On November 12, 2020, the California Department of Financial Protection and Innovation (DFPI) (until recently called the Department of Business Oversight) entered into a consent order with Allup Finance LLC (Allup) finding that Allup’s merchant cash advance (MCA) product was a disguised usurious loan offered without obtaining a license under California’s “catchall” lender licensing law, the California Financing Law (CFL). The order requires Allup to cease lending in California until properly licensed under the CFL and to refund “fees or payments collected from California-based customers . . . that were in excess of the 10 percent usurious cap under the California Constitution . . . .”
What Happened
As we have warned, most recently here, DFPI has been investigating certain MCA providers for possible violations of California’s licensing and usury laws, with particular focus on transactions calling for remittance of future receivables through fixed daily ACH debits without meaningful “true-ups.” This consent order sheds considerable light on DFPI’s thinking, including setting forth its understanding of the law in recitals.
According to the order, Allup’s MCA agreements provide that Allup is purchasing the merchant’s future receivables “in exchange for the expected equivalent amount of cash up front, plus fees and interest,” on a nonrecourse basis. Remittances are made by fixed ACH debits, and returned ACHs trigger nonsufficient funds (NSF) fees. If a merchant incurs three or more NSF fees, this constitutes an event of “default,” permitting the exercise of extensive remedies including “enter[ing] into the merchant’s business and seiz[ing] all assets—without so much as notice to the merchant.”
DFPI acknowledges in the order that a purchase of outstanding (but not future) receivables without recourse generally “is not lending and is not subject to the state’s general lending law, the CFL,” provided that the purchaser of the receivables bears the risk of loss, citing West Pico Furniture Co. v. Pac. Fin. Loans, 2 Cal. 3d 594, 601-06 (1970). However, Allup’s NSF-fee default trigger, according to DFPI, effectively places the risk of loss on the merchant, “just like a loan,” particularly because NSF fees are charged when an ACH is returned “for any reason.” Furthermore, DFPI concluded that the agreement’s “indefinite repayment period” also makes the transaction a loan because it “places the risk of repayment on the merchant by leaving the repayment period open until fully repaid (with fees and interest).”
Although it is somewhat difficult to evaluate this consent order without seeing Allup’s agreement (which we assume does not use the word “interest” as suggested by the order), we find the order troubling in several respects. First, it draws a distinction between “outstanding” and “future” receivables in discussing what is and is not a loan, possibly suggesting that DFPI does not believe that cases such as West Pico apply to sales of future receivables. Virtually all MCA agreements address only future receivables, so MCA providers should not be comforted by this “concession.” Second, the suggestion that MCAs must have a term to avoid being characterized as a loan is legally incorrect. We are aware of very few MCA agreements that have a term or deadline for remittances, so DFPI potentially could pursue any MCA company under this novel theory. Finally, it is difficult to imagine how the company will be able to make the refunds called for by the order, since MCAs have no term and no interest rate. The order does not specify what assumptions should be used to calculate the refunds.
Why It Matters
Yes, DFPI really is conducting an aggressive enforcement campaign against MCAs in California. Although few providers have been subpoenaed to date, this consent order should be a wake-up call, particularly for companies using the ACH model. It is imperative for MCA providers to be revisiting not only their contracts and deal structures but also compliance with true sale principles in marketing and collections. If you need assistance, please contact any of the authors or the Manatt professional with whom you work.