The State of Colorado is challenging the marketplace lending model. On February 15, 2017, the Administrator of the Uniform Consumer Credit Code for the State of Colorado (“Colorado”) sued Avant and Best Egg (in separate actions), claiming in both actions that they violated Colorado’s usury rate and entered into loan agreements containing a governing law provision other than Colorado. Click here to see the Complaint against Avant and hereto the see the Complaint against Best Egg. Colorado sued Avant and Best Egg, but did not sue their partner banks, WebBank and Cross River, respectively. The Complaints allege that Avant and Best Egg are the true lenders.
Shortly after, WebBank and Cross River separately sued Colorado seeking Declaratory Judgement and Injunctive Relief. Click here to see WebBank’s Complaint (Cross River’s Complaint is substantively the same). They argue that Colorado’s actions are a direct affront to their exercise of their rights to export their interest under federal law, and, therefore, the state law Colorado relies on is completely preempted.
On April 25, 2017, Colorado filed a Motion to Dismiss both Complaints for Declaratory Judgment and Injunctive Relief. Click here to see Colorado’s Motion to Dismiss against WebBank (Colorado’s Motion to Dismiss against Cross River is substantively the same). Colorado, among other things, argues that the action is already being handled in the cases brought against Avant and Best Egg – and WebBank and Cross River have no standing to bring a complaint against Colorado.
The motions filed by Colorado against WebBank and Cross River are fairly similar, so focusing on the motion to dismiss against WebBank provides a good overview of both actions. In the WebBank action, Colorado argues that Avant “is the true lender of the loans—performing the tasks fundamental to the business of lending and holding the predominant economic interest in the loans.” It alleges that WebBank only receives about 1% of the profit in the loan for “its nominal role.”
Colorado initially argues that WebBank’s action for declaratory judgement should be dismissed based on the well-pleaded complaint rule. The “well-pleaded” complaint rule provides that “absent diversity jurisdiction, a case in not removable if the complaint does not affirmatively allege a federal claim.” See Ben. Nat’l Bank v. Anderson, 539 U.S. 1, 6 (2003). There seems to be two issues with this position: (1) WebBank was purposely left out of Colorado’s initial complaint (although this theory might apply if Avant brought the federal action for declaratory judgment), and (2) diversity jurisdiction does apply as to Avant and WebBank vis-a-vis Colorado. Avant’s principal place of business (which is used to determine diversity jurisdiction) is Illinois, and WebBank’s principal place of business is Utah.
Second, Colorado argues that WebBank’s action should be dismissed because WebBank’s injury is too attenuated. It states, among other things, that WebBank’s claim that the action against Avant indirectly injures WebBank through the secondary investor market does not give rise to standing per Goleta Nat’l Bank v. Linderfelt, 211 F. Supp. 2d 711 (E.D. N.C. 2002). Similarly, Colorado argues that WebBank’s contention that it stopped making loans in Colorado through Avant is a self-inflicted injury that cannot give rise to standing. Colorado does not directly address WebBank’s contention that the suit challenges WebBank’s overall business model.
Finally, Colorado argues that “interest exportation does not preempt the application of state usury laws to non-banks as a matter of law.” Colorado seems to acknowledge WebBank’s right to preempt Colorado’s usury rate based on DIDA (the Depository Institutions Deregulation and Monetary Control Act of 1980 – extending the National Bank Act’s preemption to FDIC-insured state banks). Colorado argues that WebBank is trying to assign its preemption to Avant – that Avant is the lender. Colorado points to the proposed House Bill 5724 codification of the common law “valid when made” doctrine, as showing that valid when made is not an established doctrine because that bill was never enacted. This ignores the fact that the Bill was introduced to correct the Second Circuit decision in Madden v. Midland –where the Supreme Court declined to hear the case and the Solicitor General noted that the Second Circuit got the law wrong (in part by ignoring the valid when made doctrine). Congressman McHenry notes that the Bill was introduced because the Second Circuit’s “reading of the National Bank Act was unprecedented and has created uncertainty for fintech companies, banks, and the credit markets.” See McHenry’s press release regarding HR 5724. Colorado in fact relies on the Midland decision although it was not a true lender case and may be limited to the narrow factual circumstances primarily that the debt was charged off when sold.
Colorado also argues that the valid when made doctrine is not applicable because “there is no ‘subsequent usurious transaction’ between WebBank and Avant that is alleged to invalidate a consumer’s loan obligation. Instead, Avant merely purchased the subject consumer loans from WebBank.” This is a difficult argument to follow. Colorado sued Avant claiming that Avant loans are usurious and Avant, and not WebBank, is the true lender. Colorado points out that Avant buys the loans from WeBank within two business days of the loans being made. Relying on Midland in the Avant action, Colorado states that Avant cannot “enforce a bank’s federal interest rate exportation rights when they purchase loans from banks (or purchase loan receivables) because banks cannot validly assign such rights to non-banks.” It seems to imply that Colorado is not saying the loans are invalid (due to Avant having a Supervised Lender’s License), but rather the loans just need to be limited to the Colorado usury rate –yet, as noted, the argument is difficult to follow.
This is just a broad overview of a crucial case that could impact the future of marketplace lending—as well as other loan sales by banks. These actions in Colorado go to the heart of the marketplace lending programs that created this industry – if the Court issues an order agreeing with WebBank and Cross River, the headache of Midland will be mitigated by a case with facts that directly relate to the entire industry. It will embolden the secondary market and provide insight on how FDIC-insured state banks can structure relationships with platforms to truly export its interest rates. If the Court abstains, remands to state court, or rules against WebBank and Cross River, it will be a direct affront to the marketplace model. It will rock the entire industry and would no doubt be appealed to the Tenth Circuit and possibly the Supreme Court. To make matters worse, such a decision could also impact sales of loans by banks — commonplace throughout the industry.