When A Purchase And Sale May Be A Loan

The California Financing Law requires that persons engaged in the business of making consumer loans or making commercial loans be licensed by the Department of Financial Protection and Innovation, unless exempt.  Cal. Fin. Code §§ 22009 & 22100.  Remarkably, however, the CFL does not define the term "loan" which is the very subject of the law.  What then is a "loan"?   The California Civil Code defines a "loan" as a contract pursuant to which "one delivers a sum of money to another, and the latter agrees to return at a future time a sum equivalent to that which he borrowed".   Cal. Civ. Code § 1912.

In many cases, there is no question that a transaction constitutes a loan.  Sometimes, however, the characterization of an arrangement of a loan may be less obvious.  Such was the case in an administrative proceeding settled last month by the DFPI.   The respondent, Allup Financial LLC,  purchased shares of future revenue “without recourse" from small businesses.   This meant that, if the small business’ revenue declines for reasons outside its control, Allup loses money on the deal and is not able to otherwise recoup the upfront money it provided from the general assets of the small business or the small business’ owners.  Without more, this arrangement would seem to involve a purchase, not a loan.  

The DFPI, however, took note of other provisions in Allup's agreements that make them look like loan transactions:

"In Allup’s Agreements, however, Allup has broad authority to declare 'default' on its merchants, and when doing so may use extensive recourse allowed under its Agreement.  For example, the Agreement states that when an ACH remittance to the merchant’s account is returned due to insufficient funds or fails for any reason whatsoever, the merchant will be charged the maximum non-sufficient funds fee permitted pursuant to applicable law per occurrence.  Furthermore, it states that the occurrence of three (3) or more events of insufficient funds shall constitute an event of default under the Agreement.  When an event of default occurs, Allup has the right under the Agreement to enter into the merchant’s business and seize all assets – without so much as notice to the merchant.  The Commissioner notes that if a merchant’s business slows, through no fault of the merchant, the regular monthly payment taken from the merchant’s ACH account under the Agreement may be more than the receivables earned by the merchant over that time period.  This may lead to an “insufficient funds” situation that triggers extra fees and potentially “default” under the Agreements.  Since Allup is claiming only to buy the receivables and not to be lending with recourse if unpaid, Allup’s Agreement that allows an event of default – and therefore full recourse until the funding amount has been repaid – for 'insufficient funds' for any reason whatsoever does not put the risk of the 'purchase' of receivables on Allup’s shoulders, but rather the risk of repayment on the merchant’s shoulders, just like a loan."

In settling with the DFPI, Allup agreed to cease lending in California until it is licensed under the CFL and to refund fees or payments collected from California-based customers that were in excess of usury limitation under the California Constitution, Article 15, section 1.