A new California regulation will bring consumer-style protections to small businesses seeking loans, giving regulators in the state the ability to go after unfair, deceptive and abusive practices.
The rule appears to be the first of its kind for small businesses. It could be copied in other states, extending regulators' ability to crack down on lenders with questionable practices.
There are generally fewer protections in place for U.S. small business borrowers than consumers. Consumer lenders can already be penalized by state and federal regulators for engaging in unfair, deceptive, or abusive acts or practices, or UDAAP.
Backers of the new California rule hope that it will stamp out abusive lending and collection practices by certain nonbank lenders. Those firms, they say, take a predatory approach that puts business owners at risk of financial ruin.
"These small business owners sustain our local economies. … They're the fabric of our community," said Bianca Blomquist, California policy director at the advocacy group Small Business Majority, adding that the rule will add "much-needed oversight."
The rule from the California Department of Financial Protection and Innovation has been in the works for years and was finalized this month. It covers small businesses, nonprofit organizations and family farms in the state, ensuring that lenders cannot engage in practices that take "unreasonable advantage" of their lack of understanding of a contract, among other things. The rule exempts banks, credit unions and certain other lenders.
It's the latest example of how lenders that provide financing to small businesses are facing tougher state regulatory requirements. Though their approaches vary, California and several other states
California's latest move will give regulators the ability to take action against lenders based on UDAAP violations, mirroring the authorities the state already has to penalize consumer lenders.
That approach represents a "sea change in the potential liability of small business finance companies in California," said Scott Pearson, a partner at the law firm Manatt, Phelps & Phillips.
Lenders have had some time to prepare for the upcoming change, which was part of a 2020 law that overhauled California's financial regulatory agency.
The agency's enforcement of the rule will depend on what specifically officials view as abusive and deceptive — terms that are open to interpretation, Pearson said.
The new regime could drive some lenders out of the state — and limit financing options for businesses — if the DFPI goes after conduct that is not "unquestionably wrong," he said.
"It's really in the hands of the regulators to decide what sort of environment they want to create in the state," Pearson said.
When asked about what the agency's enforcement focus will be, a DFPI spokesman pointed to the
Lenders doing business in California should ensure that the rule becomes part of their compliance framework, lawyers at the firm Greenberg Traurig wrote in a
Specifically, lenders should confirm that their promotional materials line up with the terms and conditions of their products, ensure that any disclosures "use plain language where possible" and implement or boost processes for handling complaints, the lawyers wrote.
California has been at the forefront of increasing disclosure requirements in small business lending. As part of those efforts, the state requires nonbank business lenders to disclose the annual percentage rates that borrowers will pay.
The Small Business Finance Association, an industry group, has criticized the specific mandate to disclose APRs and has
But Steve Denis, the group's executive director, did not express opposition to the new UDAAP rule and said the group's members "strongly support" the DFPI's efforts to go after "bad actors" they compete with.
The trade group has talked often with DFPI to get clarity on what the agency may view as wrongdoing, and it launched a certification program for its members' employees to understand UDAAP violations.
The agency's views on what constitutes a bad practice could someday change, Denis said. But the Small Business Finance Association believes that its members have a firm grasp on the issue after working with the DFPI, he said.
"We're pretty confident that they understand how to operate in a way that is consistent with what we believe the DFPI would think are good practices," Denis said. "So we're not too concerned about it."
