A group of small businesses and their individual owners have filed a putative class action lawsuit in a New York federal district court against online lender Kabbage, Inc. that alleges Kabbage engaged in a “rent-a-charter” scheme to make loans at interest rates that were usurious under state law.
According to the complaint, Kabbage entered into the scheme with Celtic Bank, a foreign state-chartered bank in Utah, which has no maximum rate limit for commercial loans. More specifically, the named plaintiffs allege:
- Celtic acts as lender in name only—it owns the receivables for just two days and “does not lift a finger to service the loan”
- Kabbage is contractually obligated to buy 100% of all of the loans it originates from Celtic
- Kabbage “in economic reality” markets, underwrites, prices, approves, funds, and collects upon 100% of the loans and bears 100% risk of loss.
- Because Celtic retains no ownership or monetary interest in the loans, it bears no economic risk of loss due to a borrower’s non-payment (In June 2015, Kabbage’s “Program Management Agreement” with Celtic was amended to eliminate the 5% participation interest retained by Celtic.)
- Celtic could not make and keep the loans on its balance sheet because they would create an unacceptable risk under FDIC regulations
The complaint includes claims for violations of state usury laws (California, Massachusetts, Colorado, New York) and racketeering and conspiracy under federal RICO statutes. It also includes claims for violations of various state laws other than usury laws, including the California Financing Law Code (CFLC). In connection with the CFLC claims, the plaintiffs allege that the unlawful practices in which Kabbage engaged included acting as an unlicensed broker for commercial loans and “obtaining an arbitration provision through an unlicensed broker, which renders the arbitration provision void.” They also make a UDAP claim under Massachusetts law in which they allege that Kabbage’s loan agreements were “contracts of adhesion” that included “unconscionable and unfair provisions” such as provisions that required the plaintiffs to waive the right to a jury trial, waive the right to participate in a class action, and waive the right to seek legal redress in their home state.
In view of these allegations, it appears that Kabbage’s loan agreements included a mandatory arbitration provision with a class action waiver that the plaintiffs are seeking to invalidate. One of the exhibits to the complaint, a report issued by a rating agency in connection with a securitization offered by Kabbage, indicates that a similar lawsuit was filed against Kabbage in November 2017 and that Kabbage intended “to seek to resolve the matter in arbitration.” This suggests that Kabbage will move to compel arbitration in this new lawsuit.
We believe that Kabbage will prevail if the only basis for opposing the motion to compel arbitration is that Kabbage acted as a non-licensed broker. Under the Federal Arbitration Act (FAA) and the U.S. Supreme Court’s “Prima Paint” doctrine, a challenge to the validity of the contract as a whole is for the arbitrator to decide, while a challenge to the arbitration provision specifically is for the court to decide. For example, the Supreme Court has enforced an arbitration clause even though it was contained in a payday loan agreement alleged to be usurious, illegal and void ab initio under state law because those defenses challenged the loan agreement as a whole, not just the arbitration clause.
In addition, the Supreme Court has held that jury trial and class action waivers within an arbitration provision are valid and enforceable under the FAA, which preempts inconsistent state law. See, e.g., Kindred Nursing Ctrs. Ltd. P’ship v. Clark, 137 S. Ct. 1421, 1427 (2017) (states may not “adopt a legal rule hinging on the primary characteristic of an arbitration agreement—namely, a waiver of the right to go to court and receive a jury trial”); AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 339 (2011) (FAA preempted California state law prohibiting class action waivers in consumer arbitration provisions).