Federal judge upholds California’s small business lending disclosures

Bloomberg News

A federal judge has upheld California’s small business lending disclosure law, rebuffing efforts by merchant cash advance lenders that sued the state last year claiming the regulation violated the free speech rights of commercial lenders.

Judge R. Gary Klausner of the U.S. District Court for the Central District of California on Monday granted summary judgment to California’s Department of Financial Protection and Innovation. The Small Business Finance Association sued the California agency last year for mandating that nonbanks disclose the annual percentage rate, finance charges and total interest and fees on financings of $500,000 or less.

The issue is complicated by the proliferation of short-term, high-cost financing options online, made primarily by nonbanks to small-business borrowers with bad credit. A few states have proactively granted consumer protections to small businesses but only California and New York require that lenders calculate and disclose key terms. As states have sought to regulate small-business lending, the lenders have filed lawsuits and floated novel legal theories to gut the state laws. 

The district judge found that DFPI’s recently-adopted commercial financing disclosure regulations were lawful under the First Amendment and were not preempted by the federal Truth in Lending Act. The judge cited a letter from the Consumer Financial Protection Bureau that determined earlier this year that small business disclosure laws in four states — California, New York, Utah and Virginia — do not run afoul of TILA, the seminal consumer protection law that created the current consumer disclosure regime. 

“The CFPB’s determination is afforded a particularly high level of judicial deference,” Judge Klausner, a George W. Bush appointee, wrote in the 14-page order. “Having reviewed the agency’s analysis, the court declines to overrule its rational conclusion that TILA does not preempt SB 1235 (and by extension the Regulations.)” 

Currently there are no federal disclosure requirements for commercial loans, and TILA only governs consumer disclosures.

DFPI Commissioner Clothilde Hewlett said the regulation gave four million small businesses in the state the ability to better understand the cost of small business financing products, including merchant cash advances. 

“Judge Klausner’s order represents a significant victory for small business owners and consumer protection in the State of California,” Hewlett said in a press release. 

Steve Denis, CEO and executive director of the Small Business Finance Association, said he was “disappointed by the decision by the judge,” and the trade group is weighing its options on whether to appeal. 

“Our goal is to support meaningful and accurate disclosures for our small business customers,” Denis said in a statement adding that California’s state regulation, S.B. 1235, requires “inaccurate descriptions of the products covered.” The state bill passed in 2018 and implementing regulations went into effect in December 2022.