In two recent actions, the California Department of Business Oversight (DBO) addressed whether companies that purchase retail installment contracts should be considered bona fide purchasers of credit sales or whether those transactions should be considered loans subject to the California Financing Law (CFL). In doing so, the DBO reiterates existing case law and sets forth the factors that the DBO will consider when determining whether a purchase of a retail installment contract should be recharacterized as a loan. Companies not engaged in purchasing of retail installment contracts still should be interested in these actions because, in its analysis, the DBO acknowledged that the CFL does not define the term “loan,” and instead looked to the Civil Code definition of a “loan of money.”
“Loan” Versus “Credit Sale”
The CFL requires licensure of all finance lenders, which “includes any person who is engaged in the business of making consumer loans or making commercial loans.” Under the common law, bona fide credit sales (i.e., merchants’ sales of goods in exchange for a customer’s promise to pay later) are not loans and are not subject to California lending laws, including usury laws and the CFL. In addition, the CFL expressly provides that it “does not apply to bona fide conditional contracts of sale involving the disposition of personal property.”
In an opinion letter issued on December 30, 2019, the DBO addressed whether an unnamed requestor’s deferred payment products were “loans” regulated by the CFL. Citing prior case law addressing this issue, the DBO stated that, when looking at substance over form, the following factors taken as a whole are indicative that a transaction is a “loan” and not a “sale”:
1. The parties intended the arrangement to be a loan and treat the transaction like a loan;
2. The merchant and the third party that is providing financing are closely related and have a preexisting relationship;
3. The third party takes assignment of the contract contemporaneously with its execution or immediately thereafter;
4. The third party underwrites the transaction in a manner similar to underwriting a loan; and
5. The transaction would not be regulated under another law.
After analyzing these factors, the DBO concluded that the unnamed entity’s transactions were loans that were subject to the CFL because the parties treated the transactions like loans; the company had contracts in place to purchase the installment loan contracts from merchants before the customer contemplated the transaction: the company assumed the contracts at a discount contemporaneously with their execution without notifying customers of the discount; the company engaged in underwriting to determine whether the customers were eligible for funding; and the company argued that it was not subject to any other regulatory scheme.
Also on December 30, 2019, the DBO denied the CFL license application of a fintech company (“Company”), based on the DBO’s determination that the Company had violated the CFL by making loans without a license.
In its Statement of Issues setting forth its rationale for denying the Company’s license application, the DBO reaffirmed that, under the common law and by statute, bona fide credit sales are not loans and are not subject to California lending laws, including the CFL. The DBO looked to the substance of the Company’s purchasing of credit sale transactions, rather than the form, and took the position that the transactions were not bona fide credit sales, but rather were disguised loans in an attempt to evade the CFL.
The DBO acknowledged that the assignment of a credit sale to a third party does not in and of itself require recharacterization of the transaction as a loan; however, extensive third-party involvement may cause transactions to be deemed loans. In making its determination, the DBO’s conclusion centered on the fact that (1) the Company’s involvement with merchants was more extensive than was necessary to effectuate the purchase of credit sales, including by providing merchants with marketing, payment processing, consumer dispute resolution, and interest-bearing accounts; (2) the Company’s agreements with merchants describe the product as providing credit to consumers, not as purchasing credit sales; (3) the role of the Company and the terms of the transaction were not fully disclosed to consumers; and (4) the Company did not bear the full risk of loss from consumer performance under the credit sales it purchased.
The recharacterization of a credit sale as a loan subject to the CFL is not a new development, and the principles that the DBO relied on in these two actions are not new. However, these actions serve as a reminder that the DBO will bring actions against companies seeking to evade the CFL and will look to the substance of a transaction, rather than the form, when determining whether a transaction is a loan subject to the CFL.
On January 16, 2020 the DBO entered into a consent order with the Company to resolve the DBO’s denial action. The consent order requires the Company to pay a $28,200 penalty and refund the $282,000 in fees that it has collected from California residents in connection with the transactions. In exchange, the DBO agrees to withdraw its denial of the Company’s CFL license application, which the DBO will continue to review.
Defining “Loan” for Purposes of the CFL
As noted above, the CFL does not include a definition for the term “loan,” but in the legal opinion issued on December 30, the DBO concluded that the definition of a “loan of money” found in Civil Code § 1912 should be used in defining the term “loan” for purposes of the CFL. That statute defines a “loan of money” to mean “a contract by 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.”
Under Civil Code § 1912, a “loan of money” is distinguished from a “loan of use,” which is defined in Civil Code § 1884 as “a contract by which one gives to another the temporary possession and use of personal property, and the latter agrees to return the same thing to him at a future time, without reward for its use.”
The DBO’s incorporation of the Civil Code definition in defining a “loan” for purposes of the CFL could be used by the DBO to expand the scope of the CFL in unexpected ways. It is unclear at this time, however, just how far the DBO will go in broadening the coverage of the CFL.
 Cal. Fin. Code § 22009.
 Cal. Fin. Code § 22054.
 The California courts have struggled for many years with the question of whether the purchaser of credit sale paper is the “true lender.” Similarly, the California courts have struggled with the question of whether a third-party loan to finance the purchase of goods or services from a merchant should be treated as a “retail installment sale” that is subject to California’s retail installment sales act, the Unruh Act. See Cal. Civ. Code §§ 1801, 1801.6, and 64 Ops. Cal. Atty. Gen. 722 (Opinion No. 81-401, Sept. 22, 1981). A discussion of this case law is beyond the scope of this client alert.
 Cal. Civ. Code § 1912.
 Cal. Civ. Code § 1884.