Since 1863 when Congress passed the National Bank Act, the issue of federal preemption of state law, particularly in respect of interest rates, has generated conflict with the states. That issue continues to proliferate over 150 years later. This week, another shot was fired over the bow.
The Attorneys General of 19 states and the District of Columbia (the “AGs”) on June 27, 2018, publicly opposed to previously proposed pieces of legislation pending in Congress often referred to as the “Madden fix” bills. Namely, the AGs made their views against HR 3299 (“Protecting Consumers’ Access to Credit Act of 2017”) and HR 4439 (“Modernizing Credit Opportunities Act”) in a letter (“AG Letter”) to Majority Leader McConnell, Minority Leader Schumer, Chairman Crapo, and Ranking Member Brown. A copy of the letter can be found here: AG Letter. HR 3299 passed the U.S. House of Representatives and is pending in the Senate and revises various laws to state that a loan valid when made does not become invalid when it is sold, transferred or assigned. HR 4439 pending in a House committee would explicitly state that a bank’s being named lender is not affected by any arrangement is has with a service provider.
By way of background, as previously explained in many published articled and papers, the 2015 decision by the Second Circuit Court of Appeals in Madden v. Midland Funding, LLC precipitated uncertainty among financial services providers and the broader secondary market as the ruling found that a non-bank loan assignee could not enforce the terms of a loan made by a bank when the bank no longer held an interest in the loan. The consequence was, that some investors did not want to purchase loans made by banks in the Second Circuit (Vermont, Connecticut, and New York) above those states’ usury caps. Similarly, studies found that prospective borrowers’ access to credit was diminished.
Many legal experts asserted that the decision cast doubt on and generally ignored the longstanding legal principle of “valid-when-made.” That is, a loan or contract that was non-usurious when it was made remains non-usurious when it is subsequently transferred. In the Madden case, however, the decision found that the sale and assignment of a loan to a non-bank by a national bank did not transfer to the loan purchaser the right to collect interest at the rate allowed by the national bank and specified in the loan contract. Critics of the decision (including President Obama’s own US Solicitor General) claim the court’s conclusion is wrong and violates contractual principles of assignment as well as the long standing legal precedent that loans are “valid-when-made.”
The AG Letter asserts that the “Madden” fix bills are not needed and, if passed, “would undermine the states’ ability to enforce our consumer protection laws.” The AG Letter argues that the bills expand the scope of federal preemption to allow non-banks to circumvent state usury laws. The letter then goes on to describe a true lender analysis based on economic interests. Specifically, the letter asserts a concern that the bills will allow behavior that the AGs arguably find as an illicit way to circumvent state usury laws:
“Many of these companies contract [sic] with banks to use the banks’ names on loan documents in an attempt to cloak themselves with the banks’ rights to preempt state usury limits. The loans provided pursuant to these agreements are typically funded and immediately purchased by the non-bank lenders, which conduct all marketing, underwriting, and servicing of the loans. The banks do not pay the expenses of the lending program and bear no risk of borrower default. As compensation for their nominal role, the banks receive only a small fee. The lion’s share of profits belong to the non-bank entities that, under these bills, would be exempt from state usury limits.”
The AG Letter goes on to support the decision in Madden as in line with previous bank preemption guidance, and the AG Letter cites guidance from the Office of the Comptroller of the Currency – one being the OCC Bulletin 2018-14, Core Lending Principles for Short-Term, Small-Dollar Installment Lending.
It should be noted that the proposed Madden fix bills do not call into question the various CashCall opinions that analyzed true lender theories. CashCall is an online payday lender extending credit at rates that can reach into the hundred percentiles. A 2014 West Virginia state court found an arrangement with a South Dakota bank to be wanted and found CashCall to be the true lender of the loans as it held the “predominant economic interest” in the loans. CashCall has been sued in other cases. Most notably in 2016 a federal court in California sided with the Consumer Financial Protection Bureau (“CFPB”) in finding that CashCall was the true lender. In that arrangement, a bank was not involved, rather a Native American tribe. The loan agreement had the tribe’s law as the governing law of the loans and claimed exemption from usury laws due to sovereign immunity. Interestingly, despite the CFPB’s requested to award some $300 million in damages the court only awarded a $10 million fine stating that borrowers were not misled about the rates they were being charged for the loans and received the benefit of their bargain. The CFPB is appealing the damages ruling.
It should also be noted that the OCC guidance noted above was focused on short-term, small-dollar installment lending, loans that are usually payable within two to 12 months and range from $300 to $5,000. The Cash Call cases similarly focused on short-term, small-dollar lending and found that entities simply cannot “rent-a-charter’ or “rent-a-tribe”; rather, there has to be a true partnership between the bank and the platform providing services to the bank like underwriting, marketing, and servicing. Click here for an OLPI podcast on this matter.
In the CFPB’s case against CashCall, the CFPB analyzed the true lender factors cited in the AG Letter. In that case, the CFPB took issue with Western Sky, who was affiliated with the Cheynne River Sioux Tribe to offer loans with annual percentage rates (“APRs”) between 90% to 343%.
The Second Circuit decision in Madden v. Midland did not consider the true lender analysis.
Similar to the AG Letter, certain consumer groups have also voiced concerns about the proposed Madden fix Bills allowing the “rent-a-charter”, concerns highlighted in CashCall as well. This AG Letter, along with other groups who frame the issue, in light of the pay day lending field ignore other products offered nationally by bank and non-bank partnerships. Namely, several banks partner with fintech companies,to offer traditional, non-pay-day loans, commonly with terms between 36 and 60 months and APRs less than 36%. Those programs offered through federally and state regulated banks offer enhanced consumer protection because banking regulators hold the banks responsible for the actions of their service providers and can both regulate and examine the third-party relationships banks have under existing banking guidance.
OLPI believes the following questions and analysis can help interested parties reach a consensus of what these Bills should and should not do:
- Can states and consumer groups agree on parameters that carve out payday lenders from taking advantage of these Bills – namely, would the rate agreed-to in the Military Lending Act of 36% APR be presumptively non-usurious and in line with legitimate bank vendor partnerships to allow banks the right to export their interest rate?
- Does the intended effect of the AG’s opposition have un intended and farther-reaching consequences and would the true lender analysis of “predominant economic interest” ensnare other types of loans traditionally subject to third party bank relationships and rattle secondary markets that would restrict the availability of credit, especially to those in need of credit? For example, sales of loans by bank soon after origination are commonplace for retail and auto purchases, credit cards, student loans and most notably mortgage loans. Most mortgage loans are sold to investors. Without the Madden fix bills, it is possible that the uncertainty that has been created in both the origination and secondary markets would likely proliferate and endanger long standing practices as the Madden decision has done in the Second Circuit. Before the alarm bells of the AGs are heeded, practical and long-term effects need to be considered.
- The century and a half tension between states’ rights and federal preemption may never be eliminated, but Congress must act as the governor to strike the balance between these two competing interests.
 The letter, dated June 27, 2018, is on the letter head of the Office of Attorney General of Colorado and the Office of Attorney General of Massachusetts, and it is signed by the Attorney Generals of Colorado, Massachusetts, California, District of Columbia, Hawaii (Acting, and by the Executive Director of Hawaii Office of Consumer Protection), Illinois, Iowa, Maryland, Minnesota, Mississippi, New Mexico, New York, North Carolina, Oregon, Pennsylvania, Rhode Island, Tennessee, Vermont, Virginia, and Washington State.