Earlier this year, the California Department of Business Oversight (DBO) issued a draft rulemaking relating to the scope of the agent of a payee exemption (the “Exemption”) under the Money Transmission Act, Cal. Fin. Code § 2000 et seq. (MTA). As we observed at the time, the rulemaking affirms a broader interpretation of the scope of the Exemption than has been historically applied. However, a new interpretive opinion from the DBO appears to potentially narrow how the Exemption applies to payment processors that facilitate payments on behalf of consumer-facing merchants. This interpretation, if more widely applied, could risk undermining well-established compliance approaches for companies that provide payment processing services.
A brief overview of the Exemption and why it matters
The scope of the Exemption is a crucial factor for any company involved in facilitating payments—as a marketplace platform, a billing service, a payment facilitator, or otherwise—because California, like almost all other U.S. states, regulates money transmitters under a state-specific licensing regime (in California's case—the MTA). Statutory definitions of money transmission are quite broad across the states and, typically, can cover any entity that receives money for transmission. Under the MTA, for example, unless otherwise exempt, a license is required to engage in “[r]eceiving money for transmission.” Cal. Fin. Code §§ 2010(q)(3), 2030(a).
The underlying basis of an exemption for agent of a payee transactions under state money transmission laws, including the MTA, is that the intermediary (a marketplace platform, a billing service, a payment facilitator, etc.) facilitates the receipt of payment by merchants or other payees, rather than facilitating the transmission of funds on behalf of a sender of funds. An entity providing this type of service often has a contractual relationship with the recipient under which the entity is appointed as an agent to receive funds on behalf of that recipient (i.e., the payee). The common law principle of agency suggests (although it is not always applied in the same manner by state regulatory agencies) that the receipt of funds by the agent should be treated as tantamount to the receipt of funds by the principal and, therefore, the agent does not receive the payor's funds for transmission.
How does the Exemption apply to payment processing?
California affirmed the Exemption in amendments to the MTA that were adopted in 2014. As defined by Cal. Fin. Code § 2010(l), an exempt transaction is one “in which the recipient of the money or other monetary value is an agent of the payee pursuant to a preexisting written contract and delivery of the money or other monetary value to the agent satisfies the payor's obligation to the payee.” A payor is a person that obtains goods and services and a payee is a person that provides those goods or services. So, if a transaction does not involve goods or services, it would not fall within the scope of the Exemption, even if other criteria are met. The draft regulations promulgated by the DBO earlier this year provided an expansive interpretation of what constitutes goods and services and, therefore, who could be a “payee” for purposes of the Exemption: “Any good or service, other than money transmission services, for which the payor has a payment obligation to the payee” (emphasis added).
What could the new DBO opinion change?
The new interpretive opinion addressed a payment processor (“Processor”) that provides payment processing services for online gaming merchants (“Merchants”) to enable the Merchants' customers to make payments for activities, including sports betting. According to the DBO, customers initiate transactions on a Merchant's website to prefund an account with the Merchant for online gaming activities. To do so, each customer provides banking credentials (for ACH payments) directly to the Processor through the Processor's inline frame on the Merchant's website. Once the payment is authorized, the Processor initiates a debit from the customer's bank account and receives funds in a Processor bank account for the benefit of the Merchant. The Processor then transmits the funds to the Merchant.
The Processor provides these services to the Merchant pursuant to a written payment processing agreement that establishes that the Processor is an agent of the Merchant and that the “delivery of funds from customers to [Processor] fully satisfies the consumer's obligation to merchant with respect to goods and/or services provided by merchant to consumers.”
In spite of this agent of a payee language, the DBO concluded that the Processor's services did not come within the Exemption because the customer is prefunding an account to subsequently engage in online gaming activity with the Merchant and, therefore, “the money received by [Processor] is not owed by the Customer to the Merchant.” Though not expressly stated, the DBO appears to be saying that the Merchant is not a “payee” because the Merchant is not owed money by the customer for the provision of services by the Merchant to the customer.
One interpretation of this DBO analysis is that it is consistent with prior rulings, including a February 2018 letter in which the DBO concluded that the Exemption would not apply to prefunding an account for betting (“advanced deposit wagering”): “[T]here is no payment obligation because the money is being put into an account for the user to use when he chooses; at the time the funds are being transferred to the account, there is no obligation by the person putting money into the account in the sense that that person is not paying anyone for goods or services.” Nevertheless, given that the intermediary in this case was a payment processor operating on the Merchant's own website, it also suggests broader limitations on the Exemption than the DBO's prior interpretation. It suggests that a payment processor could be excluded from the agent of a payee Exemption if it acquires transactions on behalf of a merchant that provides financial services (e.g., open loop stored-value gift cards or funds transfers) or even the sale of the merchant's “closed loop” gift cards if the DBO were to conclude that there is no “obligation” of the payor with respect to such transactions.
Notwithstanding a DBO interpretation as described above, an opposite conclusion is not without merit. One could reason that there is a payment obligation in connection with such transactions—as with the transactions on an online gaming merchant's website—because once the merchant agrees to the transaction (e.g., agrees to fund the account or sell the gift card), the consumer is obligated to pay for the transaction, and the payment processor facilitates the merchant's acceptance of payment to meet that obligation. While the DBO's interpretation does not appear to be consistent with this approach, what the DBO's new ruling does make clear is that even with an impending rulemaking that likely will affirm a broad interpretation of the Exemption, payments companies still need to consider whether specific activities in which they engage meet the criteria that the DBO has set forth in its opinion letters and, when finalized, the agent of payee rulemaking.
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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