Of interest to the consumer finance industry, the California Department for Business Oversight (the “DBO”) recently took two actions related to point-of-sale, deferred payment products. In the first action, the DBO denied a license under the California Financing Law (“CFL”) to Sezzle, Inc. based upon its prior unlicensed activity. Sezzle had been partnering with merchants to offer an interest free, short-term installment contract. DBO concluded, however, that Sezzle’s activity constituted a loan under the CFL. In a second action, the DBO issued a legal opinion to a separate FinTech company, stating that the company’s point-of-sale products are loans and must be offered in California pursuant to a CFL license.  These two decisions have obvious implications for companies operating in the deferred payment space. They also suggest that DBO will look for creative ways to extend the scope of its authority under CFL.
Sezzle, Inc. License Denial
Sezzle is one of many companies that has introduced a short-term installment product to support retail purchases. Like others in the space, Sezzle has targeted younger consumers, a segment of the market that currently has few traditional credit options, by offering the service to retailers who sell goods and services to younger buyers. In some ways, the product operates like a slightly updated charge card. Sezzle signs merchants who want to offer consumers the ability to extend the payment period for a purchase. The merchant agrees to accept the transactions at a discount to face value by paying a merchant discount, and Sezzle effectively provides the financing, buying from the merchant the consumer’s promise to pay. If the consumer pays the installments on time, the service costs the consumer nothing. If the consumer is late, or misses a payment, the consumer will be assessed certain fees.
Sezzle had a reasonably straight forward argument for why it did not need a license to operate such a program, claiming that credit sale contracts offered by merchants to their customers are not loans under the CFL, as such transactions are explicitly exempt from the CFL, though they are otherwise subject to California’s consumer protection laws. The exemption is, however, limited, and California law only excepts bona fide credit sales from its lending laws, where such “sales agreements…[are] not used for the purpose of evading the CFL.” 
In reviewing Sezzle’s CFL application, DBO confronted the question of whether Sezzle’s existing credit sale activity was bona fide and concluded that the company’s activities were not in fact bona fide. As the decision explains, DBO reached this conclusion on two somewhat parallel paths. DBO first analyzed the activity and Sezzle’s user agreement. On the basis of those facts, DBO concluded that the credit sales made by Sezzle’s merchant partners were not bona fide. Second, DBO extracted three principles from cases that have evaluated credit sale activity, and, applying those factors, concluded that the transactions were in substance loans, rather than credit sales.
In examining Sezzle’s activity, DBO’s decision highlights a number of facts in support of the conclusion that Sezzle was engaged in lending. The decision notes that Sezzle’s User Agreement and Merchant Agreement describe Sezzle as “providing credit to consumers, rather than purchasing credit sales contracts from merchants.” The decision further observes that Sezzle inverted the traditional credit financing model. Traditionally, a credit sale involves a merchant entering into a credit sale contract with a consumer and then selling the merchant-consumer contract to a financing entity. In the Sezzle program, Sezzle markets its financing products to consumers before the consumers decided to shop at a particular merchant or purchase a particular product.
The decision also notes that Sezzle permitted consumers to establish a Sezzle account in advance of a purchase or even visit to a merchant website, and that the account opening process authorized Sezzle to make credit inquiries to a consumer’s credit history. The decision found further support for the conclusion that Sezzle, not the merchant, was providing financing in the Sezzle User agreement. The decision identifies eight instances in which the agreement informs the consumer that “Sezzle has extended you credit and the right to defer payment for the goods and/or services you have purchased.” In the DBO’s view, these facts indicated that Sezzle was engaged in lending, which requires a license under the CFL.
The decision also identified three principles that it claims demark the line between a credit sale and a loan:
- First, a transaction may be considered a loan, if a third-party’s involvement with the merchant goes beyond that necessary to effectuate the purchase of credit sales, i.e., the finance company becomes an integral part of the merchant’s financing program.
- Second, a transaction may be considered a loan, if the role of the third party and the terms of the transaction, are not fully disclosed to the consumer.
- Third, a transaction may be considered a loan, if the third party does not bear the full risk of consumer performance under the credit sale.
Applying these principles to Sezzle, the DBO concluded that Sezzle was engaged in lending activity. The decision notes Sezzle’s “extensive involvement” with merchants. The decision observes that beyond purchasing the credit sales, Sezzle provides merchants with marketing services, payment processing services, consumer dispute resolution services and interest-bearing accounts for merchants to hold revenue from Sezzle.
The decision also claims that Sezzle did not fully inform users of its role in the transaction. In particular, the decision points out that the User Agreement reserves to Sezzle, not the merchant, the right to unilaterally impose new fees on consumers subsequent to execution of the User Agreement.
The decision also finds that Sezzle does not bear the full risk of loss from performance on the credit sales contracts it purchases. Under its Merchant Agreement, Sezzle can shift risk to the merchant after the purchase of the credit sale by delaying when Sezzle provides a merchant with the funds associated with a consumer’s decision to pay with the Sezzle service. According to the decision, Sezzle’s merchant agreement gave it the right to extend the time at which funds would be made available to a merchant from a usual period of one to seven days after shipment to as many as forty-two days.
Legal Opinion Addressing Deferred Payment Products
Shortly before denying Sezzle’s request for CFL license, DBO handed down a separate advisory opinion to a different, unnamed Fintech company related to its point-of-sale product. The opinion notes that the CFL does not define the term “loan” and to define the term, the opinion looks to a general definition in the California Civil Code. That definition defines a loan “as 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 they borrowed.” Like the later Sezzle decision, the opinion to the unidentified requestor (the “Requestor”) also concludes that what looks like a credit sale is, in fact, a loan.
In reaching that conclusion, the opinion implements a multi-factor test for determining whether a transaction constitutes a loan. The opinion identifies five factors for determining whether a transaction is a loan and makes clear that no factor is determinative:
- The intent of the parties, i.e., whether consumer, merchant, and third-party financer treat the transactions like loans, despite contradictory language in the applicable contracts;
- Whether the merchant and third-party financer are closely related, and thus, the third party may be viewed as extending a loan on behalf of the merchant;
- Whether the third party assumes the contract at the point of sale or later. Where a third party purchases a credit sale at a discount; the amount of the discount effectively represents a finance charge;
- Whether the third party evaluates the credit-worthiness of the customer; and
- Whether the financing transaction is not otherwise regulated.
In applying this analysis to the requester, the decision finds that the Requestor’s deferred payment products have the indicia of loan. Specifically:
- The Requestor and the Requestor’s customer treat the Requestor’s products like loans.
- Customers must apply for funds from Requestor; customers must agree to Requestor’s terms of service, and the Requester is responsible for all credit decisions, financing, administration and customer services with regards to the deferred payment products.
- The Requestor and merchants have contracts in place even before the customer has contemplated the purchase. This close relationship, explained the DBO, is indicative of a loan rather than a credit sale.
- The Requestor has a relationship with merchants and assumes their customer contracts contemporaneously with their execution, without notifying customers of the terms of such sale. Importantly, the DBO noted Boerner v. Colwell Company, a case in which a financer was found to purchase credit sales (not loans) despite the contemporaneous nature of the merchant-customer transaction and the merchant-financer credit sale. Although, the DBO claimed to distinguish Boerner from the facts at hand, it did not provide any substantive reasons for treating the Requestor’s deferred payment products differently from those at issue in Boerner.
- The Requestor underwrites customers in the manner of underwriting a loan. Again, however, the DBO pointed to Boerner in recognizing that such underwriting could be utilized in a credit sale transaction.
- The Requestor’s product was not subject to any other laws, and thus, there was no regulatory mechanism in place to ensure that Requestor’s deferred payment products included appropriate consumer protections. Notably, however, the DBO made clear that the Requestor did not address whether Requestor’s deferred payment products could be considered to involve retail installment sales. Had the Requestor made such an argument, the DBO suggested that it would consider that a factor weighing in favor of finding that the activity was intended to be regulated under a different regulatory scheme.
In sum, although the DBO acknowledged that Boerner and other cases suggested that the Requestor’s products have the indicia of sales, DBO found that the factors weigh in favor of regulating the Requestor’s products as loans. Accordingly, the DBO directed the Requester to maintain its CFL license, in order to offer its deferred payment service.
The re-characterization of Sezzle’s product as a loan, and the public disclosure of the legal opinion on deferred payment products, suggests that DBO will closely scrutinize “unregulated” transactions, and will, in certain circumstances, take steps to prevent a provider from offering such products. Although, numerous DBO enforcement actions for unlicensed lending advise a lender to seek a license, here, the DBO denied Sezzle’s license outright, even though Sezzle claimed its products fell outside regulation. As the DBO found, claiming a product is exempt from the CFL is different from being exempt—especially, when a provider’s transaction agreements document that such products have significant loan-like features.
DBO’s recent actions provide useful guidance for helping to assess whether a consumer-facing point-of-sale financing transaction is likely to be considered a loan versus a sale. To help bolster a claim that such transaction involves the purchase of a bona fide credit sale, providers should ensure that their contractual relationships and terminology reflect a credit sale, and do not otherwise, suggest a lending relationship; notify consumers of any financing relationship in conjunction with their purchase; and consider whether deferred payment products are subject to consumer-oriented regulatory schemes.
Although these actions apply only to Sezzle and the unidentified Requestor, the decisions have implications for providers of other “unregulated” financial products. As noted above, the opinion from DBO justifies the decision to characterize the services as loans, in part, on the grounds that the products as structured would not otherwise be specifically regulated. Similar arguments could be made about other services that provide consumers and businesses with access to capital. For example, California law does not specifically regulate merchant cash advance services (“MCAs”) or factoring agreements.
In the wake of these two decisions, firms that offer such services should look carefully at the terms to ensure that they do lend themselves to re-characterization as loans. Loan-like terms such as guarantees or other repayment obligations could provide DBO with ammunition to treat such services as loans and require providers to obtain a CFL license to offer them. Paul Hastings attorneys frequently work with providers of credit, with respect to the proper regulatory structure of their products.
SeeDBO Denies Lending License Sought by Unregulated Point-of-Sale Financer and Issues Related Legal Opinion, (Dec 30, 2019).Cal. Fin. Code, § 22000 et seq.
 For example, Unfair Competition Law (Business and Professions Code § 17200), the False Advertising Act (Business and Professions Code § 17500), and the Consumer Legal Remedies Act (Civil Code §§ 1750-1784).
 Cal. Fin. Code § 22054 (emphasis added).
 California Department of Business Oversight-Statement of Issues, Sezzle and its Application available at: https://dbo.ca.gov/wp-content/uploads/sites/296/2019/12/Sezzle-Statement-of-Issues.pdf page 8
Marchand, See Sections 1.2 (“Sezzle may unilaterally decide to change this Agreement from time to time, including your credit limit . . . .”); 2.1 (“Sezzle is a payment processing platform designed to allow Users to finance and buy products today and pay for them later, through a down payment followed by installment payments.”); 2.2 (referencing “your promise to pay the amount of the goods and services financed by . . . Sezzle” and “confirming the financing of any purchases through . . . Sezzle”); 2.6 (“We provide you with financing for your purchases.”); 3.1 (“You can use Sezzle to pay for purchases of goods and services from Sezzle Merchants . . . .”); 3.2 (“We may, at our discretion, impose limits on the amount of money you can use to purchase goods or services . . . .”); 4.1 (obtaining authorization to identify “business risks that may exist to Sezzle in offering financing to you”); and, separate “legal definition” for “Merchant Account” (“an account created with Sezzle by the Merchant for the purposes of accepting Sezzle as a payment option”).)
 Interestingly, DBO did not address whether offering interest-bearing accounts constitutes unlicensed banking.
Cal Civ. Code § 1912.
 21 Cal.3d 37 (1978).