail installment contracts,” “conditional sales agreements,” “sales finance companies” or similar terms. Such laws may apply to both a “retail seller” and a third party that purchases contracts from retail sellers. Further, in some states, these types of laws may more broadly apply to commercial equipment.
In Texas, for example, a lease of a commercial vehicle is considered a retail installment transaction if the lessee (i) agrees to pay an amount that is “substantially equal to or exceeds the value of the vehicle” and (ii) upon full compliance with the lease, becomes the owner or, for no or nominal additional consideration, has the option to become the owner of the vehicle. Florida has a substantially similar statute, under which a motor vehicle retail installment seller must obtain a license to enter into a retail installment contract.
Licenses for Ancillary Activities
Licensure may also apply to activities that are ancillary to equipment finance, such as a dealer’s participation in a loan or bargain-purchase lease negotiation or advising of borrowers or lessors, any of which may require a broker license in certain jurisdictions. Separately, collecting commercial debt for a third party, such as a syndicate purchaser of loans and leases, may also trigger licensure. Arizona, for instance, requires licensure of a “collection agency,” defined broadly as any person engaged, directly or indirectly, in soliciting claims for collection or in collection of claims owed, due or asserted to be owed or due.
The applicability of state licensing laws may depend on multiple factors, including transaction structures, business entity types and whether the activities are appropriately classified as “commercial” or another type of non-consumer transaction.
Alternative Finance Companies
Online platforms are increasingly offering equipment and motor vehicle financing options by engaging in bank partnership models. While the precise structure of this model may vary, typically a bank originates the loans and enlists a non-bank partner to assist with origination. The non-bank partner subsequently purchases the loans after a seasoning period, and in many instances the bank may retain an ownership interest in the loans. This partnership model may permit nonbanks to forego state lending licenses and take advantage of federal preemption of state usury laws, but other state licenses may still be necessary for activities such as brokering and servicing, including in some cases for commercial-purpose transactions.
Trends in Litigation and Enforcement
States such as New York and California have historically been very vigilant about enforcing state licensing requirements. Regulators in both of these states regularly target unlicensed activity. Additionally, recent litigation and enforcement actions have taken aim at bank partnership models under a “true lender” theory, examining whether a non-bank has the predominant economic interest in the loan and then asserting that federal rate preemption does not apply and state usury caps control.
Companies engaging in the leasing or financing of commercial equipment should understand the triggers for licensure in each state in which they do business and that the analysis will vary state by state. Additionally, companies should consider the advantages of obtaining a license to conduct their equipment finance activities, including the ability to finance equipment at a rate otherwise exceeding state usury laws. Finally, companies seeking to engage in a bank partnership should keep apprised of developments in recent litigation as courts continue to consider the model’s viability.