California law targeting small-business loan fees takes effect

David Paul Morris/Bloomberg

A new California law that took effect at the start of the year bans small-business lenders from charging certain types of fees that the legislation’s advocates say can be predatory and misleading.

The law — signed in October by Gov. Gavin Newsom — seeks to protect entrepreneurs and small-business owners from commercial loan offers that build costly add-on charges into the servicing and repayment agreement.

Specifically, Senate Bill 666 prohibits financing companies from charging specific types of fees, including Automated Clearinghouse transfer debits and Uniform Commercial Code termination fees, plus due diligence fees, risk assessment fees and undisclosed prepayment penalties, according to the text of the legislation.

It also bars lenders from charging small businesses for the preparation of documents related to the remaining amount owed on the loan, including accrued interest, as well as fees that do not have a “clear corresponding service,” according to the text of the legislation.

Stephen Denis, chief executive of the Small Business Finance Association, a trade group whose members provide financing to smaller companies, said that the SBFA supported SB 666’s enactment, but the group is seeking clarity around the provision about charging fees without providing a clear corresponding service.

“The role of a regulator is to make sure that bad actors and predatory lenders are exposed and prohibited from doing business,” Denis said in an interview. “We support any legislation or regulation that is aimed at going after bad actors in the industry.”

The California law is the latest action that state-level politicians and regulators have taken to address what consumer and small-business advocacy groups say are predatory lending practices.

Across the U.S. in recent years, some states have weighed and adopted borrower protection measures in the small business lending realm. Policymakers in California have led some of these initiatives.

In 2018, lawmakers in the Golden State passed a first-in-the-nation law requiring disclosures of annual percentage rates and other information on small business loans. That law finally took effect in 2022.

And last year, a new regulation gave California regulators the authority to go after unfair, deceptive and abusive practices in small business lending.

Carolina Martinez, chief executive of the California Association for Micro Enterprise Opportunity, a small-business advocacy group, said that the latest law promotes “fairness in lending,” especially for minority small-business owners who are at higher risk of being subject to predatory lending practices.

CAMEO pointed to data from the nonprofit Woodstock Institute, which found that lenders are charging fees to small businesses that end up costing between 8% and 14% of the total loan amount.

CAMEO also cited research published by the Federal Reserve Bank of Atlanta in 2019, which found that Black and Latino small-business owners were more likely than their white counterparts to be impacted by lenders offering higher-cost and less transparent credit products.

California’s new legislation will “continue leveling the playing field for entrepreneurs,” Martinez said in an interview.

“It will shine a light on hidden fees so business owners can make informed decisions,” Martinez said. “We want to make sure that, however big or small a company might be, the market for lenders using junk fees is reduced to zero.”