Understanding the California Finance Lenders Law
Author: Catrine Brown
January, 2011 Issue
Who is—and isn't—bound by the California Finance Lenders Law…and why.
When tempted to make a loan to carry a business through to better times, it’s important to understand lending laws. For example, will the lender be subject to regulation as a finance lender in California? It very well may, particularly if the lender has made more than one loan during the last 12 months. This is true even if the lender is located outside of California, and even if the previous loans have been made to other businesses or even to its own employees. This is because California law seeks to regulate anyone engaged in the business of making loans through the California Finance Lenders Law (CFLL). This article will focus on the CFLL as it applies to commercial loans (loans not for personal, family or household purposes).
Certain exceptions and potential traps
Several entities aren’t required to be licensed under the CFLL, including banks and savings and loan associations, credit unions, mortgage lenders, licensed check cashers, licensed pawn brokers or those licensed under the deferred deposit transaction law. Notably absent from the list of exempt entities are hedge funds that make loans as part of their portfolio. As a result, a hedge fund that regularly makes loans may be subject to the CFLL.
There’s also no exemption for businesses making loans to their employees. The Department of Corporations has indicated that a business making loans to its employees may be considered to be a finance lender, subject to regulation, unless the loans are interest-free with no profit or gain by the employer.
Bridge loans made by venture capital companies to operating companies also aren’t exempt from the CFLL. The bridge loan, venture capital company and the operating company each have to meet the requirements detailed in the CFLL. To qualify for an exemption, the bridge loan cannot have a maturity that exceeds one year, even though bridge loans are often structured to mature after that 12-month timeframe. The bridge loan also must be made in connection with (or in contemplation of) an equity investment in the operating company.
A loan may be exempt from the CFLL if it’s secured by real property and either made or arranged by a licensed real estate broker. Since the licensed real estate broker can arrange the loan, the broker doesn’t need to be the lender or borrower for this exemption to apply, so long as the broker arranges the loan and is actively involved in the negotiation of the transaction. One advantage to being a licensed finance lender is that the license applies to the business as a whole and there’s no need to license individual employees, which is in contrast to the requirements of a real estate broker.
If a lender makes only one loan in any 12-month period, then the lender falls under the safe harbor of the CFLL. Anytime more than one loan is made, even if they’re different types of loans to different types of borrowers, then the safe harbor is lost and the lender may be subject to regulation under the CFLL. The safe harbor only applies to commercial loans.
Out-of-state lenders may be subject to the CFLL even if the loan documents are governed by another state’s laws. If the negotiation, credit investigation or repayment of the loan takes place in California or the loan is to a California borrower, then there’s a risk that the lender is subject to the CFLL. Borrowers cannot waive any provision of the CFLL.
Obtaining a California Finance Lenders License
If no exemption applies, then a lender will need to apply for a California Finance Lenders License, which can be a time-consuming administrative ordeal. The lender must prepare and submit an application form, provide financial statements, obtain a surety bond for $25,000 and have net worth of at least $25,000. The executive officers, board members, 10 percent shareholders and any persons responsible for the applicant’s lending activities must also provide fingerprints and complete a questionnaire. They may not have a criminal history or a history of noncompliance with governmental regulations.
Obligations of a California Finance Lender
Once licensed, a lender must maintain its books and records on any loan for three years after the last payment of the loan has been made, file an annual report to the Department of Corporations, pay an annual fee, maintain the $25,000 surety bond as well as maintain a net worth of at least $25,000. The license must be posted in a conspicuous location, and the lender has to notify the Department of Corporations of certain events such as a change of location, change of name or any change in the persons listed on the application.
Before circulating any advertisements, a licensed lender has to receive approval from the California Commissioner of Corporations. The advertisements may not be false, misleading or deceptive. The licensed lender then needs to maintain a file of any of its advertisements for at least 90 days.
Note that, to the extent a lender makes consumer or commercial loans of less than $5,000, much more stringent obligations apply under the CFLL.
One advantage to being licensed under the CFLL is that a licensed lender is exempt from the usury restrictions under the California constitution.
Violating the CFLL can result in penalties of $2,500 for each violation, imprisonment (for not more than one year)—or both—and willful violations can also be punished by a fine of $10,000 in addition to imprisonment (for not more than one year) or both.
Businesses often make commercial loans, whether to their employees or to other struggling businesses. Any time a business is considering making a loan, it should review the CFLL to see whether an exemption exists. If it’s a one-time loan, then the business can rely on the safe harbor of no more than one loan in a 12-month period. However, where the safe harbor and other exemptions don’t apply, then the business may need to apply for a license under the CFLL.
Catrine Galler Brown is an attorney with Howard Rice in San Francisco in the firm’s business department. She has experience representing lenders and borrowers in various financing transactions, including acquisition financing, conventional revolving and term loan credit facilities and public debt issuances. You can email her at firstname.lastname@example.org.
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