By Melissa Richards, Esq. and Michael Flynn, Esq.
Buchalter1

Misclassifying a consumer-purpose loan as a business-purpose loan can have serious risks and consequences. As is well known, business-purpose loans are exempt from the Truth in Lending Act (TILA2) and its implementing Regulation Z3. Misclassifying a consumer-purpose loan as a business-purpose loan (an issue which can arise with investment loans), resulting in an accompanying failure to comply with TILA can expose creditors to administrative, civil (actual damages, civil money penalties and attorney’s fees),
and criminal penalties, such as:

  •  Three years to rescind the transaction;
  •  A refund of finance charges; or
  •  A defense to foreclosure.

In an early case, the Ninth Circuit weighed in on this issue. Equally important, in a recent amicus brief filed with the Maine Supreme Court in Franklin Savings Bank v. Bordick,4 the CFPB addressed the issue of what investment loans should be considered business-purpose loans in relation to TILA and Reg Z. This article first discusses which loans are subject to TILA/Reg Z, and the business-purpose exemption to TILA/Reg Z. It then discusses the Ninth Circuit’s detailed analysis and the CFPB’s position on this issue as articulated in its amicus brief.

Which Loans Are Subject to TILA/Reg Z?

TILA/Reg Z applies when:

  •  Credit is offered or extended to consumers;
  •  The offering or extension of credit is done regularly;
  •  The credit is subject to a finance charge or is payable by a written agreement in more than four installments; and
  •  The credit is primarily for personal, family, or household purposes.5

The Business-Purpose Loan Exemption Special Rules for Investment Loans – the CFPB and the Ninth Circuit

One of the key exemptions to Reg Z coverage is business-purpose loan or extension of credit. TILA/Reg Z does not apply to credit
extended primarily for a business, commercial or agricultural purpose.6 This means that a creditor must determine in each case if the transaction is primarily for such an exempt purpose.7 8

Along with special rules for rental property loans9 and credit cards,10 the CFPB’s comments on Reg Z’s business-purpose credit exemption contains special rules for investment loans. In Reg Z Comment 3(a)-3, the CFPB identified five general factors to determine if a loan is a business-purpose loan:

A. The relationship of the borrower’s primary occupation to the acquisition. The more closely related, the more likely it is to be business purpose.

B. The degree to which the borrower will personally manage the acquisition. The more personal involvement there is, the more likely it is to be business purpose.

C. The ratio of income from the acquisition to the total income of the borrower. The higher the ratio, the more likely it is to
be business purpose.

D. The size of the transaction. The larger the transaction, the more likely it is to be business purpose.

E. The borrower’s statement of purpose for the loan.

The Ninth Circuit Decision

The Ninth Circuit gave a detailed analysis of the application of the factors set forth in the Reg Z commentary in Thorns v.
Sundance Properties, 726 F.2d 1417 (9th Cir.1984). In that case, the court considered whether there is a business-purpose
loan or a consumer-purpose loan when two individuals apply for a loan to invest in a limited partnership, formed to purchase an apartment building. The court reversed and remanded the trial court’s determination that the loan was not covered by TILA, stating that a factual analysis of the five factors had to be made, and accordingly did not itself determine whether or not the particular loan was covered by TILA.

The court first noted that “[p]urchase of a limited partnership interest for investment purposes, however, can be for a personal as opposed to a business or commercial purpose under the TILA.”11 The court went on to discuss the investment loan factors in Reg Z’s commentary.

The court stated that in determining whether credit to finance an acquisition (such as securities, antiques, or art) is primarily for a business or commercial purpose (as opposed to a consumer purpose), Reg Z’s commentary provides that creditors “should” consider the five factors discussed above. The Ninth Circuit stated:

Whether an investment loan is for a personal or a business purpose requires a case by case analysis … Thus, in some circumstances, a loan for the purpose of purchasing a limited partnership interest for investment may be covered by the TILA.12

The CFPB’s Recent Amicus Brief

Often we see a borrower-signed loan document that unambiguously states that the loan had a commercial purpose. Is that document a smoking gun? Such a document is being put to the test in a lawsuit, Franklin Savings Bank v. Bordick, before the Maine Supreme Court. In short, the creditor is relying on such a document to argue that the subject loan was a business-purpose loan exempt from TILA/Reg Z. The borrowers are trying to bring in extrinsic evidence showing that the loan, in fact, was for a consumer purpose. The CFPB filed an amicus brief in this case.13 As summarized in the CFPB’s brief, the trial court held that if the loan documents unambiguously state that the loan had a commercial purpose, the loan is not eligible for TILA’s protections and did not allow the borrowers to present extrinsic evidence to possibly prove otherwise. The CFPB also summarized its position, which was the following:

This holding is contrary to both the text of the statute and to authoritative guidance promulgated by the Bureau, both of which indicate that TILA coverage is determined by looking to the transaction as a whole and assessing the borrower’s primary purpose in entering into the transaction. That inquiry must elevate substance over form and is not limited to the language in the loan documents. If affirmed, the trial court’s holding would allow creditors to evade TILA merely by labeling the loan “commercial.”

Conclusion

The CFPB’s amicus brief shows that it views the rule and its commentary as indicating that the consumer’s statement of the purpose of the loan is just one of the five investment loan factors creditors must consider and is not by itself not dispositive of the issue. The Ninth Circuit decision supports this perspective. Thus, in making an investment loan, a creditor should conduct careful analysis to be sure it is classifying the loan properly so that it can determine the proper course of action in regard to making initial TILA disclosures, following TILA requirements and restrictions, and in the event that it has to send a demand letter, file a notice of default, or take other action that could implicate TILA requirements.

Endnotes:

  1. No statement in this communication constitutes legal advice nor should any communication herein be construed, relied upon, or interpreted as legal advice. This communication is for general information purposes only regarding recent legal developments of interest and is not a substitute for legal counsel on any subject matter. No reader should act or refrain from acting on the basis of any information included herein without seeking appropriate legal advice on the particular facts and circumstances affecting that reader. For more information, visit www.buchalter.com.
  2. 15 U.S.C. § 1601 et seq.
  3. 12 C.F.R. Part 1026.
  4. Cfpb_franklin-savings-bank-v-bordick_amicus_2023-07.pdf
  5. 12 C.F.R. 1026.1(c)(1).
  6. 12 C.F.R. 1026.3(a)(1).
  7. Reg Z Comment 3(a)-1.
  8. Reg Z’s commentary states that if a creditor is uncertain about whether a loan is in fact a business-purpose loan, the creditor may choose to make the TILA disclosures, and the fact that disclosures are made under such circumstances is not controlling on the question of whether the transaction was exempt. Id.
  9. Reg Z Comments 3(a)-4, 5.
  10. Reg Z Comment 3(a)-2.
  11. 726 F.2nd at 1418-1419.
  12. Id. at 1419.
  13. The brief is available at: https://www.consumerfinance.gov/compliance/amicus/briefs/franklin-savings-bank-v- bordick/

Michael Flynn is Co-Chair of Buchalter’s Financial Services Regulatory Group, and its Consumer Financial Services and Mortgage Regulatory Industry Group. Mr. Flynn applies his unique background as the former Acting General Counsel of HUD, and the former General Counsel of PNC Mortgage and Flagstar Bank, to counsel clients on a variety of regulatory, mortgage, consumer financial services, FinTech and real estate matters. His full bio is available at: https://www.buchalter.com/attorneys/michael-c-flynn/#bio.

Melissa Richards, CMB has a national practice specializing in federal and multistate compliance, licensing and enterprise risk management for the financial services industry. Her clients are engaged in residential and commercial mortgage, fintech, licensed non-depository and depository institution consumer and commercial lending, either directly or in supporting vendor roles. Ms. Richards has both outside counsel experience as well as general counsel experience serving as Chief Legal & Risk Officer for a mid-size independent mortgage company ranked as one of Scotsman Guide’s Top 15 Mortgage Lenders in 2018-2019. She can be reached at 415.227.3543 and MRichards@buchalter.com. Her full bio is available at: https://www.buchalter.com/attorneys/melissa-richards/#bio.