California Regulator reiterates that credit score gross sales can’t be used to evade financing legislation | Morrison & Foerster LLP


In two latest actions, the California Division of Enterprise Supervision (DBO) addressed whether or not companies that buy retail installment contracts needs to be thought-about bona fide consumers of credit score gross sales or whether or not these transactions needs to be thought-about installment loans topic to the California Financing Regulation. (CFL). In doing so, the DBO reiterates current jurisprudence and establishes the components that the DBO will contemplate in figuring out whether or not a purchase order of an installment settlement needs to be re-characterized as a mortgage. Firms that aren’t engaged within the buy of retail installment contracts ought to nonetheless be thinking about these actions as a result of, in its evaluation, the DBO acknowledged that the CFL doesn’t outline the time period “mortgage” and as an alternative resorted to the definition of the time period “mortgage”. Civil Code of a “mortgage of cash.”

“Mortgage” versus “Sale on credit score”

The CFL requires the license of all monetary lenders, which “contains anybody who’s within the enterprise of constructing client loans or making business loans.”[1] Underneath frequent legislation, bona fide credit score gross sales (that’s, gross sales of merchandise of products in alternate for a buyer’s promise to pay later) aren’t loans and aren’t topic to California mortgage legal guidelines, together with usury legal guidelines and CFLs. Moreover, the CFL expressly states that it “doesn’t apply to bona fide conditional gross sales contracts involving the disposition of non-public property.”[2]

In a opinion letter Issued December 30, 2019, the DBO addressed whether or not an unidentified applicant’s deferred fee merchandise had been CFL-regulated “loans.” Citing earlier jurisprudence on this topic,[3] The DBO said that, when contemplating substance over kind, the next components taken collectively are indicative {that a} transaction is a “mortgage” and never a “sale”:

1. The events supposed the settlement to be a mortgage and handled the transaction as a mortgage;

2. The service provider and the third celebration offering the financing are intently associated and have a pre-existing relationship;

3. The third celebration assumes the project of the contract concurrently its execution or instantly after;

4. The third celebration underwrites the transaction in a fashion much like underwriting a mortgage; Y

5. The transaction wouldn’t be regulated by one other legislation.

After analyzing these components, the DBO concluded that the company’s transactions had been loans that had been topic to the CFL as a result of the events handled the transactions as loans; the corporate had contracts in place to buy the retailers’ installment mortgage contracts earlier than the client contemplated the transaction: the corporate assumed the contracts at a reduction on the identical time they had been executed with out notifying clients of the low cost; the corporate participated within the underwriting to find out if clients had been eligible for financing; and the corporate argued that it was not topic to another regulatory scheme.

Additionally on December 30, 2019, the DBO denied a CFL license utility from a fintech firm (“Firm”), based mostly on the DBO’s dedication that the Firm had violated the CFL by making loans with no license.

In its Downside assertion In stating its rationale for denying the Firm’s license utility, the DBO reaffirmed that, beneath frequent legislation and statute, good religion credit score gross sales aren’t loans and aren’t topic to California mortgage legal guidelines, together with CFL. The DBO examined the substance of the Firm’s credit score sale transactions, somewhat than the shape, and took the place that the transactions weren’t bona fide credit score gross sales, however loans disguised in a try and evade the CFL.

The DBO acknowledged that the project of a sale on credit score to a 3rd celebration doesn’t in itself require a requalification of the transaction as a mortgage; nonetheless, intensive third celebration involvement could qualify transactions as loans. In making its dedication, the DBO’s conclusion centered on the truth that (1) the Firm’s involvement with retailers was extra intensive than essential to impact the acquisition of gross sales on credit score, together with offering retailers with advertising and marketing, processing fee, client dispute decision, and interest-bearing accounts; (2) the Firm’s agreements with retailers describe the product as a supplier of credit score to shoppers, not as a gross sales buy on credit score; (3) the position of the Firm and the phrases of the transaction weren’t totally disclosed to shoppers; and (4) the Firm didn’t assume the total danger of loss for client efficiency beneath the credit score gross sales it bought.

The requalification of a sale on credit score as a mortgage topic to the CFL will not be a brand new improvement, and the rules on which the DBO relied on these two actions aren’t new. Nonetheless, these actions function a reminder that the DBO will take motion in opposition to corporations in search of to evade the CFL and can contemplate the substance of a transaction, somewhat than the shape, when figuring out whether or not a transaction is a CFL mortgage.

Definition of “mortgage” for CFL functions

As famous above, the CFL doesn’t embrace a definition for the time period “mortgage”, however within the authorized opinion issued on December 30, the DBO concluded that the definition of “cash mortgage” discovered within the Code needs to be used. Civil § 1912 within the definition of the time period “mortgage” for the needs of the CFL. This statute defines a “cash mortgage” within the sense of “a contract by which one provides a sum of cash to a different, and the latter agrees to repay sooner or later an quantity equal to that which he borrowed.”[4]

In response to Civil Code § 1912, a “cash mortgage” is distinguished from a “mortgage of use”, which is outlined in Civil Code § 1884 as “a contract by which one provides one other short-term possession and use of non-public property, and the latter agrees to return the identical factor sooner or later, with out reward for its use.[5]

The DBO’s incorporation of the Civil Code definition into the definition of a “mortgage” for CFL functions might be utilized by the DBO to broaden the scope of the CFL in sudden methods. Nonetheless, at the moment it’s not clear how far the BOD will go to broaden the CFL’s protection.


[1] California. Fin. Code § 22009.

[2] California. Fin. Code § 22054.

[3] California courts have struggled for a few years with the query of whether or not the client of credit score gross sales paper is the “actual lender.” Equally, California courts have wrestled with the query of whether or not a third-party mortgage to finance the acquisition of products or providers from a service provider needs to be handled as a “retail installment sale” that’s topic to the retail gross sales act to California deadlines, the Unruh. Act. See Cal. Civ. §§ 1801, 1801.6 and 64 Ops. California. Atty. 722 (Opinion No. 81-401, September 22, 1981). A dialogue of this jurisprudence is past the scope of this buyer alert.

[4] California. Civ. Code § 1912.

[5] California. Civ. Code § 1884.

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