The Overlooked Risks of Dodd-Frank Section 1071 for Factoring Companies

Written by: Alex McFall, Esq., Senior Counsel, and Chris Friedman, Esq., Partner, Husch Blackwell

In the world of factoring, the recent developments concerning the Consumer Financial Protection Bureau’s (CFPB) implementation of Section 1071 of the Dodd-Frank Act have been greeted with a mixture of relief and anticipation. Factoring companies collectively exhaled a sigh of relief when the Bureau announced that the regulation would not categorize true factoring transactions as “covered credit transactions.” But in every victory, it’s important to remain vigilant. The devil, as they say, is in the details. While factoring itself might be excluded, the same cannot be said for credit transactions associated with factoring services.

What is Dodd-Frank Section 1071

Section 1071 modifies the Equal Credit Opportunity Act by introducing specific reporting obligations for financial services firms that provide business loans. The final regulation mandates that lenders gather and report detailed data concerning small business credit applications, including demographic details (like the race, ethnicity, and gender of the main owners), lending outcomes, and credit costs. This rule applies to lenders that issue over 100 small business loans or financing products annually. In turn, this information will be anonymized and made available to the public.

Section 1071 increases regulatory risk for business finance companies in two primary ways. First, the compliance burden is substantial, and failure to comply could carry regulatory penalties. Second, the data collected and reported could help regulators and private plaintiffs establish disparate impact claims under the Equal Credit Opportunity Act.  

Dodd-Frank’s Hidden Hook: Credit Associated with Factoring

The issue lies within the seemingly benign Comment 104(b) to the final rule. The term “covered credit transaction,” under Section 1071, includes a multitude of financial products, all primarily business or commercial in nature. Factoring in its purest form—a sale of receivables—is undoubtedly excluded, but credit extensions that are “incident to a factoring transaction” are not. This signals that additional credit offerings tightly coupled with factoring services, such as fuel card programs or an advance on invoices, would trigger Section 1071 reporting requirements.

Examples That Could Trigger Section 1071 Compliance

Consider a scenario where a factoring firm offers its clients a fuel card service. This service assists trucking company clients to manage fuel expenses efficiently, often seen as an attractive value-added service in the competitive factoring landscape. Despite its benefits, such a service is an extension of credit: it allows clients to defer the immediate payment for fuel purchases through a credit mechanism provided by the factoring company. In these cases, the credit service—though intrinsically linked to the factoring agreement—qualifies as a “covered credit transaction” and requires compliance with Section 1071’s reporting mandates, necessitating the collection and reporting of a multitude of data points, potentially including the demographics of the borrowing entity and the principal owners thereof.

But fuel cards are only the tip of the iceberg. Think of early payment programs, where factors provide an advance on unpaid invoices for a fee, or the extension of credit lines tied to the advance purchase of invoices. So even if a factoring company’s core process sidesteps Section 1071, these associated services could reel them back into compliance territory. It’s a true catch-22: on one hand, ancillary credit perks can be powerful incentives in a competitive market, yet on the other hand, they may bring about a hefty compliance burden. It’s essential, therefore, to conduct a granular assessment of all products and services offered.

Stay Alert, Stay Compliant

The trap for the unwary factoring company lies in equating being a non-loan entity with blanket exclusion from credit regulations. Factoring companies must remain vigilant, particularly those offering or considering credit-related services that run parallel to their factoring arrangements.

To mitigate the risk, factors should begin by auditing their products, policies, and procedures to ensure that any credit offerings associated with factoring are clearly defined and separated from the factoring arrangements. A thorough compliance assessment can identify potential vulnerabilities and guide the creation of internal systems and controls to collect, monitor, and report the required data. 

Factoring companies should also be familiar with the compliance date for Section 1071. In particular, there are three tiered compliance deadlines based on the number of covered transactions originated by the reporting institution:

• Institutions that originated at least 2,500 covered credit transactions in both 2022 and 2023: Begin collecting data on October 1, 2024 and begin reporting data on June 1, 2025.

• Institutions that originated at least 500 covered credit transactions in both 2022 and 2023, but not 2,500 or more in both 2022 and 2023: Begin collecting data on April 1, 2025 and begin reporting data on June 1, 2026.

• Institutions that originated at least 100 covered credit transactions in both 2022 and 2023, but not 500 or more in both 2022 and 2023: January 1, 2026 and begin reporting data on June 1, 2027.

Note, however, that the final rule has been stayed for all affected institutions by the trial court in Monticello Banking Company v. CFPB, No. 6:23-cv-00148-KKC (E.D. Ky.). While the final rule is on hold pending resolution of this litigation, as well as additional litigation filed in the Southern District of Texas, we recommend that factors and other participants in the commercial finance space begin considering their potential compliance burden now. 

Additionally, engaging with legal counsel or a regulatory consultant is crucial to navigate the complexities of the new rules and ensure compliance posture is robust. Factors should also consider participating in industry groups or forums to stay updated on emerging trends and best practices in compliance. These steps can help to avoid costly penalties and maintain smooth, compliant business operations.

The views expressed in the Commercial Factor website are those of the authors and do not necessarily represent the views of, and should not be attributed to, the International Factoring Association.