United States: No Recourse, No License? Not Quite.

In the July edition of Licensing Link, we addressed licensing developments for novel earned wage access products designed to allow employees access to their earned but unpaid wages on a non-recourse basis. In this article, we discuss the application of state licensing laws and recent licensing developments related to other innovative non-recourse financial products: income share agreements ("ISAs") and home equity option agreements. In light of current market conditions, and the increasing number of homeowners who have significant equity in their homes, home equity products—including home equity option agreements—may be attractive options for homeowners seeking funds for a variety of reasons. However, these innovative products carry their own unique regulatory considerations—including state licensing considerations in the states that have enacted laws to regulate these products as mortgage loans.

Home Equity Option Agreements

Many homeowners have enjoyed significant home price appreciation during and after the COVID-19 pandemic, in light of the continuing (and perhaps increasing) interest in remote work arrangements. Coupled together with significant increases in interest rates resulting in homeowners who are incentivized to remain in their homes—because they are enjoying fixed interest rates that are significantly lower than they could obtain today—has created a perfect storm of homeowners who have significant equity in their primary residences. A number of companies that offer home equity option agreements have sought to engage with these equity-rich homeowners who would benefit from access to funds for debt elimination, home improvement, or other personal expenses without incurring debt under a home equity line of credit or closed-end subordinate-lien mortgage loan.

A typical home equity option agreement involves providing a homeowner with a lump sum payment in exchange for a share of the future appreciation of their home. This lump sum payment is usually termed as an investment or an option to purchase an interest in the homeowner's property. Home equity option agreement providers typically receive proceeds from their investment when they exercise the option in connection with a sale of the property by the homeowner, or if the homeowner repurchases the option from the provider. Some companies also secure their option with a mortgage or deed of trust on the homeowner's property.

Because a home equity option agreement is structured as an option contract or an investment under which the provider bears the risk of loss, in the event that the homeowner's home decreases in value or does not appreciate sufficiently to allow the provider to recover its investment, many home equity option providers take the general position that the agreements are not loans. Nevertheless, two states recently enacted legislation to regulate home equity option agreements as mortgage loans and license providers as mortgage lenders. Maryland enacted legislation that became effective on July 1, 2023, and which amends the Maryland Mortgage Lender Law to specifically require a mortgage lender license in order to enter into home equity option agreements with Maryland consumers. The amended Mortgage Lender Law requires a license to make a "mortgage loan," with a "mortgage loan" now defined to include any agreement that evidences:

Connecticut previously amended its Mortgage Lenders, Correspondent Lenders, Brokers and Loan Originators Law in October 2021 to require a mortgage lender license prior to entering into a "shared appreciation agreement," which the law defines similarly to Maryland as:

Income Share Agreements

Generally speaking, ISAs are agreements under which students are provided education funding on the condition that the student pay an agreed-upon percentage of the student's future income to the ISA provider over a defined, post-graduation timeframe. Many ISAs do not require customers to pay anything until their income exceeds a contractually defined floor. A percentage of income exceeding that floor is paid to the ISA provider as an investment return—potentially subject to a cap on overall payments depending on the terms of the specific ISA at issue. Under many common ISA structures, it is conceivable that some customers will ultimately pay nothing in the defined, post-graduation timeframe and, therefore, will see the ISA expire without any payment obligation; other customers will pay an amount less than the funding originally provided; and a final set of customers will pay amounts exceeding the original funding (though, as noted, frequently subject to a total payment cap). While most ISAs provide educational funding, similar products, such as litigation funding and merchant cash advances, exist to provide funding to consumers, small businesses, and even professional musicians.

Given their structure, ISA providers historically took the position that ISAs are not credit, and therefore are not subject to the requirements of many consumer financial protection laws. The CFPB appeared to reject this position in a September 2021 consent order with an education finance nonprofit, in which the CFPB took the position that the nonprofit's "ISAs are credit under the CFPA because they grant consumers the right 'to defer payment of a debt, incur debt and defer its payment, or purchase property or services and defer payment for such purchase,'" although the CFPB did not impose a civil money penalty on the nonprofit in light of its good faith and substantial cooperation with the CFPB.

Several states also have moved to extend existing licensing laws or enact new laws to require licensing, registration, or other requirements to be approved by financial services regulators to companies offering ISAs. Earlier this year, Maryland Governor Wes Moore signed House Bill 913, which enacts a new registration requirement to act as a "student financing company" in Maryland, with "student financing" defined to include ISAs. House Bill 913 takes effect on October 1, 2023, and "student financing companies" will have until March 15, 2024 to register with the Maryland Office of Financial Regulation. Previously, the Washington Department of Financial Institutions issued guidance in November 2020 to clarify that most ISAs constitute "loans" for purposes of the Washington Consumer Loan Act, which requires a license to make consumer loans of any dollar amount or interest rate. In 2021, Colorado enacted its Student Loan Equity Act, which requires private student lenders to register; the Colorado Uniform Consumer Credit Code administrator subsequently issued proposed regulations to clarify that ISAs constitute a "consumer credit transaction" that is subject to the Uniform Consumer Credit Code, including the requirement to hold a license to make "supervised loans" of $75,000 or less with APR exceeding 12%. (A hearing on the proposed ISA rule is scheduled for August 25, 2023.) In March 2023, the California Department of Financial Protection and Innovation issued proposed regulations under the California Consumer Financial Protection Law that would, if finalized, require providers of certain financial products or services to register with the DFPI. The proposed regulations would, if finalized, require providers of education financing, including ISAs, to register with the DFPI and adhere to the limits on interest rates and charges applicable to consumer lenders licensed under the California Financing Law. (In exchange, the proposed regulations provide that ISA providers who register with the DFPI and adhere to the CFL rate and fee limitations would be deemed to not be "engaged in the business" of a finance lender under the CFL and would not be required to hold a CFL license.) Last, Illinois introduced legislation in March 2023 that would require ISA providers to obtain a student loan servicer license in order to offer ISAs in Illinois. That bill passed the Illinois House of Representatives, but did not pass the Illinois Senate prior to adjournment. Nevertheless, we expect to see additional states attempt to enact legislation, promulgate regulations, or issue guidance to regulate and license providers of income share agreements.

Recent state law developments related to ISAs and home equity option agreements show that state regulators remain attentive to novel financial products, including nonrecourse products. Companies engaged in offering nonrecourse financial products should closely track state law developments to ensure that they remain compliant with state licensing laws.

Footnotes

1. Md. Code Ann., Fin. Inst. § 11-501.

2. Conn. Gen. Stat. Ann. § 36a-485.

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