Marks & Associates, P.C. 
Newsletter
November 2015
In This Issue
Firm News
You Don't have to Worry About Data Security...Or Do You?
Off-The-Cuff Advice
A Growing Trend: Electronic Chattel Paper
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FIRM NEWS

Dear Folks - Sorry We Haven't Written...

As the tardiness of this issue would indicate (I think we skipped two months), we have been pretty busy around here.  My marketing department reminds me I should say we are NEVER too busy to take your calls , etc.

In recent weeks, we have been engaged in the sale of a leasing company to a bank, several vendor operations starting up leasing companies, a couple of new small ticket lessors entering the market and the usual variety of form preparations, transactions and research and advice regarding UCC issues. 

You will see a couple of things in this month's issue that should raise eyebrows.  Anytime business begins to pick up, "interesting" issues arise and some people try to use shortcuts to address increased volume. 

The facts are simple:  if we are going to do more business, we need to increase attention to detail and knowledge, and not the other way around.  I say "we" for good reason:  we learn new things every day, including a couple mentioned below. 

Good luck to everyone. 

Barry
YOU DON'T HAVE TO WORRY ABOUT 
DATA SECURITY... OR DO YOU?

NOTE: As you read this, Matt Evans will be on the way home from participating in a panel presentation and a breakout session at the NEFA Fall Expo. We are readying advice for clients on how to address these important and timely issues.

You have read about Target and Sony. You have seen the Wall Street Journal article on recent indictments of an international data theft ring. If you are like us, you have assumed that because you do not take credit cards or keep client and customer "personal" information, none of that is your problem. 

If you are like us, you have been wrong.

Under federal and state law, anyone collecting "personal identification information" has certain responsibilities, including in varying degrees, the obligation to protect the information, destroy it once it is used and notify the affected person if a data breach has occurred. Forty-seven states have adopted data security laws. These laws are somewhat similar but not identical in many respects. One common thread is that there is a cost-benefit analysis on what a company must do to protect information, meaning that showing you are taking all reasonable steps can be almost as important as avoiding a breach altogether.

While the risk of regulatory action is real, we are more concerned with how banks and other regulated institutions will respond to pressure from FDIC and other bodies - some are already requiring originators to have programs in place - and in the potential for lawsuits, including class actions, as plaintiffs' lawyers become more and more aware of the potential for actions against lessors and brokers.

What does all this mean? 

1. YOU need to be concerned. The sweeping growth of federal and state laws on data protection and privacy may mean that this is "next big thing" for the equipment finance industry. Much of the information gathered in applications, not to mention credit and reference checks, is clearly within the ever-expanding definition of "personal identification information." This information is in the files and computers of every equipment leasing and finance company. While the FTC appears to be focused on consumer transactions, state laws in many states expressly include information obtained in the course of commercial financings.

2. Paper, as well as electronic. Everything from disgruntled former employees stealing files to dumpster-diving identity thieves can serve as the basis for a data security breach. The nightmare is already becoming real for companies who thought their computer firewalls provided ample protection, forgetting their good, old-fashioned paper files.

3. Electronic documents equal exponentially increased exposure. As we move to electronic documents, including documents signed by electronic signature, documents filled out on the internet, PDF and fax copies and anything else that is transmitted electronically, the risk of a data breach increases markedly. A firewall may be sufficient for some purposes, but many in the industry note that information protected to leave from one source may not be protected when it goes out to another. Funders: how secure are your connections with your brokers and how secure are their data bases? If information transmitted to you winds up in the wrong hands, can you prove the breach occurred somewhere else and will that be enough to insulate you from liability?

4. Do you have a program to notify clients and customers? Regulated financial institutions, such as banks, are legally required to have certain programs in effect. These include programs to notify customers in the event of a data breach. More and more of these institutions are requiring originators, brokers and others with whom they do business to have similar programs and protections. Your bank may not be asking about your data protection plan yet, but it probably will before too long.

5. You need to have an Incident Response Plan. NOW. What happens if there is a data breach? If your answer is that you will ask your IT person, go sit in the corner. An Incident Response Plan not only directs your actions in the event of a breach, it serves as evidence that you are doing what you can to protect information.

6. You cannot rely on firewalls. First, remember that this is not just about electronic information. Second, what about how information is received by you from unprotected sources or transmitted by you to funders or others? Hacking gets the press but what about a salesman who copies files on his way out the door? Do you have insurance coverage? Really?

Recently, the Federal Trade Commission won a landmark decision against Wyndham Hotels. Federal Trade Commission v. Wyndham Worldwide Corporation, (3rd Cir. 2015). Without going into details, the FTC established that Wyndham was liable for failure to protect "personal identification information" from its customers. While the case involved consumer information, the FTC did not merely rely on its consumer protection regulations in 14 CFR 313 ETSEQ, but on the more generally applicable deceptive trade practices theory allowing it to impose sanctions. The FTC has never issued clarifying regulations as to exactly what "deceptive trade practice" means. Wyndham tried to argue this point but the Court of Appeals allowed the FTC to impose sanctions anyway.

The point is that the government's and plaintiffs' attorneys' attention is focusing on data security. Yours should be too.

California: The Madness Continues

It began innocently enough. Several months ago, Dennis Brown of ELFA, who is always on the job it seems, notified us that the California legislature was considering amending the law to allow funders to pay referral fees to unlicensed brokers under certain circumstances.

In case you missed it, the California Finance Lenders Law requires lenders AND brokers making or arranging loans to in-state residents to be licensed. Licensure insulates the lender's transactions from California's usury law, which many lenders found a reasonable tradeoff. What has never been clear is to what extent the broker version of the license applied to loans arranged by out of state brokers and how failure to ensure that the broker had a license affects the lender or the loan itself.

As we had to inform one client last month, the nice folks in California say, a corporation or llc formed outside their state cannot get a license unless it qualifies to do business as a foreign corporation - registered agent, franchise taxes, the works. One of our friends, a California lawyer, refers to his state as the Peoples' Republic of California. Just sayin'.

Some well-meaning legislator wanted to help non-profits make a little money by taking referral fees, or open lending channels to the non-profits or something, but the "California Department of Business Oversight" (we can't make this stuff up) jumped in and turned the law on its head just before it went up for a vote. What happened was that a friendly, benign plowhorse we would probably be telling you to ignore turned overnight into a skittish thoroughbred, then an insane camel and came out a fire-breathing dragon.

As it reads, the law, which is slated to become effective January 1, requires that ANY loan to a California resident be arranged by a licensed broker or that the funder, before paying a commission or referral fee to the broker, ensure that a list of criteria are met. These criteria include:

* Verification that the borrower is not a consumer
* A limitation on interest (APR) of 36% (remember the no-usury provision mentioned above?); and this one we will just cite verbatim, that the lender:
* Performs underwriting and obtains documentation to ensure that the prospective borrower will have sufficient monthly gross revenue with which to repay the loan pursuant to the loan terms, and does not make a loan if it determines through its underwriting that the prospective borrower's total monthly expenses, including debt service payments on the loan for which the prospective borrower is being considered, will exceed the prospective borrower's monthly gross revenue. Examples of acceptable forms of documentation for verifying current and projected gross monthly revenue and monthly expenses include, but are not limited to, tax returns, bank statements, merchant financial statements, business plans, business history, and industry-specific knowledge and experience. If the prospective borrower is a sole proprietor or a corporation and the loan will be secured by a personal guarantee provided by the owner of the corporation, a credit report from at least one consumer credit reporting agency that compiles and maintains files on consumers on a nationwide basis shall also be considered.

As we read the law (there is more to it*), unless something changes:

* Brokers, wherever they are located, should either obtain licenses or stay out of California.
* Funders, even if licensed, should only do business with brokers licensed in California, only do true leases to customers in California, or stay out of the Golden State.

The good news is that ELFA is on the job and we understand that NEFA and NAELB have pledged support. We are working on a committee of California and out of state lawyers to obtain clarification of the law and limit its (absurd) reach.

We will each take a Valium before we meet with anyone from the Department of Business Oversight.


* The law is reproduced below. Like we said, we can't make this stuff up.

Senate Bill No. 197

CHAPTER 761


An act to add Sections 22602, 22603, and 22604 to the Financial Code, relating to finance lenders.

[Approved by Governor October 10, 2015. 
Filed with Secretary of State October 10, 2015.]


LEGISLATIVE COUNSEL'S DIGEST

SB 197, Block. Finance lenders: commercial loan: referral.

Existing law, the California Finance Lenders Law, provides for the licensure and regulation of finance lenders by the Commissioner of Business Oversight. Existing law makes a willful violation of the law by any person a crime. Existing law defines a finance lender as any person who is engaged in the business of making consumer loans or commercial loans. Existing law defines a commercial loan as a loan of a principal amount of $5,000 or more, or any loan under an open-end credit program, whether secured by either real or personal property, or both, or unsecured, the proceeds of which are intended by the borrower for use primarily for purposes other than personal, family, or household.

This bill would authorize a licensed finance lender to compensate an unlicensed person in connection with the referral, as defined, of one or more prospective borrowers to the licensee for a commercial loan if certain requirements are met. These requirements would include, among other things, that the referral leads to the consummation of a commercial loan, the loan contract provides for an annual percentage rate that does not exceed a certain percentage, the licensed finance lender obtains documentation from the prospective borrower documenting the borrower's commercial status, and that the licensee maintains records of compensation paid to an unlicensed person, as specified. The bill would make a licensee paying compensation to an unlicensed person in connection with a referral liable for any misrepresentation made to a borrower in connection with that loan made to that borrower by that licensee. The bill would authorize the commissioner to adopt regulations imposing conditions on this referral activity, as specified. The bill would also require a licensed finance lender who receives an application for a commercial loan from a prospective borrower who has been referred by an unlicensed person to provide a specified statement to the borrower regarding the referral arrangement. The bill would prohibit any person receiving compensation in connection with a referral that leads to the consummation of a commercial loan from engaging in specified acts and would authorize the commissioner to order this person to desist and refrain from engaging in the business or further violating those provisions governing such referral.

By creating new requirements, the willful violation of which would be a crime, the bill would impose a state-mandated local program.

The California Constitution requires the state to reimburse local agencies and school districts for certain costs mandated by the state. Statutory provisions establish procedures for making that reimbursement.

This bill would provide that no reimbursement is required by this act for a specified reason.

DIGEST KEY
Vote: majority Appropriation: no Fiscal Committee: yes Local Program: yes
________________________________________

BILL TEXT
THE PEOPLE OF THE STATE OF CALIFORNIA DO ENACT AS FOLLOWS:

SECTION 1.
Section 22602 is added to the Financial Code, to read:
22602.
(a) A licensee that is a finance lender may pay compensation to a person that is not licensed pursuant to this division in connection with the referral of one or more prospective borrowers to the licensee, when all of the following conditions are met:

(1) The referral by the unlicensed person leads to the consummation of a commercial loan, as defined in Section 22502, between the licensee and the prospective borrower referred by the unlicensed person.

(2) The loan contract provides for an annual percentage rate that does not exceed 36 percent.

(3) Before approving the loan, the licensee does both of the following:

(A) Obtains documentation from the prospective borrower documenting the borrower's commercial status. Examples of acceptable forms of documentation include, but are not limited to, a seller's permit, business license, articles of incorporation, income tax returns showing business income, or bank account statements showing business income.

(B) Performs underwriting and obtains documentation to ensure that the prospective borrower will have sufficient monthly gross revenue with which to repay the loan pursuant to the loan terms, and does not make a loan if it determines through its underwriting that the prospective borrower's total monthly expenses, including debt service payments on the loan for which the prospective borrower is being considered, will exceed the prospective borrower's monthly gross revenue. Examples of acceptable forms of documentation for verifying current and projected gross monthly revenue and monthly expenses include, but are not limited to, tax returns, bank statements, merchant financial statements, business plans, business history, and industry-specific knowledge and experience. If the prospective borrower is a sole proprietor or a corporation and the loan will be secured by a personal guarantee provided by the owner of the corporation, a credit report from at least one consumer credit reporting agency that compiles and maintains files on consumers on a nationwide basis shall also be considered.

(4) The licensee maintains records of all compensation paid to unlicensed persons in connection with the referral of borrowers for a period of at least four years.

(5) The licensee annually submits information requested by the commissioner regarding the payment of compensation in the report required pursuant to Section 22159.

(b) A licensee that pays compensation to a person that is not licensed pursuant to this division in connection with a referral for a commercial loan made by that licensee to a borrower shall be liable for any misrepresentation made to that borrower in connection with that loan.

(c) The following activities by an unlicensed person are not authorized by this section:

(1) Participating in any loan negotiation.

(2) Counseling or advising the borrower about a loan.

(3) Participating in the preparation of any loan documents, including credit applications.

(4) Contacting the licensee on behalf of the borrower other than to refer the borrower.

(5) Gathering loan documentation from the borrower or delivering the documentation to the licensee.

(6) Communicating lending decisions or inquiries to the borrower.

(7) Participating in establishing any sales literature or marketing materials.

(8) Obtaining the borrower's signature on documents.

(d) The prohibitions in subdivision (c) do not apply if the unlicensed person meets one or more of the following criteria:

(1) Is exempt from licensure under this division.

(2) Is exempt from federal income taxes under Section 501(c)(3) of the Internal Revenue Code.

(3) Is a business assistance organization recognized by the United States Small Business Administration.

(4) Is engaged in one or more of the activities described in paragraphs (1) to (8), inclusive, of subdivision (c) in connection with five or fewer commercial loans in a 12-month period made by persons licensed under this division.

(e) The commissioner may adopt regulations under this section to impose conditions on the referral activity authorized under this section. The commissioner may classify persons, loans, loan terms, referral methods, and other matters within his or her jurisdiction, and may prescribe different requirements for different classes of loans.

(f) Nothing in this section shall authorize the payment of a referral fee to an unlicensed person for a residential mortgage loan, nor the payment of a referral fee to a person required to be licensed under Section 10131 or 10131.1 of the Business and Professions Code, unless such person is licensed by the Bureau of Real Estate pursuant to Division 4 (commencing with Section 10000) of the Business and Professions Code.

(g) For the purposes of this section, "referral" means either the introduction of the borrower and the finance lender or the delivery to the finance lender of the borrower's contact information.

SEC. 2.
Section 22603 is added to the Financial Code, to read:
22603.
A licensee that is a finance lender shall provide a prospective borrower who has been referred by an unlicensed person the following written statement, in 10-point font or larger, at the time the licensee receives an application for a commercial loan, and shall require the prospective borrower to acknowledge receipt of the statement in writing:

"You have been referred to us by [Name of Unlicensed Person]. If you are approved for the loan, we may pay a fee to [Name of Unlicensed Person] for the successful referral. [Licensee], and not [Name of Unlicensed Person] is the sole party authorized to offer a loan to you. You should ensure that you understand any loan offer we may extend to you before agreeing to the loan terms. If you wish to report a complaint about this loan transaction, you may contact the Department of Business Oversight at 1-866-ASK-CORP (1-866-275-2677), or file your complaint online at www.dbo.ca.gov."

SEC. 3.
Section 22604 is added to the Financial Code, to read:
22604.
(a) Any person that receives compensation in connection with a referral, as described in Section 22602, that leads to the consummation of a commercial loan under this division may not do any of the following:

(1) Make a materially false or misleading statement or representation to a prospective borrower about the terms or conditions of a prospective loan.

(2) Advertise, print, display, publish, distribute, or broadcast any statement or representation with regard to the conditions for making or negotiating a loan that is false, misleading, or deceptive, or that omits material information that is necessary to make the statements made not false, misleading, or deceptive.

(3) Engage in any act in violation of Section 17200 of the Business and Professions Code.

(4) Commit an act that constitutes fraud or dishonest dealings.

(5) Fail to safeguard a prospective borrower's personally identifiable information.

(b) For purposes of this section, "personally identifiable information" means information that is not publicly available, that a prospective borrower provides for the purpose of obtaining a loan or other financial product. Personally identifiable information includes information a prospective borrower provides on an application to obtain a loan, credit card, or other financial product or service.

(c) Whenever, in the opinion of the commissioner, any person is engaged in the business of soliciting borrowers for a loan to be made by a licensee under this division, and the person is not in compliance with this section, Section 22602, Section 22603, or any other provision of this division authorizing such activity or exempting the person from this division, the commissioner may order the person to desist and to refrain from engaging in the business or further violating this division.

SEC. 4.
No reimbursement is required by this act pursuant to Section 6 of Article XIII B of the California Constitution because the only costs that may be incurred by a local agency or school district will be incurred because this act creates a new crime or infraction, eliminates a crime or infraction, or changes the penalty for a crime or infraction, within the meaning of Section 17556 of the Government Code, or changes the definition of a crime within the meaning of Section 6 of Article XIII B of the California Constitution.

Electronic Signatures and Chattel Paper Perfection
Part One

We are going to address this issue in two parts. Several of our clients have asked over the past few months about this scenario:

1. Lessee manually a signs lease (or EFA) and sends the signed copy to Lessor by fax or as an attachment to an email. By "manually signs", we mean that the lessee signs by hand with a "wet" signature, as opposed to signing electronically by typing in a code that inserts a digital signature into an electronic document.

2. Lessor prints and signs the copy sent to it and takes this to its bank or other funder for discounting. Lessee (presumably) destroys the copy with its signature.

As defined by UCC Section 9-102, a lease, like a security agreement, is chattel paper. Under UCC Sections 9-312 and 9-313, a security interest in chattel paper can be perfected by filing a UCC financing statement OR, in the case of tangible chattel paper, by possession of the tangible chattel paper. In the case of electronic chattel paper, Section 9-314 provides that, in lieu of possession, control of electronic chattel paper perfects the secured party's security interest under 9-105 control means control of the single authenticated record - the one with the digital signature that most commonly goes to a secure electronic vault . Without belaboring the issue, a piece of paper with a faxed or copied signature is tangible chattel paper and not electronic chattel paper for these purposes.

Looking back at the rules regarding tangible chattel paper, we still have a question: if one party perfects by filing and the other by possession...who wins? Does a bank taking assignment of a lease from a lessor have to do a UCC check? What if there is a blanket lien on the lessor? The answer is in UCC Section 9-330(b), which provides that possession wins over filing where tangible chattel paper is concerned.

OK, so possession of what? Comment 4 to 9-330 makes it clear that, in cases where there may be multiple copies (counterparts) of tangible chattel paper, each of which could be signed and therefore, "original", the parties may designate one as the "original chattel paper." Moreover, under 9-330(b), in order to defeat a competing interest in chattel paper, a creditor must act in good faith and "without knowledge that the purchase [of the chattel paper] violates the rights of the secured party." In other words, if the lease itself warns a prospective other creditor that the copy it is getting is not the right one, it loses its claim of priority.

For many years, it has been common practice to label one of the manually-signed copies the "sole original counterpart" or "sole original" or something similar. Many lessors only allow the lessee to sign one copy and then sign that copy and mark it as the original.

Here is where the problem comes in: If the copy signed by the lessee is floating around somewhere, what is to prevent the lessor fraudulently, or accidentally, signing it as well as the received fax or emailed copy? If two or more funders show up with the same lease, it seems at least probable that the one with two manual signatures will be considered the "original."

What to do? Control of electronic chattel paper by funders and possession manually signed, wet signature tangible chattel paper is at least equally safe and almost universally accepted. More and more banks are getting comfortable with electronic vaults and systems to create control. Courts are routinely enforcing and becoming more familiar with authentication of these electronic documents as well. This hybrid of tangible paper with a duplicate signature electronically transmitted, however, raises problems.

As noted, comment 4 to 9-330 allows the parties to the original transaction to designate which copy is the original for chattel paper perfection purposes. Therefore, it would seem that a funder should be comfortable with an arrangement under which the copy in its hands matches the language of the lease. In other words, the lease itself should identify the original chattel paper to be held in the funder's possession.

One proposal would be to provide that there is no chattel paper original and that perfection of a security interest in the lease may only be by filing, not possession. In the case of active lessors, that would seem impractical, but a funder who files a blanket lien with no security interest ahead of it might feel protected. This works well if there will be only one funder used by the lessor...which is not the usual case.

Another possibility is simply to provide that the lessor represents to the funder that it will only sign and designate one copy as the original, and this is the one it will deliver to the funder. This leaves the funder at risk for fraud by the lessor itself, but, in the case of reputable, creditworthy lessors, this may be the best option available.

In the next issue, we will go into detail about electronic chattel paper and its uses, as well as examining perfection issues further.
Published Articles for Additional Reading
Due Diligence for Municipal Lessors
By: Barry Marks & 
Bill Phillips
ELFA's Equipment Leasing & Finance Magazine, Nov/Dec 2015

By:  Matt Evans
Leasing News, Sept 2, 2015

By:  Bill Phillips
Leasing News, Sept 28, 2015




Marks & Associates, P.C.
400 Century Park South
Suite 100
Birmingham, AL 35226
(205) 251-8301
_________
P.O. Box 11386
Birmingham, AL 35202



Nothing in this newsletter constitutes legal advice or is intended as a substitute for consultation with a qualified lawyer, accountant or other professional.