The Regulations on Business Loans
Written by Elizabeth M. Young LaBerge, Senior Regulatory Compliance Counsel, NAFCU
A couple weeks ago, we blogged about the regulations that applied to business accounts. Today we will touch on several regulations related to lending and their applicability to business loans.
Most consumer protection rules do not apply to loans held by a business or an individual when made for business purposes. As with accounts, it is important to understand that a business-purpose loan can be made to a legal entity or to an individual operating a business. Understanding whether an individual or a legal entity will serve as the borrower on the loan, as well as the loan’s purpose, can be important to determining the applicability of a rule, as well as the credit union’s ability to make the loan under its internal policies and field of membership considerations.
NCUA’s Lending Regulation
Occasionally, credit unions will ask whether the limitations of NCUA’s lending rule in section 701.21 also apply to commercial loans and member business loans covered by NCUA’s Part 723. For federal credit unions, section 723.1(c) specifically states that subsections 701.21(a)-(g) also apply to commercial loans. For federally-insured, state chartered credit unions, subsections 701.21(c)(8) and (d)(5) would still apply to commercial loans.
The goal of the Equal Credit Opportunity Act is to prohibit discrimination in the extension of credit based on race, color, religion, national origin, sex, marital status or age. It does not generally limit its scope to individual consumers, but the definitions in section 1002.2 do distinguish between “business credit” and “consumer credit.” Business credit is primarily for business or commercial purposes. Consumer credit is credit extended to a natural person primarily for personal, family, or household purposes. Regulation B permits the credit union to rely on the borrower’s representations to determine what the “primary” purpose of the loan is. 12 CFR Part 1002, Supp. I, comment 2(g)-1.
Generally speaking, the provisions that refer to business credit in Regulation B allow for less onerous provisions for business credit applications. For example, section 1002.9 contains separate provisions for providing notifications to business credit applicants. The larger the business, the more relaxed the requirements. Section 1002.12 contains shorter retention timeframes for records related to business credit. A credit union has the option to treat a business applicant like a smaller business or a consumer – in other words to comply with more onerous requirements than is strictly necessary. 12 CFR Part 1002, Supp. I, comment 9(a)(3)-4. Certain provisions, like the provision about furnishing credit information under section 1002.10 only apply to consumers. The model application forms in Appendix B are intended for use with consumer credit. Appendix C contains sample notification forms for both business and consumer credit.
Fair Housing Act
The Fair Housing Act is implement through NCUA’s section 701.31. It applies to any loan for which an application is made to finance or refinance the purchase, construction, improvement, repair, or maintenance of a dwelling. It prevents discrimination based on race, color, national origin, religion, sex, handicap or familial status against applicants in lending, appraisals, and advertising such loans. The regulation does not refer to consumers, legal entities, or the purpose of the loan being made.
As discussed in the accounts blog, the FCRA applies to reports on “consumers,” defined to mean “individuals,” which the FTC interpreted to mean “only a natural person. It does not include artificial entities, such as partnerships, corporations, trusts, estates, cooperatives, associations or entities created by statute, such as governmental agencies.”
However, this does not mean that the FCRA would never be implicated in opening a business loan. A credit union might still obtain a credit report on an individual consumer in connection with the application, for example, because the applicant is an individual applying for business-purpose credit or because the credit union wants to ensure an individual associated with the legal entity applying for credit can offer a sufficient personal guarantee.
When a report is obtained on an individual and the report meets the definition of a “consumer report” under the FCRA, the FCRA would apply. If the credit union chose to deny an application for credit based on that report, section 615 of the FCRA may require an adverse action notice.
Truth in Lending/Regulation Z
Regulation Z covers loans that are, among other things, credit extended "primarily for personal, family, or household purposes." 12 CFR § 1026.1(c)(1)(iv). A loan is exempt from Regulation Z if it is "[a]n extension of credit primarily for a business, commercial or agricultural purpose." It is also exempt if the loan is extended to an applicant “other than a natural person,” for example a corporation, LLC, or other legal entity. 12 CFR § 1026.3(a). It is important to note that the commentary to paragraph 3(a) states that a consumer-purpose loan to a trust can fall within the scope of Regulation Z under certain circumstances.
Comment 1 to paragraph 2(a)(12) states "[t]here is no precise test for what constitutes credit offered or extended for personal, family, or household purposes, nor for what constitutes the primary purpose." The commentary to paragraph 3(a) contain several examples of loans which are exempt based on their business purpose: loans to expand a business; add a business office to a principal residence; acquire, improve or maintain rental property with certain occupancy limitations; or finance the planting, harvesting, transporting or processing of crops or livestock.
While there is not a hard and fast test for the “primary” purpose, the commentary does indicate that providing Regulation Z disclosures “just in case” does not cause a loan which would otherwise be exempt to lose that exemption.
Under paragraph 1024.5(b)(2), “business purpose loans” are exempt from RESPA coverage. Rather than write a definition of “business purpose loans,” RESPA merely directs the reader to Regulation Z’s section 1026.3(a)(1) which is discussed above. Therefore, a loan that is exempt from Regulation Z’s coverage because it is a business purpose loans is also exempt from Regulation X.
HMDA applies to any “covered loan,” which is defined as “a closed-end mortgage loan or an open-end line of credit that is not an excluded transaction under §1003.3(c).” 12 C.F.R. § 1003.2(e). Loans made primarily for business or commercial purposes are excluded from the definition of a “covered loan” under paragraph 1003.3(c)(10) unless they are for one of three specific purposes regarding the property. If the business or commercial purpose loan meets the definition of a “home improvement loan,” “home purchase loan” or “refinancing,” it IS a covered loan under HMDA. 12 C.F.R. § 1003.2(i), (j) and (p).
Under section 1003.2, a home improvement loan is a loan for the purpose, in whole or in part, of repairing, rehabilitating, remodeling, or improving a dwelling or the real property on which the dwelling is located. A home purchase loan is for the purpose, in whole or in part, of purchasing a dwelling. A refinancing is a new, dwelling-secured debt obligation that satisfies and replaces an existing, dwelling-secured debt obligation by the same borrower. So, where a loan is obtained to expand a business office and a mortgage is taken on a guarantor’s residence to provide additional collateral on the loan, that loan would be excluded from HMDA coverage. On the other hand, if a loan is obtained to build additional rental units to an apartment complex, this would be a “home purchase loan” and would therefore be covered by HMDA, even though its primary purpose is related to business.
With regard to what constitutes a “primary” purpose, HMDA also relies on Regulation Z’s section 1026.3 and its commentary, discussed above, to determine whether a loan is primarily for a business or commercial purpose.
As discussed in the accounts blog, Regulation P specifies its scope as solely applying to individuals. Therefore, loans to legal entities or individuals for business, commercial or agricultural purposes are not covered by Regulation P.
Also as previously discussed, the E-SIGN Act’s provisions regarding consent and the provision of disclosures electronically only apply to consumers. A credit union seeking to provide disclosures electronically may be able to do so by simple agreement, rather that following E-SIGN’s provisions, unless specifically required to by other federal or state regulation.
BSA and OFAC
As referenced before, the requirements of the BSA and OFAC absolutely apply to businesses. A “customer” for the purposes of the Customer Identification Program (CIP) is a “person” which includes a corporation, partnership, a trust, an estate or any other entity recognized as a legal person. There is guidance on performing CIP and conducting due diligence on legal entity customers in the FFIEC’s BSA/AML Manual. The requirements of OFAC as well as the BSA’s other requirements, such as risk rating, monitoring accounts and filing reports, all also apply to legal entities.
State Law and Other Considerations
As with accounts, in the absence of applicable regulation at the federal level, state laws and any private agreements may come into play. Where federal and state regulations or private requirements do not require specific treatment of business loans, the credit union would be able to establish its own risk-based requirements through its internal policies and loan agreements.