Substance Over Form

The CFPB, along with the State of Maine, filed an amicus brief with the Supreme Court of Maine, dated July 12, 2023, arguing that determining whether a loan is covered by TILA requires assessing all material facts and circumstances relevant to determine the borrower’s primary purpose of entering into the transaction. In short, this case involves borrowers who took out a balloon payment loan to pay off the remaining balance on a house that they sold. When the balloon payment came due, they could not pay off the loan, and the bank began the foreclosure process. The borrowers argued that the loan should be covered by Regulation Z, as it was consumer credit, and that they did not get the required disclosures nor did the bank determine their ability to repay. The bank argued that since the loan documents stated that the loan was for a commercial purpose, the loan was not subject to the requirements. The trial court determined that since the loan documents stated that the loan was for a commercial purpose, it was not subject to Regulation Z’s disclosure and ability to repay requirements. The borrowers appealed this decision.

How do you determine whether a loan is for consumer or commercial credit? Regulation Z bases that determination on substance over form – what is the primary purpose of the loan? Regulation Z generally applies to consumer credit and not commercial credit.

Consumer credit means credit offered or extended to a consumer primarily for personal, family, or household purposes. (§1026.2(a)(12))

Official Interpretations state that there is no precise test for what constitutes credit offered or extended for personal, family, or household purposes, nor for what constitutes the primary purpose. It references the commentary to §1026.3(a) regarding business purposes.

§1026.3(a)(1) states that an extension of credit primarily for business, commercial, or agricultural purposes is exempt from Regulation Z’s requirements. Official Interpretations to this section include a five-prong test to determine whether the loan is primarily for consumer or commercial purposes:

  1. The relationship of the borrower’s primary occupation to the acquisition. The more closely related, the more likely it is to be for a business purpose.
  2. The degree to which the borrower will personally manage the acquisition. The more personal involvement there is, the more likely it is to be for a business purpose.
  3. The ratio of income from the acquisition to the total income of the borrower. The higher the ratio, the more likely it is to be for a business purpose.
  4. The size of the transaction. The larger the transaction, the more likely it is to be for a business purpose.
  5. The borrower’s statement of purpose for the loan.

Official Interpretations also gives examples of business-purpose and consumer-purpose loans.

Examples of business-purpose credit include:

  • A loan to expand a business, even if it is secured by the borrower’s residence or personal property
  • A loan to improve a principal residence by putting in a business office
  • A business account used occasionally for consumer purposes

Examples of consumer-purpose credit include:

  • Credit extensions by a company to its employees or agents if the loans are used for personal purposes
  • A loan secured by a mechanic’s tools to pay a child’s tuition
  • A personal account used occasionally for business purposes

It is the institution’s responsibility to determine whether a loan is for commercial or consumer purposes. If the institution cannot determine whether the loan is primarily for commercial or consumer purposes, Interpretations to §1026.3(a) allow the institution to make the required Regulation Z consumer disclosures.

You should also be aware that certain states are now requiring Regulation Z style disclosures for commercial loans. The CFPB has determined that these disclosure requirements are not preempted by TILA. Our own Cliff Cook has been working closely with many lenders to ensure that their disclosures meet the states’ specific requirements.

If you have questions, we are here to help.


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