CFPB Deems Merchant Cash Advances to Be “Credit” Under ECOA

On March 30, 2023, the Consumer Financial Protection Bureau (CFPB) released its small business data collection and reporting rule (Rule). The Rule amends Regulation B to implement changes to the Equal Credit Opportunity Act (ECOA), pursuant to Section 1071 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Rule generally requires financial institutions that originate at least 100 small business credit transactions annually to collect and report loan application, origination, and pricing information, as well as certain applicant/borrower demographic information, in a “small business lending application register.” We summarized the Rule in a prior client alert. Here, we focus on the commentary in the Rule’s adopting release indicating the CFPB’s view that merchant cash advances are “credit” for purposes of ECOA. This view has implications not only for the Rule but also for the fair lending and adverse action compliance obligations of merchant cash advance providers more generally.

What Is a Merchant Cash Advance?

A merchant cash advance is a form of commercial financing that is typically structured as a sale to a provider by a merchant of the merchant’s future receipts (sometimes referred to as revenues or sales), in which a provider advances funds to a merchant in exchange for a share of the merchant’s future receipts until the advance, plus an additional amount, is paid to the provider. A properly structured merchant cash advance should not create an absolute obligation on the part of the merchant to repay the provider; rather, whether and when the provider is paid depends on the existence and amount of the merchant’s future receipts.

Why Does the CFPB Believe Merchant Cash Advances Are “Credit” Under ECOA?

Provisions of the Rule expressly apply to merchant cash advances, and the CFPB’s Official Interpretations accompanying the Rule state that, for purposes of the Rule, the term “covered credit transaction” includes merchant cash advances. The adopting release, however, goes beyond the Rule by including a discussion deeming merchant cash advances to be “credit” more generally for purposes of ECOA.

ECOA prohibits unlawful discrimination in credit transactions, and for such purposes the term “credit” is defined as “the right granted by a creditor to a debtor to defer payment of debt or to incur debts and defer its payment or to purchase property or services and defer payment therefor.” The Rule incorporates ECOA’s definition of “credit.” In its adopting release, the CFPB states its belief that the term “credit” encompasses merchant cash advances, such that they are “credit” for purposes of not only the Rule but also ECOA. Focusing on ECOA’s definition of “credit,” the CFPB contends that merchant cash advance providers advance funds to merchants and grant them the right to defer payment by allowing repayment over time, and that ECOA does not require consideration of factors such as the absence of recourse or analysis of who bears the risk of loss.

In the adopting release, the CFPB attempts to differentiate merchant cash advances from factoring transactions, which are expressly excluded from the term “credit” by the CFPB’s Official Interpretations. The CFPB asserts that in a factoring transaction, a merchant sells to a provider the merchant’s legal right to payment from a third party for goods supplied or services rendered, and that right to payment exists at the time of the financing transaction; while in a merchant cash advance transaction, the merchant has no existing rights to payment that the merchant can transfer to a provider because proceeds from the merchant’s future sales of goods and services do not exist at the time of the financing transaction. In this way, the CFPB rejects public comments favoring a different view. For example, trade associations representing the merchant cash advance industry submitted comment letters opposing the inclusion of merchant cash advances under the Rule. Their comments emphasize, among other things, what they describe as the “substantially contemporaneous exchange of value” between the merchant cash advance provider and the merchant, similar to factoring; and the CFPB’s inconsistent reasoning for the inclusion of merchant cash advances and the exclusion of factoring, leases, and trade credit.

The CFPB does not appear to be alone in its belief that merchant cash advances are “credit” under ECOA. During the rulemaking process, the state attorneys general of New York and New Jersey submitted a comment letter asserting the same view. Neither state’s financial regulatory agency, however, submitted such a comment.

How Will Merchant Cash Advance Providers Be Impacted by the CFPB’s Position?

The Rule’s adopting release suggests the CFPB will more generally subject providers to the broader compliance requirements under ECOA and Regulation B, such as the anti-discrimination and adverse action provisions. Vendors assisting merchant cash advance providers, such as those gathering applicant and customer data and/or tracking transaction details, should also be aware of and may be impacted by these requirements.

The CFPB’s position could also have a precedential effect on how merchant cash advances are characterized for purposes of other credit laws. Many merchant cash advance providers have argued that their products are not credit or loans (a subcategory of credit) under federal or state law. The CFPB’s express labeling of merchant cash advances as “credit” will mark a material deviation from providers’ historical positions and practices and could implicate credit laws outside of ECOA and state ECOA analogs. Fortunately for providers, lender licensing and usury laws in many states apply only to loans and not more generally to “credit.” While it is still too early to know how other regulators will react to the CFPB’s views, providers should be mindful of the CFPB’s position when designing and implementing merchant cash advance programs.

We Can Help

In addition to their data collection and reporting obligations under the Rule, merchant cash advance providers and their vendors should consider adopting, or reviewing their existing, adverse action policies and procedures and fair lending controls and monitoring processes in light of these developments. For specific evaluations and recommendations, or for additional information about any of the issues discussed in this client alert, please contact Alexander J. Callen, or Danielle Reyes.