The U.S. Court of Appeals for the Third Circuit recently ruled that the application of Pennsylvania usury laws to auto title loans made to Pennsylvania residents who travel outside of Pennsylvania to obtain such loans does not violate the Commerce Clause of the U.S. Constitution.  The decision could have significant implications for all providers of consumer credit whose operations involve cross-border lending.

In TitleMax of Delaware, Inc. v. Weissman, the Pennsylvania Department of Banking (DOB) issued a subpoena to TitleMax requesting documents regarding TitleMax’s interactions with Pennsylvania residents, including loan agreements between TitleMax and Pennsylvania residents.  TitleMax makes auto title loans from brick-and-mortar locations outside of Pennsylvania.  The entire loan process—from application to the execution of a loan agreement to the disbursement of funds—takes place at such locations, with a borrower receiving the loan proceeds at a brick-and-mortar location in the form of a check drawn on a bank outside of Pennsylvania.  TitleMax has no offices, employees, agents, or brick-and-mortar locations in Pennsylvania and is not licensed in Pennsylvania.  It claimed that it never used employees or agents to solicit Pennsylvania business and, while its advertisements could reach Pennsylvania residents, it did not run television ads in Pennsylvania.

Under the loan agreement, a borrower grants TitleMax a security interest in the vehicle which TitleMax records with the appropriate authority in the borrower’s state, such as the Pennsylvania Department of Transportation (PennDOT).  TitleMax also conducts various activities in the borrower’s state (which the Third Circuit referred to as “servicing activities”), such as collecting payments, sending phone calls or text messages, and repossessing vehicles.  Borrowers can make loan payments using various methods (e.g., mail, calling TitleMax to use a debit card, using a local money transmitter to send funds to a TitleMax location) that allow them to remain physically present in their home states.

TitleMax charges interest rates that are substantially in excess of the rates allowed by the Pennsylvania Consumer Discount Company Act or the state’s Loan Interest and Protection Law.  It stopped making loans to Pennsylvania residents after receiving the DOB’s subpoena and filed an action in federal district court seeking injunctive relief for, among other things, Commerce Clause violations.  The DOB separately filed a petition to enforce the subpoena in Pennsylvania state court.  The district court, after concluding that the DOB’s petition did not require it to abstain from hearing the case under the Younger abstention doctrine, found that the subpoena’s effect was to apply Pennsylvania usury laws extraterritorially in violation of the Commerce Clause.

The Third Circuit reversed and ordered the district court to enter judgment in favor of the DOB.  After agreeing  with the district court that Younger abstention was not a bar to reaching the merits of the case, the Third Circuit set forth the law applicable to a Commerce Clause analysis as follows:

A state law that directly controls commerce wholly outside its borders violates the dormant Commerce Clause, regardless of whether the state legislature intended for the statute to do so.  If the state statute does not have such extraterritorial reach or discriminate against out-of-staters, then it will be upheld unless the burden on interstate commerce is “clearly excessive in relation to the putative local effects.” (citations omitted.)

In the first step of its analysis, the Third Circuit concluded that applying Pennsylvania usury laws to TitleMax did not violate the extraterritoriality principle because TitleMax conducted servicing activities in Pennsylvania and obtained security interests in property located in Pennsylvania.  The Third Circuit stated:

TitleMax’s transaction with Pennsylvanians involve both loans and collection, and those activities do not occur “wholly outside” of Pennsylvania.  TitleMax’s transactions involve more than a simple conveyance of money at a brick-and-mortar store in a location beyond Pennsylvania’s border.  Rather, the loan creates a creditor-debtor relationship that imposes obligations on both the borrower and lender until the debt is fully paid.  For instance, Pennsylvanians with TitleMax loans made payments to TitleMax while physically present in the state.  In addition, TitleMax’s loan agreements grant TitleMax “a security interest in the Motor Vehicle,” which in the case of a Pennsylvania borrower is a Pennsylvania-registered automobile.  TitleMax records these liens with PennDOT and may repossess the vehicle if the consumer defaults on his loan.  Thus, by extending loans to Pennsylvanians, TitleMax takes an interest in property located and operated in Pennsylvania. (citations omitted.)

While the Third Circuit’s conclusion on extraterritoriality appears to have been based on TitleMax’s “servicing activities” and security interests, the Court suggested in a footnote that the extraterritoriality principle might not have been violated even if TitleMax did not engage in such activities or take security interests.  The Third Circuit stated:

[E]ven if TitleMax’s transactions were understood to be limited to ‘origination’ of the loan, our precedent makes clear that contracts between a Pennsylvanian and an out-of-stater do not occur ‘wholly outside’ Pennsylvania….Under the “traditional” approach [to the territorial scope of contracts], a contract is “made” in the state where the offer is accepted.  Under the “modern” approach, contracts formed between citizen of different states “implicate the regulatory interests of both states.”  Here, TitleMax extended credit to Pennsylvanians and, under the modern view, it does not matter that the consumers would have been physically outside of Pennsylvania when the transaction was initiated.

In the second step of its analysis, the Third Circuit looked at whether the burdens from Pennsylvania’s usury laws being applied to interstate commerce substantially outweighed the local benefits.  The Third Circuit found that (1) the application of Pennsylvania usury laws to transactions with Pennsylvanians did not put TitleMax in a different position than an in-state lender, and (2) the fact that TitleMax could be subject to different usury limits depending on the borrower’s state of residence was not a clearly excessive burden on interstate commerce because “a burden on a lender is not a burden on interstate commerce” and “a lack of uniformity in state interest rates is not an undue burden.”  With regard to local benefits, the court found they weighed in favor of applying Pennsylvania law to TitleMax because they protect the state’s residents from usurious lending rates.

In concluding there was no Commerce Clause violation, the Third Circuit expressly refused to follow the Seventh Circuit’s decision in Midwest Title Loans, Inc. v. Mills, which it called “unpersuasive.”  In Midwest Title, which dealt with very similar facts, the Seventh Circuit found that applying Indiana law to auto title loans made in Illinois violated the Commerce Clause.  (The Third Circuit stated in a footnote that Midwest Title relied on the U.S. Supreme Court’s decision in Quill Corp. v. North Dakota, which is no longer good law.  However, in addressing in its brief why the Seventh Circuit should follow Midwest Title, TitleMax argued that Midwest Title is not grounded on Quill and instead is grounded on current Supreme Court precedent that, in applying the extraterritoriality doctrine, focuses on where the activity a state seeks to regulate is physically located to determine whether such regulation is constitutional.)

The Third Circuit’s decision thus creates a circuit split that could result in Supreme Court review if sought by TitleMax.  Most significantly, the decision also creates a risk for consumer credit providers with customers residing outside of the Seventh Circuit, particularly those with customers residing in the Third Circuit, that credit agreements entered into exclusively at brick-and-mortar locations could nevertheless be subject to usury challenges by regulators and attorneys general from states where they do not have locations but that are a source of customers.  It is also likely to affect the choice of law analysis in usury and other civil litigation brought by borrowers against lenders located in other states where the interest rates in question are lawful.