FinTech companies continue to revolutionize the way financial services companies provide credit and market their products. These new technology-driven models provide a low barrier to entry for startup non-bank financial services companies, but there is a catch: even where you may view your business as a software provider, online marketing platform, or other non-lending model, state regulators may see it otherwise. Many state regulators take the view that non-bank FinTech companies must comply with laws regulating loan origination or brokerage and, thus, subject them to licensure, compliance, and examination requirements. Unfortunately, this view likely means that many non-bank financial services FinTech companies may need to obtain dozens of state licenses to offer services nationwide.
Given the size of the state's market and the breadth of activities it covers, the California Finance Lender (CFL) license can be an absolute necessity for any financial services business. However, determining whether your business is subject to CFL licensing can be difficult, especially given the statute's tautological construction and confusing application to certain business models, particularly marketing and lead generation. Further, the licensing application and approval process can be cumbersome and take months or longer, potentially stalling your next innovation or funding ability. This article provides a refresher on the scope of the license and its application to lenders, brokers, lead generators, and mortgage companies.
Scope: What Businesses Does the CFL Cover?
The CFL law starts from the basic statement that the license is required to engage "in the business of a finance lender or broker." From there, it stretches outward to encompass a wide variety of activities in connection with lending, brokering, lead generation, and mortgage activities for both consumer and commercial loans. According to California's Department of Business Oversight (DBO), CFL licensees are the largest group of financial service providers that it regulates.
Usually a discussion of exemptions comes at the end; however, the CFL law is so broad that it is helpful to note entities that are exempt from its coverage as a precursor to discussing the substance of the law. "Exempt Entities" include, but are not limited to, the following:
- Banks, trust companies, savings and loan associations, credit unions, and certain other regulated financial institutions;
- Colleges and universities when making student loans (i.e., to permit "a person to pursue a program or course of study leading to a degree or certificate");
- Broker-dealers; and
- Any company that makes, in a 12-month period, (1) five or fewer commercial loans if the loans are incidental to the company's business; or (2) no more than one commercial loan.
A "finance lender" is any company engaged in the business of making consumer loans or commercial loans—so if you are extending any type of credit to California residents, you may be covered (some exemptions apply).
A "consumer loan" is any loan of less than $5,000 and any loan where the proceeds are intended for use primarily for personal, family, or household purposes.
A "commercial loan" is any loan of $5,000 or more that is not primarily for personal, family, or household purposes. The CFL law imposes certain requirements on interest, fees, and other terms and conditions for consumer loans, while generally providing greater flexibility for commercial loans.
A "broker" includes any company engaged in the business of "negotiating" or "performing any act as broker" in connection with "loans made by a finance lender." In addition, the CFL law prohibits a CFL licensee from compensating an unlicensed company for accepting loan applications or soliciting loans on the licensee's behalf.
In 2016, the DBO provided additional guidance on what constitutes "broker" activities that trigger the license requirement. According to the DBO these include the following:
|Category||Activities in Connection with Loans Made by a CFL Licensee|
|Always "broker" activity||
|May be "broker" activity, depending on facts and circumstances||
Note that the CFL statutory language indicates that it only applies to brokering loans for a company that is or should be a licensee. Based on this language, a CFL license is likely not required to broker loans to a bank or other Exempt Entity. However, see the Mortgages section below for certain licensing issues specific to credit secured by real property.
Online Marketplaces and Lead Generators
One of the most challenging aspects of the CFL is how it relates to online marketplaces, lead generation platforms, or other, similar businesses that do not appear to be "broker" businesses. Conventional wisdom and common sense may tell you that your business is not a brokerage, but remember that the statute's triggering activity is to negotiate or "engage in the business of a broker." In other words, the state believes you are required to get a broker's license if the state thinks you are a broker. This gives the state quite a bit of flexibility to interpret the statute's scope broadly.
Even though lead generators are not traditionally considered "brokers," these businesses may perform some of the activities for which a CFL license is required. Further, a CFL licensee cannot compensate an unlicensed third party for accepting applications or soliciting loans. Thus, a lead generator may need to be licensed to get paid for leads of California residents provided to a licensee. For commercial loans only, the CFL law provides a limited exemption and certain conditions that permit a CFL licensee to compensate an unlicensed third party for referring a borrower. Among these, the unlicensed party many not perform any of the activities listed above, including those that are not "broker" activity.
While the broker provisions of the CFL law apply to loans made by CFL licensees, an argument can be made that a CFL license is not required to generate leads for (non-mortgage) loans made by Exempt Entities. However, this argument does contain some regulatory risk, as it is fact-specific.
To date, efforts have been made to pass legislation clarifying how lead generators and other marketing services providers fit within the CFL framework. In 2017, a bill was introduced in the California legislature that would have clarified the difference between brokers that are required to hold a CFL license and lead generators that would only require a registration filing. To date, that bill has not passed, and lead generators, depending on their activities, may still be subject to broker licensing requirements.
Under California law, a license issued pursuant to the Real Estate Broker (REB) law generally provides authority for the broadest range of mortgage-related activities, including origination, brokering, and servicing. However, many companies have chosen to obtain a CFL license instead. The CFL law allows mortgage-related companies to conduct other non-mortgage credit operations, avoids the need for multiple licenses, and is available to limited liability companies (the REB law does not permit limited liability companies to obtain a license). FinTech companies choosing the CFL route should be aware, though, that the CFL law places important limitations on a licensee's mortgage activities.
For example, a CFL licensee is only authorized to broker mortgage loans to other CFL licensees. Because the REB license is the default authority for mortgage broker activities, a CFL licensee that wants to broker mortgages to entities exempt from the CFL law (e.g., banks) may be required to also obtain an REB license. The same is true for lead generation activities; if a license is required, the CFL license is sufficient for non-mortgage loans, but an REB license may be required to solicit mortgages for banks and other entities exempt from the CFL law.
These are only a few of the intricacies of the California licensing laws as related to mortgage activities. We highly recommend a careful review before engaging in regulated activities or applying for licenses, to avoid both unlicensed activity and duplicative licensing.