Legal Update | California finalizes UDAAP rule for small business financing

On August 2, 2023, the California Department of Financial Protection and Innovation (DFPI) issued an order The final rule Certain persons are prohibited from engaging in unfair, deceptive, or abusive business or practices (UDAAP) in connection with offering or providing trade finance or other financial products or services to small businesses, nonprofits, or family farms. Notably, the final rule applies the standard of federal arbitrariness to small business financing and is part of the trend toward expanding consumer-style protections to small business financing. The final rule also sets out annual reporting requirements for some people who provide trade finance. DFPI issued this final rule under its rulemaking authority in the California Consumer Financial Protection Act (CCFPL), the law that created the so-called “Mini CFPB” in California.

UDAAP ban

The final rule adopts the general standards for injustice, deception, and abuse under federal law without prohibiting any specific conduct. With regard to the unfair and deceptive criteria, the rule also provides that the act or practice is unfair or deceptive according to the California Unfair Competition Act and California case law under that law. In comments accompanying the final rule, the DFPI said the rule “provides general guidance through longstanding standards familiar to the regulated community.”

The people and products covered by the new UDAAP rule are more limited than they seem at first. While the term “covered service provider” includes a person who offers or provides business financing or financial products or services to small businesses, nonprofit organizations, or family farms, the term excludes persons who are exempt from CCFPL, including but not limited to banks and credit unions. California Licensed Finance Lenders and California Licensed Brokers.

For the new UDAAP rule to apply under its terms, the recipient of the funding, product, or service must be a small business, nonprofit, or family farm whose activities are primarily directed or managed from California. The Investment Development Administration has adopted a fairly simple definition of a “small business,” which includes business entities organized for profit with no greater than $16 million in annual gross revenue or the annual gross revenue level as revised every two years under California law, whichever is greater. A covered service provider may rely on the company’s written representations regarding its total annual revenue and whether its activities are primarily directed or managed from California.

The types of products covered by the new UDAAP rule include “trade finance,” as defined in the California Trade Finance Disclosure Act and a group of financial products or services provided to small businesses, nonprofits, or family farms for use primarily for a purpose other than personal or family or household. As such, the rule applies to conventional loans as well as alternative trade finance products, such as factoring and revenue-based financing.

annual reporting requirements

The rule also establishes new annual reporting requirements that apply to a narrow group of covered service providers. Beginning in March 2025, a covered provider that provides trade finance must provide a verified report to DFPI that includes certain information regarding the covered provider and certain information regarding its trade finance transactions during the previous calendar year. “Trade Finance Transaction” means a completed Trade Finance Transaction for which disclosures have been made as required by the Trade Finance Disclosure Act.

Why is this new rule important?

California’s new UDAAP rule is notable in several respects. First, the rule prohibits abusive actions or practices in relation to financial products or services provided to small businesses. At the federal level, the FTC has enforced the prohibitions on unfair or deceptive business or practices (UDAP) under the FTC Act to small businesses. However, the FTC’s UDAP authority does not extend to abusive acts or practices. California’s new rule prohibits abuse. Other countries have alleged that small business finance providers have engaged in behavior that could be considered abusive. For example, earlier this year, the New Jersey State Attorney General announce nearly $28 million settlement with a revenue-based financing provider based on behavior the attorney general described as “unreasonable, deceptive, and abusive lending, service, and collection tactics.”

The new California rule is also notable because it adopts the abuse standard set forth in the federal Dodd-Frank Act that is primarily imposed by the Consumer Financial Protection Bureau (CFPB) and applies to consumer financial products or services. In April 2023, the CFPB issued a Policy statement which provides guidance on the abuse standard and outlines the standard. Since issuing the policy statement, the CFPB has identified and alleged abuse in its publication of supervisory points and in its enforcement actions. It remains to be seen how much influence the CFPB’s interpretations of the abuse standard in a consumer context will have on California’s interpretation of the same abuse standard in the context of small business finance.

Finally, as a large pro-consumer state, California tends to be the first mover in state regulation. Other states such as New York may follow suit and expand their state business practice laws in a similar fashion. Overall, California’s new rule is part of a growing trend to extend consumer-like protections to small business financing.

private discussion

In September, Susan Seaman will moderate a panel in time for the Business Law Division meeting of the American Bar Association on federal compliance risks and state compliance risks following the CFPB’s breach policy statement. Members of the Consumer Financial Protection Bureau and the Pennsylvania Attorney General’s Office will participate in the discussion. A new UDAAP rule in California will be part of the discussion.

call us

We regularly advise small business finance providers about the growing body of federal and state regulations that apply to them, including state commercial finance disclosure laws and the Section 1071 Small Business Data Collection Rule. If you have questions about the new UDAAP rule for California small businesses or For other small business financing regulations, contact us Christopher Friedman, Susan Seaman, Daniel WilkinsonOr your Husch Blackwell attorney.