The OCC and FDIC issued proposed rules this week intended to eliminate the uncertainty created by the Second Circuit’s decision in Madden v. Midland Funding.  In that decision, the Second Circuit held that a nonbank that purchased charged-off loans from a national bank could not charge the same rate of interest on the loan that Section 85 of the National Bank Act (NBA) allowed the national bank to charge.  The proposals would codify each agency’s interpretation that a bank loan assignee can charge the same interest rate that the bank is authorized to charge under federal law.  Comments on the OCC’s proposal must be submitted by January 21, 2020.  Comments on the FDIC’s proposal must be submitted no later than 60 days after the date the proposal is published in the Federal Register.

The rules rely on the power of national banks, federal savings associations, and state banks to make loans, assign loans to third parties, and charge interest on such loans.  With regard to interest rate authority, the OCC points to Section 85 (applicable to national banks) and 12 U.S.C. §1463(g) (the provision of the Home Owners’ Loan Act (HOLA), patterned on Section 85 and applicable to both federal and state-chartered savings associations).  These provisions give national banks and savings associations “most favored lender” status, meaning they can charge interest at the highest rate allowed to any lender by the laws of the state where the national bank or savings association is located and can also “export” that rate to borrowers in other states, regardless of any other state law purporting to limit interest charges.  The FDIC points to Section 27(a) of the Federal Deposit Insurance Act (FDI Act), 12 U.S.C. §1831d(a), also patterned on Section 85, which allows an FDIC-insured state bank to export to out-of-state borrowers the interest rate permitted by the state in which the state bank is located to its most favored lender, regardless of any contrary laws of such borrowers’ states.

As support for their interpretations, both agencies reference the “valid-when-made” and “stands-in-the shoe” principles.  As articulated by the agencies, the “valid-when-made” principle provides that a loan that is non-usurious at origination does not subsequently become usurious when assigned.  The “stands-in-the shoe” principle provides that a loan does not become usurious after assignment because the assignee stands in the assignor’s shoes when enforcing the contractually agreed upon interest term.

The OCC rule would provide: “Interest on a loan that is permissible under 12 U.S.C. 85 [or 12 U.S.C 1463(g)(1)] shall not be affected by the sale, assignment, or other transfer of the loan.”

The FDIC rule would provide: “Whether interest on a loan is permissible under section 27 of the Federal Deposit Insurance Act is determined as of the date the loan was made.  The permissibility under section 27 of the Federal Deposit Insurance Act of interest on a loan shall not be affected by any subsequent events, including … the sale, assignment, or other transfer of a loan.”

The OCC’s rule would be added to 12 C.F.R. §7.4001 which interprets a national bank’s interest rate authority under Section 85 and 12 C.F.R. §160.110 which interprets a savings association’s interest rate authority under 12 U.S.C. §1463(g).  The FDIC’s rule would become part of previously-reserved 12 C.F.R. Part 331.  Part 331 would be titled “Federal Interest Rate Authority” and in addition to the new rule above addressing loan assignments, would include other rules intended to implement Section 27 of the FDI Act as well as FDI Act Section 24(j) (which deals with the application of state law to a branch of a state bank located in a state in which the bank is not chartered).

Both agencies elected not to address a second major source of uncertainty concerning the interest rate authority of loans that are made by banks with substantial origination, marketing and/or servicing assistance from nonbank third parties.  At least where the nonbank agent acquires the “predominant economic interest” in the loans, the interest charges have been challenged by enforcement authorities and plaintiffs’ attorneys on the theory that the nonbank agent is the “true lender,” and therefore the loan is subject to state licensing and usury laws.

The OCC stated that its proposed rule “would not address which entity is the true lender when a bank makes a loan and assigns it to a third party” and that “[t]he true lender issue, which has been considered by courts recently, is outside the scope of this rulemaking.”  Likewise, the FDIC stated that its proposed rule does not “address the question of whether a State bank … is a real party in interest with respect to a loan or has an economic interest in the loan under state law, e.g. which entity is the ‘true lender.’”  The FDIC added that “it will view unfavorably entities that partner with a State bank with the sole goal of evading a lower interest rate established under the law of the entity’s licensing State(s).”

We are pleased that the OCC and FDIC have squarely addressed the problem created by the Madden decision (an action we have advocated for) but disappointed that they have chosen not to grapple with the “true lender” issue at this time.  As recognized by the U.S. Supreme Court in its seminal Marquette decision, banks have a need for certainty in their lending operations.  It is Congress or the banking agencies, through their legislative, rule-making and supervisory powers, and not the courts, through piece-meal litigation, who are best suited to determining when a loan is properly made by a bank or savings association under its home-state rate authority.

In our view, each agency should adopt a rule that provides loans funded by a bank in its own name as creditor are fully subject to Section 85 or Section 27(a) and other provisions of the NBA, HOLA or FDIC Act, as applicable, for their entire term.  The rule should clarify that this does not give financial institutions a free ride; rather, they are expected to manage and supervise the lending process in accordance with OCC or FDIC guidance and will be subject to regulatory consequences if and to the extent that loan programs are unsafe or unsound or fail to comply with applicable law.  In other words, it is the origination of the loan by a bank or savings association (and the attendant legal consequences if the loans are improperly originated), and not whether the bank retains the predominant economic interest in the loan, that should govern the regulatory treatment of the loan under federal law.

We are also disappointed by the FDIC’s statement that it will take an unfavorable view of bank-nonbank partnerships, where the “sole goal [is] evading” state-law rate limits.  This statement appears to be taken directly from the bulletin issued by the OCC in May 2018, setting forth core lending principles and policies and practices for short-term, small-dollar installment lending by national banks, federal savings banks, and federal branches and agencies of foreign banks.  The FDIC’s statement could be read to call into question a valuable distribution channel for bank loans and seems at odds with the broad view of federal preemption enunciated by the FDIC in the proposal with respect to Section 27(a) as well as the FDIC’s stated goal of eliminating uncertainty regarding the enforceability of interest rate terms.  At the very least, the FDIC should clarify that the propriety of relationships of this type is a matter for the FDIC to address in the supervisory process and not a matter for the courts to address as a matter of law.

Despite our griping that the OCC and FDIC are not dealing with the “true lender” argument in their proposals, we believe that, overall, the proposals represent a very positive step forward.  Unsurprisingly, the proposals have already generated a storm of criticism and threats of eventual litigation from consumer advocates with more paternalistic views than our own.  Madden and “true lender” controversy are likely to remain for many years in the future.