What is the California Finance Lenders Law?
June 26, 2008
Under the California Finance Lenders Law (the “CFLL”), a person engaged “in the business of a finance lender or broker” within California generally must obtain a license from the California Department of Corporations. The law provides a number of exemptions from this requirement, including exemptions available for small business investment companies and persons that limit their lending activities to no more than one loan in any 12-month period.
However, the licensing requirements of the CFLL are not triggered by a qualified bridge loan (“QBL”), which is defined as a “commercial bridge loan” made by a “venture capital company” to an “operating company.” Thus, a venture capital fund that made only QBLs would not be required to obtain a license under the CFLL. However, a fund that makes other types of loans should be subject to licensing requirements only if those loans cause the fund to be engaged in the business of a finance lender or broker.
In general, a “commercial bridge loan” is any loan that:
1. Has a principal amount of $5,000 or more;
2. The proceeds of which are intended to be used by the borrower other than for personal, family or household purposes;
3. Matures in one year or less;
4. Is made in connection with, or in contemplation of, an equity investment in the borrower;
5. Is secured, if at all, solely by the borrower’s business assets (but not by real property); and
6. Is subject to the implied covenant of good faith and fair dealing arising under Section 1655 of the California Civil Code.
A venture capital fund generally will be a “venture capital company” if it:
1. Engages primarily in the business of promoting economic, business, or industrial development through “venture capital investments” or the provision of financial or management assistance to operating companies;
2. At all times maintains at least 50 percent of its assets in venture capital investments or commitments to make venture capital investments;
3. Maintains or, assuming consummation of the equity investment to which a commercial bridge loan relates, will maintain a material equity interest in the borrower;
4. Approves each loan made to an operating company through the fund’s board of directors, executive committee, or similar policy body, based on a reasonable belief that the loan is appropriate for the operating company after reasonable inquiry concerning the operating company’s financing objectives and financial situation; and
5. Complies, when making the loan, with all applicable federal and state securities laws.
A ”venture capital investment” is “an acquisition of securities in an operating company that a person, an investment adviser of the person, or an affiliated person of either, has or obtains management rights to.” The statute provides no definition of the term “management rights,” but the term is well defined in other places. The first is the definition of “venture capital operating company” under the Employee Retirement Income Security Act of 1974 (“ERISA”). The second is Rule 260.204.9 of the California Code of Regulations, which deals with the regulation of investment advisors.
In general, a borrower is an “operating company” if it:
1. Engages (directly or through subsidiaries) in the production or sale, or the research or development, of a product or service other than the management or investment of capital;
2. Uses all of the bridge loan proceeds for the operations of its business; and
3. Approves the bridge loan through its board of directors, executive committee, or similar policy board, based on a reasonable belief that the loan is appropriate for the borrower after reasonable inquiry concerning the borrower’s financing objectives and financial situation.