It can be difficult to turn down an employee who asks for an advance on their earnings. However, there are lots of reasons for companies to think twice before making payroll advances to employees.
One big and obvious reason is the administrative burden. Another is the possibility that the advances will be subject to the disclosure requirements of the Federal Truth in Lending Act (TILA). Specifically, a company may be subject to TILA requirements if, when advancing payroll, it charges a fee which is treated as a finance charge, and has extended such payroll advances or other types of consumer credit more than 25 times in the preceding calendar year. Such advances may also be subject to state consumer credit laws and wage assignment statutes in the states where employees are located. Additionally, state laws regulating payday lenders may apply and require licensing if the company takes a post-dated check from the employee.
Now, there is yet another reason to think twice about making such advances. The Federal Consumer Financial Protection Bureau (CFPB) has issued a Proposed Rule (Rule), which is intended to regulate (some would say, shut down) companies that make payday loans or vehicle title loans. The theory behind the proposed regulation is that such loans carry high interest rates and, arguably, have the potential to trap consumers in a cycle of debt.
The bad news is that any company could become a “lender” subject to the Rule, whether or not it is a financial institution or otherwise in the business of making loans, if it makes payroll advances to its employees, and has made more than 25 such advances in the preceding calendar year. Unlike TILA, the Rule is not limited to loans which bear interest, are subject to any other finance charges, or are payable in more than four installments. Moreover, there is no cap on the dollar amount of loans which could be subject to the Rule. The only requirement is that the loans be made for personal, family, or household purposes. Accordingly, the Rule could apply to short-term loans made to executives.
Any loan made by a lender would be covered by the Rule if it has a maturity of 45 days or less. This would capture most payroll advances made to employees because payment will be due at the end of the next pay period. Longer-term loans are less likely to be a problem for non-financial companies because they would be covered by the proposed Rule only if the total cost of credit exceeds 36 percent per year and certain other requirements are met.
Compliance with the Rule will be burdensome because the company would be required to obtain detailed information about the employee’s ability to repay, including obtaining a credit report and a separate report from a new kind of reporting agency to be established pursuant to the Rule. Covered employers are also required to develop written policies and procedures to ensure compliance, and would be subject to record retention requirements. Loans of $500 or less would not be subject to the detailed requirements for evaluating the borrower’s ability to repay, but the company would still have to check the employee’s borrowing history and comply with other restrictions.
The Rule is not yet effective, and we will provide an update when the CFPB takes further action or provides additional guidance. However, now is a good time to review your company’s policies and practice with regard to payroll advances.