Banking and Financial Services Update

California Department of Business Oversight December 2019 Actions

January 10, 2020

The California Department of Business Oversight (CDBO) recently concluded that the point of sale consumer financing programs offered by Sezzle, Inc., and another, unnamed party constituted making loans for purposes of the California Financing Law (CFL). A number of payment providers and technology companies have been developing innovative payment options, including consumer financing options, that are facilitated by advances in technology and mobile connectivity. Some market participants have structured their products such that a license should generally not be required under state law. The CDBO’s actions, however, may require companies to revisit that analysis and consider their licensing obligations.

Background. How consumers choose to pay for retail products continues to rapidly evolve with changing technology. This expansion of payment options through the use of technology has found its way to point of sale installment payment plans.

One type of offering allows consumers to split a payment into four or fewer installment payments with no interest charges — a structure that falls outside of disclosure obligations under the Truth in Lending Act and many state laws. The programs may also be structured as credit sales initially made by a merchant and then sold to a finance company rather than as direct loans to a consumer. This “retail installment sale” structure generally results in fewer state licensing obligations. The CDBO’s recent actions concern this type of structure.

CDBO Decisions. On December 30, 2019, the CDBO denied a CFL application made by Sezzle, Inc. Sezzle’s business model, according to the CDBO’s statement denying the application (the Statement), is that Sezzle “purchases credit sale contracts from merchants who sell goods to consumers.” However, the CDBO found that Sezzle was instead making loans. Because Sezzle had already engaged in this business without a license when a license was required, the CDBO denied the application.

In the second action taken the same day, the CDBO published a legal opinion to another, unnamed entity that its deferred payment products also constituted loans regulated under the CFL (the Opinion).

In each action above, the CDBO considered whether the transactions at issue were loans subject to regulation under the CFL or should be considered as retail installment sales. In California, retail installment sales are governed by the Unruh Act, but transactions involving four or fewer installments and no interest charges are exempt from the Unruh Act (just as they are exempt from the Truth in Lending Act). The CDBO identified the following (nonexclusive) factors (taking the Statement and Opinion together) that it used to assess whether a structure constituted a loan:

How involved or closely related is the third party to the merchant?
Does the consumer receive disclosures explaining the role of the third party and the terms of the transaction?
Do the parties intend the transaction to be a loan?
Does the third party provide the contract to the consumer and evaluate the consumer’s creditworthiness?
Does the third party assume the contract contemporaneously with the completion of the transaction (at the point of sale) or at a later time?
Does the third party take the full risk of consumer performance under the credit sale?
Is the financing product otherwise regulated under another statutory scheme?

In both cases, the CDBO found that the financing products being offered were loans as defined under the CFL.

In the Sezzle order, the CDBO noted that consumers establish an account directly with Sezzle in advance of any purchase or visit to a merchant website and that Sezzle’s agreement with the consumer described terms between Sezzle and the consumer for financing provided by Sezzle. The CDBO further indicated that there were at least eight other parts of the Sezzle consumer agreement that refer to Sezzle’s providing direct financing.

Next Steps. The CDBO’s actions raise concerns at several levels. First, developers of innovative payment products will need to consider whether their products are at risk of falling within the scope of the CFL and potentially other states’ lending laws. Second, parties relying on retail installment transactions in other contexts may need to consider whether the approach taken by the CDBO in these actions could affect the characterization of those transactions. Third, the actions reinforce the need for new entrants in the highly regulated consumer financial services space to consider applicable licensing and other requirements.

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