Opportunity Financial LLC (OppFi) has filed a cross-complaint against the Commissioner of California’s Department of Financial Protection and Innovation (DFPI), asserting that the DFPI’s reliance on the so-called “true lender doctrine” in order to subject OppFi to interest rate limitations under the California’s Financing Law (CFL) constitutes adoption and enforcement of an “underground regulation”, which is impermissible under California’s Administrative Procedure Act (APA).  The cross-complaint explains that “[b]ecause DFPI did not submit its ‘true lender doctrine’ to the APA’s rule making process, it is invalid as an ‘underground regulation’ and cannot be enforced.”  Accordingly, OppFi maintains, the court should issue a “peremptory writ of mandate setting aside and rendering invalid use of the true lender doctrine” because the DFPI failed to comply with the rulemaking requirements of the APA; and should declare “that DFPI’s adoption of the true lender doctrine . . . violated the rulemaking requirements of the APA and is therefore invalid.”

OppFi’s cross-complaint, filed October 17, 2022 along with an answer in response to the DFPI Commissioner’s earlier cross-complaint, names the DFPI itself as a defendant in addition to the Commissioner.

The litigation between OppFi and the DFPI concerns the applicability of California’s Fair Access to Credit Act (AB 539), effective January 1, 2020, which amended the CFL to include an interest rate cap of 36% plus the federal funds rate on certain consumer loans.  In March 2022, OppFi filed a declaratory judgment complaint in response to the Commissioner’s stated intent to enforce CFL interest rate caps against OppFi in connection with loans originated by OppFi’s bank partner.  The Commissioner responded with her cross-complaint asserting that the CFL interest rate caps applied to the loans in question because OppFi, not its bank partner, was the “true lender”, based on “the substance of the transaction” and the “totality of the circumstances”, primarily “which entity—bank or non-bank—has the predominant economic interest in the transaction.”  OppFi’s demurrer to the DFPI Commissioner’s cross-complaint was overruled

In its cross-complaint, OppFi points out that the “true lender doctrine” does not appear in any California statute or in any regulation promulgated by the DFPI, and no California statute requires a lender to have or retain any particular level of economic interest in a loan.  OppFi notes that “the DFPI’s underground adoption of its ‘true lender doctrine’ is a significant departure” from the way the CFL’s interest rate caps were enforced before enactment of AB 539, and that the DFPI intends for the “true lender doctrine” to apply generally to implement or interpret AB 539.  These factors, OppFi reasons, demonstrate that the DFPI now has adopted the “true lender doctrine” as a de facto or “underground” regulation, underscoring the need for DFPI’s reliance on the “true lender doctrine” to be subjected to the notice and comment rulemaking procedures required under the APA:

“The APA was designed to provide regulated entities notice of a regulation’s requirements so that they could conform their activities accordingly and, if necessary, test the authority of the agency to implement such a rule beforehand. Here, DFPI adopted the true lender doctrine without any formal notice at all, much less fair or adequate notice, and without complying with the APA.  Service providers like OppFi now face an existential threat to their businesses, as well as significant monetary penalties, based on an interpretation of the CFL adopted by the DFPI without complying with the APA.  They also face the challenge of complying with a vague and amorphous test that leaves the applicability of the CFL’s interest rate cap to the discretion of the regulator.  At base, this renders the CFL’s exemption for state-chartered banks meaningless.  The APA’s rulemaking procedures are intended to prevent these unfair results.”

The DFPI Commissioner responded to OppFi’s cross-complaint two days later with an ex parte application to strike the cross-complaint as improper under California’s civil procedure code, claiming ex parte relief was warranted because the cross-complaint, in conjunction with OppFi’s original complaint, “leaves the Commissioner at an untenable crossroads on how to respond.”  OppFi opposed the application to strike the same day, and the next day, the court denied the DFPI’s ex parte application, holding: “There are no exigent circumstances or good cause shown for emergency relief.  The application does not meet the standard for ex parte relief.”

We will continue to follow with greatest interest and concern this increasingly complex case, which we agree has the potential to create significant risks to the viability of certain bank – fintech partnerships.