Opportunity Financial, LLC (OppFi) has filed a Demurrer to the cross-complaint filed by the California Department of Financial Protection and Innovation (DFPI) in which it asks the California trial court to reject the DFPI’s attempt to apply California usury law to loans made through OppFi’s partnership with FinWise Bank (Bank) by alleging that OppFi is the “true lender” on the loans.

In 2019, California enacted AB 539 which, effective January 1, 2020, limited the interest rate that can be charged on loans less than $10,000 but more than $2,500 by lenders licensed under the California Financing Law (CFL) to 36% plus the federal funds rate.  In March 2022, OppFi filed a complaint in a California state court seeking to block the DFPI’s attempt to apply the CFL rate cap to loans made through its partnership with the Bank.  OppFi’s complaint recites that prior to 2019, the Bank entered into a contractual arrangement with OppFi  (Program) pursuant to which the Bank uses OppFi’s technology platform to make small-dollar loans to consumers throughout the United States (Program Loans).  It alleges that in February 2022, the DFPI informed OppFi that because it was the “true lender” on the Program Loans, it could not charge interest rates on the Program Loans that were higher than the rates permitted to be charged by lenders licensed under the CFL.

OppFi’s complaint alleges that because the Bank and not OppFi is making the Program Loans and the Bank is a state-chartered FDIC-insured bank located in Utah, the Bank is authorized by Section 27(a) of the Federal Deposit Insurance Act to charge interest on its loans, including loans to California residents, at a rate allowed by Utah law regardless of any California law imposing a lower interest rate limit.  The complaint seeks a declaration that the CFL interest rate caps do not apply to Program Loans and an injunction prohibiting the DFPI from enforcing the CFL rate caps against OppFi based on its participation in the Program.

In response to the complaint filed by OppFi seeking to block the DFPI from applying California usury law to loans made through the partnership, the DFPI filed a cross-complaint seeking to enjoin OppFi from collecting on the loans and to have the loans declared void.  In the cross-complaint, the DFPI alleges that “OppFi is the true lender of [the Program Loans]” based on the “substance of the transaction” and the “totality of the circumstances,” with the primary factor being “which entity—bank or non-bank—has the predominant economic interest in the transaction.”  In the cross-complaint, the DFPI identifies various characteristics of the Program to demonstrate that OppFi holds the predominant economic interest in the Program Loans.  The DFPI claims that the Program Loans are therefore subject to the CFL and that OppFi is violating the CFL and the California Consumer Financial Protection Law (CCFPL) by making loans at interest rates that exceed the CFL rate cap. 

The DFPI also alleged additional CFL violations by OppFi, including the CFL’s “anti-evasion” provisions.  One of such provisions is Section 22326 which applies to “any person, who by any device, subterfuge, or pretense charges, contracts for, or receives greater interest, consideration, or charges than is authorized by this division for any loan….”  The other provision is Section 22324 which prohibits “contract[ing] for or “negotiat[ing] in this state for a loan to made outside of the state for purpose of evading or avoiding” California lending law.

In its Demurrer to the cross-complaint, OppFi argues that the DFPI’s claim that the Program Loans violate the CFL fails as a matter of law because the Program Loans were made by the Bank and loans made by a state-chartered bank are exempt from the CFL’s rate cap pursuant to the usury exemption for state-chartered banks in the state’s Constitution as well as the CFL’s exemption for such banks.  It also argues that the DFPI’s attempt to avoid this result by asserting that OppFi is the “true lender” on the Program Loans has no basis in California statutes or common law.  OppFi cites as dispositive two federal district court decisions in which the courts rejected the plaintiffs’ usury claims that were based on “true lender” theories, including a 2021 case involving OppFi, Sims v. Opportunity Fin., LLC.

OppFi also argues in the Demurrer that the DFPI’s other CFL claims fail as a matter of law.  With respect to the DFPI’s CFL claims based on its “anti-evasion” provisions, OppFi asserts that “it is not unlawful to take advantage of [statutory exemptions].”  It argues that “the Program is structured in a manner to lawfully qualify for the constitutional and statutory exemptions to interest rate caps in California.  If such conduct constitutes actionable ‘evasion,’ that would render the constitutional and statutory exemptions null and void.”

The Connecticut Department of Banking (“Department”) has issued a temporary cease and desist order (“Order”) that directs SoLo Funds, Inc., (“SoLo”) a fintech company that uses peer-to-peer technology to assist consumers in obtaining small dollar loans from third-party lenders, to immediately stop engaging in such activity because it is not licensed as a small loan company in Connecticut.  The Order also directs SoLo to stop enforcing loans made to Connecticut residents and make restitution of any amounts it obtained in connection with such loans together with interest.  In addition, the Order sets forth the Department’s intention to issue a permanent cease and desist order and to impose a civil penalty and other legal or equitable relief subject to SoLo’s right to request a hearing.

As described in the Order, SoLo’s website promotes its ability to “connect lenders and borrowers” through a mobile application (“Platform”).  The Department alleges that loans on the Platform are initiated by a consumer’s request for a certain loan amount, and include a proposed tip amount to the lender (“Lender Tip”) and a proposed tip to SoLo (“SoLo Tip”).  Consumers are encouraged to offer a Lender Tip in an amount up to 12% of the loan amount and a SoLo Tip of up to 9% of the loan amount.  The Department alleges that 100% of the loans to Connecticut residents originated on the Platform from June 2018 to August 2021 either contained a Lender Tip or a Solo Tip.

The Department also alleges:

  • SoLo controls many aspects of the loan transaction on its Platform, including the form of promissory note and TILA loan disclosures.
  • To lend or borrow using the Platform, lenders and borrowers are required to set up a special account at a designated bank.
  • SoLo assigns proprietary SoLo scores to borrowers to assist lenders in determining borrowers’ creditworthiness.
  • If the proposed terms of a loan request are satisfactory to a lender, the borrower executes a promissory note with the lender via the Platform and the lender funds the loan through the borrower’s account at the designated bank. On the due date, the designated bank initiated a debit from the borrower’s account for the lender’s benefit.
  • Upon loan consummation, lenders are required to pay the offered SoLo Tip [to SoLo] on the borrower’s behalf.
  • From at least June 2018 to the date the Order was issued, SoLo facilitated over 1,600 loans to over 275 Connecticut borrowers via the Platform, with $100 the most common principal loan amount, an average Lender Tip of $21, and an average SoLo Tip of $10. 
  • Regulation Z requires both tips to be included in the finance charge, resulting in APRs on the loans made to Connecticut borrowers ranging from approximately 43% to over 4280%.
  • The loan disclosures stated that the loans had 0% APRs.
  • Lenders are not permitted to communicate directly with borrowers and must collect delinquent loans through SoLo or consumer collection agencies under contract with SoLo. 
  • Some Connecticut borrowers were assessed a late fee equal to 15% of the principal loan amount, which was generally split equally between the lender and SoLo.  SoLo also charged other fees on delinquent loans, including an administrative fee, a synapse transaction fee, and a 20% recovery fee for its collection efforts.  Loans that remained unpaid after a “delinquency period” were referred by SoLo to collection agencies that were permitted to retain 30% of all payments received on defaulted loans.

Under Connecticut law, it is unlawful for any person, unless exempt, to engage “by any method, including, but not limited to, mail, telephone, Internet or other electronic means” in the following activity without having first obtained a small loan license from the Department: (1)  “[o]ffer, solicit, broker, directly or indirectly arrange, place or find a small loan for a prospective Connecticut borrower;” or (2)”any other activity intended to assist a prospective Connecticut borrower in obtaining a small loan, including, but not limited to, generating leads.”  (“Small loans” are defined as loans of $1500 or less with an APR greater than 12%.)

In addition to alleging that SoLo was required to hold a small loan license, the Department alleges in the Order that SoLo was required to be licensed in Connecticut as a consumer collection agency.

The Order also includes a claim for violations of the federal Consumer Financial Protection Act’s (CFPA) UDAAP prohibition.  The Department alleges that SoLo’s  activities made it a “service provider” to “covered persons” (lenders) under the CFPA and that SoLo engaged in deceptive acts and practices by providing false and misleading information to borrowers, including that the loans had 0% APRs.  The Department asserts that it is authorized to assert the UDAAP claim pursuant to Section 1042 of the CFPA.  Section 1042 authorizes a state regulator to bring an enforcement action to enforce the CFPA “with respect to any entity that is State-chartered, incorporated, licensed, or otherwise authorized to do business under State law (except [national banks and federal savings associations]).”

A California Court of Appeal recently found a bank liable to a judgment creditor under California’s Enforcement of Judgments Law for the bank’s registered agent’s mistake in misreading, and subsequently rejecting, a notice of levy.  Although the bank itself did not have knowledge of the mistake, the Court held the bank responsible through principles of agency, rendering the bank liable for amounts that the account holder drained from the account when the levy should have been in effect.

In Bergstrom v. Zions Bancorporation, N.A., the judgment creditor had a $4.1 million judgment against Northamerican Sureties, Ltd. and Robert S. Michaels.  In seeking to collect on the judgment, the judgment creditor learned that Michaels’ wife, Cheryl Pitcock, held two bank accounts at Zions, totaling $118,010.97.  Since California allows community property held by a debtor’s spouse to be used to satisfy a judgment against the debtor, the creditor served Zions’ registered agent, Corporation Service Company (CSC), a notice of levy on “all accounts standing in the name of” Northamerican, Michaels, and/or his spouse.

At the time CSC received the notice of levy, someone had underlined the words “Northamerican Sureties, Ltd.”  Unfortunately, the CSC employee mistakenly believed that the underlined entity was the party to be served, and erroneously rejected the notice because its principal was Zions, not Northamerican.  Upon notice of the rejection, the creditor immediately notified CSC of the mistake, but Pitcock had already substantially drained the accounts in the interim.

Pursuant to the applicable section of California’s Enforcement of Judgments Law, at the time of a levy, or promptly thereafter, a financial institution shall deliver the property unless it has “good cause” for failure or refusal.  The trial court accepted Zion’s argument that good cause existed for its failure to deliver the property because CSC followed the “custom and practice” of assuming the underlined entity was the person to whom the notice was directed.

The Court of Appeal reversed.  It explained that “good cause” includes a showing that the institution did not know or have reason to know of the levy.  The question of whether CSC – and, by extension, its principal, Zion – had reason to know turned on whether CSC acted unreasonably under the circumstances, i.e., whether it was negligent.

Turning to whether CSC was negligent, the Court of Appeal held that CSC’s conduct was unreasonable as a matter of law, reasoning that CSC’s very job is to read papers served on it, and that the custom and practice of reading only what was underlined was not controlling as to the standard of care.  In turning to the law of agency, the court emphasized the fundamental tenet that a principal is deemed to know what its agent knows while acting within the scope of the agent’s authority.  In rejecting Zions’ argument that CSC was merely its agent “for service of process, not its general agent,” the court held that the scope of CSC’s agency was precisely intended for this context.

Zions was able to avoid liability for a portion of the funds drained from the account.  Zions argued that its internal policy of responding to notices of levy includes freezing the affected funds by 4:00 p.m. the business day after the notice of levy is served, which the court found consistent with the statute requiring “prompt delivery.”  Therefore, Zions was only liable for the spouse’s withdrawals made after the bank would have instituted the hold, consistent with its internal policies. 

The Bergstrom decision demonstrates that depository institutions can be held liable for their registered agents’ mishandling of a levy.  For that reason, depository institutions should carefully vet their registered agents, and try to obtain appropriate protections in their agreements with their registered agents.

After moving alone in 2020 to reform its Community Reinvestment Act (CRA) regulation, the Office of the Comptroller of the Currency (OCC) has joined the Federal Deposit Insurance Corporation (FDIC) and Federal Reserve Board in issuing a joint notice of proposed rulemaking setting forth proposed amendments to their regulations implementing the CRA.  The action follows the OCC’s rescission in December 2021 of its 2020 CRA final rule and replacement of that rule with one that is largely based on the OCC’s 1995 CRA rule adopted jointly with the Federal Reserve and FDIC.  The OCC’s 2020 final rule, which was welcomed by some OCC-supervised institutions and widely criticized by consumer advocates, represented a change from a ratings system that was primarily subjective to one that was primarily objective.  While the agencies have acknowledged concerns about subjectivity in the current proposal, further review of the proposal is needed to determine whether the proposal adequately addresses those concerns.  Comments on the NPR must be received on or before August 5, 2022.

Below we provide highlights of the proposal.  In the coming weeks, we will explore the proposal in more detail, including how the proposal differs from the OCC’s rescinded rule, how assessment areas are delineated, the Community Development Test, and the impact of the rule on small, intermediate, and large banks.

Highlights of the proposal include the following:

Assessment areas.  Banks would continue to delineate facility-based assessment areas where they have their main offices, branches, and deposit-taking remote service facilities.  However, the proposal would tailor the geographic requirements for delineating facility-based assessment areas based on bank size.  For large banks, wholesale or limited purpose banks, such assessment areas would be required to consist of: (1) one or more Metropolitan Statistical Areas (MRAs) or metropolitan divisions; or (2) one or more contiguous counties within an MSA, metropolitan division, or the nonmetropolitan area of a state.  Consistent with current practice, small and intermediate banks could delineate facility-based assessment areas that include a partial county.

The proposal would require large banks to also establish retail assessment areas in any MSA or combined non-MSA areas of a state, respectively, in which it originated in that geographic area, at least 100 home mortgage loans, or 250 small business loans, outside of its facility-based assessment area.  Small and intermediate banks would not be subject to this requirement.  In the retail assessment areas, large banks would be evaluated only under the Retail Lending Test, and not under other performance tests.

Under the proposal, retail loans located outside any facility-based assessment area or retail lending assessment area for a large bank and outside of any facility-based assessment area for intermediate banks with substantial outside assessment area lending, would be evaluated on an aggregate basis at the institution level as part of the Retail Lending Test.

In addition to evaluating the community development performance of large banks, wholesale and limited purpose banks, and intermediate banks that elect evaluation under the Community Development Financing Test within each facility-based assessment area, the proposal would consider any additional qualifying activities that banks elect to conduct outside of facility-based assessment areas.  A bank would receive consideration for any qualified community development activity, regardless of location, in its overall rating, while being separately assessed for their performance in each of its facility-based assessment areas.

Performance Tests, Standards, and Ratings.  The evaluation framework would include four tests: a Retail Lending Test, a Retail Services and Products Test, a Community Development Financing Test, and a Community Development Services Test.  The proposal substantially retains the current lending test for small banks and the community development test for intermediate banks.  The four tests would apply as follows:

  • Large banks (those with assets of at least $2 billion) would be evaluated under all four tests;
  • Intermediate banks (those with assets of at least $600 million and less than $2 billion) would be evaluated under the Retail Lending Test and under the current community development test, or at the bank’s option, the proposed Community Development Financing Test; 
  • Small banks (those with assets of less than $600 million) would be evaluated under the current small bank lending test or, at the bank’s option, the proposed Retail Lending Test;
  • Wholesale and limited purpose banks would be evaluated under a modified Community Development Financing Test; and
  • Banks of all sizes would retain the option to request approval to be evaluated under an approved strategic plan.

Under the proposal, a bank’s “operations subsidiaries” or “operating subsidiaries” would be included in the evaluation of a bank’s CRA performance, with banks retaining the current ability to choose to include or exclude the relevant activities of other bank affiliates.  This approach follows from the agencies’ view that evidence of discriminatory or illegal practices by such subsidiaries should be factored into a bank’s performance evaluation because their activities would be considered to be a component of the bank’s own operations.

The proposal includes five performance scores: Outstanding, “High Satisfactory,” “Low Satisfactory,” “Needs to Improve,” and “Substantial Noncompliance.”  Scores would be assigned for each applicable performance test at the assessment area level, as well as the state, multistate MSA, and institution levels.  A bank’s rating would be based on combining the scores from its performance test in, as applicable, states, multistate MSAs, and at the institution level.  A bank would receive one of the four statutorily-required ratings: “Outstanding,” “Satisfactory,” “Needs to Improve,” or “Substantial Noncompliance.”

Retail Lending Test.  The proposal is intended to standardize retail lending evaluations through the use of retail lending metrics and establish performance standards based on local and tailored benchmarks as follows:

  • A product line (closed-end mortgage loans, open-end home mortgage loans, multifamily loans, small business loans, small farm loans, automobile loans) would generally be considered a major product line if it constitutes 15 percent or more of the dollar value of a bank’s retail lending in a particular assessment area over the evaluation period.  An agency would evaluate a bank’s performance in lending to low-and moderate income (LMI) individuals and communities separately for each major product line.
  • A Retail Lending Volume Screen would be used to compare the ratio of a bank’s retail lending to deposits to that of other banks in the same facility-based assessment area.  If a large bank’s ratio meets or exceeds 30 percent of the aggregate (market) ratio, the bank’s major product lines would be evaluated under the geographic and borrower distribution metrics approach.  For large banks that do not pass this screen, examiners would review performance context information that is specific to a bank’s level of retail lending in a facility-based assessment area to determine if there is an acceptable basis for the bank not meeting the retail lending volume screen.  If those factors do not account for the bank’s low volume of retail lending, the bank would only be eligible for a Retail Lending Test score in a facility-based assessment area of “Needs to Improve” or “Substantial Noncompliance.”  For intermediate banks and small banks that elect to be evaluated under the Retail Lending test, failing to pass the screen would be a qualitative consideration that could adversely impact Retail Lending Test scores for facility-based assessment areas.
  • To evaluate retail lending for each of a bank’s major product lines in its facility-based assessment areas and, as applicable, retail lending assessment areas and outside retail lending areas, the following metrics and calculation methods would be used:
    • Geographic distribution metrics would evaluate a bank’s record of serving, respectively, low-income census tracts and moderate-income census tracts.      
    • Borrower distribution metrics would evaluate a bank’s retail lending to respectively, low-income borrowers, moderate-income borrowers, small businesses with revenues below or between certain thresholds, and small farms with revenues below or between certain thresholds for each of a banks major product lines except multifamily.
    • To calculate these distribution metrics, the number of a bank’s retail loans, rather than the dollar amounts, would be used to avoid weighing larger dollar loans more heavily than smaller dollar loans.  A bank’s metrics would be measured against corresponding market and community benchmarks reflecting, respectively, aggregate retail lending in an assessment area and community characteristics.  An agency would assign a bank’s recommended Retail Lending Test performance score based on the application of the metrics and benchmarks in an assessment area in conjunction with a review of a targeted set of additional factors to reach a final performance score.

Retail Services and Products Test.  The test would have the following two prongs:

  • A  delivery systems prong that would evaluate three components of a bank’s performance: (1) branch availability and services, (2) remote service facility availability, and (3) digital and other delivery systems.  For large banks with assets of $10 billion or less, only the first two components would be evaluated unless the bank requests consideration of its digital and other delivery systems and collects the required data.
  • A credit and deposits prong that would incorporate qualitative factors to separately evaluate the responsiveness of credit products and programs to the needs of LMI individuals, small businesses, and small farms and the responsiveness of deposit products to the needs of LMI individuals.  Both credit and deposit products would be assessed at the institution level and would be required for large banks with assets of more than $10 billion.  For banks with assets of $10 billion or less, only the responsiveness of credit products and programs would be required.

Community Development Financing Test.  The test would consist of a community development financing metric, benchmarks, and an impact review.  These components would be assessed at the facility-based assessment area, state, multistate MSA, and institutions levels as follows:

  • The community development financing metric would measure the dollar amount of a bank’s community development loans and community development investments, together, relative to the bank’s capacity, as reflected by the dollar value of its deposits.  Under the current approach for large banks, community development loans and investments are evaluated separately.  The financing metric would be the ratio of a bank’s community development financing dollars (numerator) relative to deposits within a facility-based assessment area (denominator).  The numerator would be a bank’s annual average of dollars of community development financing activity in each assessment area.
  • The benchmarks would consist of one local and one national benchmark for each assessment area.  The agencies would compare the bank assessment area community development financing metric to both benchmarks to help inform its assessment area scores.  Both benchmarks would be based on the aggregate amount of community development financing activity relative to the aggregate level of capacity, based on deposits, of all large banks and, as applicable, intermediate banks in each bank assessment area, or nationwide. 
  • To evaluate the impact and responsiveness of a bank’s community development activities, the agencies would use defined impact factors.  Due to the current lack of data, the process would initially be primarily qualitative in nature, with the agencies considering the percentage of the bank’s activities that meet each impact factor but not using multipliers or specific thresholds to directly tie the impact review to specific scores. Impact factors would include whether the activities serve persistent poverty counties, serve geographic area with low levels of community development financing, serve low-income individuals and families, or support small businesses or small farms with gross annual revenues of $250,00 or less.

Community Development Services Test.  The test would consist of a primarily qualitative assessment of a bank’s community development service activities.  For large banks with assets of over $10 billion, the agencies would use a metric to measure the hours of community developments services per full time equivalent bank employee.  Community developments services would be evaluated in facility-based assessment areas, in eligible states, multistate MSAs, and nationwide.  The proposal would retain the current definition of such activities to include activities that have as their primary purpose community development and are related to the provision of financial services.  Activities that reflect other areas of expertise of bank employees such as human resources, information technology, and legal services would also be considered to be related to the provision of financial services under the proposal.  In nonmetropolitan areas, banks can receive credit for certain volunteer activities that meet an identified community development need even if unrelated to financial services.  The evaluation for all large banks would include a qualitative review of the extent to which the bank provides community development services, as well as the impact and responsiveness of the activities to community needs.

Assigned Scores and Ratings.  Performance scores would be assigned for each applicable test at the state, multistate MSA, and institution level based on a weighted average of assessment area scores as well as consideration of other additional test-specific factors.  The proposal provides that the agencies would combine these scores across tests to produce ratings at the state, multistate MSA, and institution level, and would use an evaluation framework  with specific weights attributed to each performance test which vary based on the bank’s asset size.  For large banks, the heaviest weight would be given to the Retail Lending Test (45%), with different weights attributed to the Retail Services and Products /test (15%), Community Development Financing Test (30%), and  the Community Development Service Test (10%).  For intermediate banks, tests would be weighted equally between the Retail Lending Test and the current community development test (or Community Development Financing Test when elected by a bank).

As expected, the American Law Institute (“ALI”) approved the Restatement of the Law, Consumer Contracts yesterday at ALI’s 2022 Annual Meeting in Washington, DC.  The Restatement sets forth a series of rules that are intended to represent the current black letter law for contracts between businesses and consumers and culminates an 11-year project by ALI on the subject. 

Discussion of the Restatement kicked off Day 2 of ALI’s meeting, with a briefing on significant changes to the tentative draft from the 2019 Annual Meeting and then comments from ALI members in attendance on the topics covered in the Restatement.  Following discussion, the draft was approved with minor technical changes that will be made to the official text for publication.

More discussion regarding the Restatement can be found here as well as in this week’s Consumer Finance Monitor Podcast episode with Ballard Spahr’s Alan Kaplinsky (who is on the ALI Board of Advisers to the new Restatement) and special guest Steven Weise from the ALI Council.

The CFPB recently ordered a bank to cancel garnishment fees, review its system for processing garnishment orders, cease using contracts which limit consumer rights, and pay a $10 million penalty to the CFPB’s Civil Penalty Fund.  

The garnishment process is a method for creditors to recover amounts that a judgment debtor owes from a third party that holds the judgment debtor’s assets, such as a deposit account held by a bank.  Typically garnishments follow a court order, and a bank, upon receipt of a garnishment notice, may freeze accounts, garnish funds, collect fees, and send payments to creditors.  State and federal laws impose restrictions on the garnishment process, including exemptions for certain assets, such as benefit payments.

According to the CFPB, the bank committed UDAAP violations both in its garnishment procedures and by including certain waiver language in its deposit account agreements.  The CFPB contends that the bank wrongly applied the garnishment exemption laws of the state that issued the order, rather than the consumer’s state of domicile.  In addition, the CFPB claimed that the bank mishandled garnishment orders issued from states that prohibit garnishment of out-of-state accounts. 

The CFPB also found violations based upon the bank’s inclusion in the account agreement of a waiver provision purporting to limit a consumer’s rights during the garnishment process.  The CFPB claimed that the waiver was improper because under federal and state law certain exemption rights cannot be waived.  Inclusion of the waiver language therefore constituted a deceptive practice that was likely to mislead consumers about their rights and potentially dissuade consumers from seeking available protections.  The CFPB further claimed that the provision constituted an unfair practice by purportedly allowing the bank not to contest improper garnishment orders, thus preventing consumers from asserting their rights.

The Bureau’s action should cause banks to review their garnishment procedures and account agreements in light of the Bureau’s criticisms.  Because state laws vary in this area, this may require a careful analysis of the bank’s practices.  Ballard Spahr can help banks assess their garnishment procedures and understand the legal issues surrounding the domicile of bank accounts, extra-territorial garnishment orders, governing exemption rules, and the validity of waiver provisions in account agreements.  Please reach out to us with questions about how the CFPB’s action impacts your institution.

The CFPB recently issued its annual fair lending report covering its fair lending activity in 2021. 

In the report’s discussion of its risk-based approach for prioritizing fair lending supervisory and enforcement activity, the CFPB indicates that much of its enforcement and supervision efforts were focused on advancing its priorities of advancing racial and economic equity and promoting economic recovery related to the COVID-19 pandemic.  It also identifies the following additional fair lending supervisory areas of focus: “mortgage origination and pricing, small business lending, student loan origination work, policies and procedures regarding geographic and [income types] exclusions in underwriting, and on the use of artificial intelligence (AI) and machine learning models [in evaluating applicants for credit].”  For these areas, the CFPB identifies the following specific issues:

  • Mortgage origination—redlining (and whether lenders intentionally discouraged prospective applicants living in, or seeking credit in, minority neighborhoods from applying for credit); assessing whether there is discrimination in underwriting and pricing processes such as steering; and HMDA data integrity and validation reviews (both as standalone exams and in preparation for ECOA exams that follow).
  •  Small business lending—assessing whether there are disparities in application, underwriting, and pricing processes, redlining, and whether there are weaknesses in fair lending-related compliance.
  • Student loan origination—lender’s policies and practices in underwriting or pricing.

The report’s discussion of fair lending enforcement actions indicates that in 2021, the Bureau announced four fair-lending enforcement actions.  One of those actions is an action brought jointly with the DOJ and OCC against Trustmark National Bank (TNB) which alleged TNB engaged in lending discrimination by redlining predominantly Black and Hispanic neighborhoods in Memphis, Tennessee.  Another is the CFPB’s lawsuit against online lender LendUp that included allegations that LendUp violated the ECOA and Regulation B by failing to provide timely and accurate adverse action notices to consumers whose loan applications were denied.   

The other two enforcement actions that the CFPB labels “fair lending” actions are the CFPB’s lawsuits against Libre by Nexus and JPay.  The Libre lawsuit targeted activities directed at immigrants seeking to obtain bonds in order to be released from federal detention centers, the majority of whom were alleged to be “Spanish-speakers, most of whom do not read or write English and many of whom cannot read or write in any language.”  The immigrants’ limited English proficiency was the basis of a claim by the CFPB that the defendants engaged in abusive acts and practices in violation of the CFPA’s UDAAP prohibition.

The JPay lawsuit involved prepaid cards that JPay issued to formerly incarcerated individuals upon their release from prison.  The cards contained the balance of funds owed to former inmates upon their release, including their commissary money, and any “gate money” to which they were entitled under state or local law.  The CFPB alleged that JPay engaged in unfair, deceptive, and abusive acts and practices in violation of the CFPA’s UDAAP prohibition through conduct that included causing fees to be imposed on consumers who were required to get a JPay debit release card to access money owed to them at the time of their release from prison and misrepresenting fees.  Neither the CFPB’s press release nor Director Chopra’s statement about the lawsuit mentions concerns about vulnerable populations or discrimination.  However, in her introductory message to the report, Fair Lending Director Patrice Ficklin stated: “In the United States, incarcerated individuals and individuals reentering society are overwhelmingly men of color.  The CFPB will continue to fight discrimination that manifests as unfair, deceptive, or abusive acts and practices.”

Ms. Ficklin’s comment would appear to confirm that the CFPB’s decision to include these lawsuits in the report and characterize them as “fair lending enforcement actions” despite the absence of any apparent “lending” or “credit” in either case is tied to the CFPB’s recent announcement that it intends to use its UDAAP authority to challenge discrimination even when fair lending laws do not apply, even though that announcement occurred some months after these lawsuits were filed.  While the report does not directly reference the CFPB’s announcement in the section on pending fair lending enforcement investigations, the CFPB states that it “is looking into potential discriminatory conduct, including ECOA and unfairness, as well as unlawful conduct targeted at vulnerable populations.”

For a more detailed discussion of the new Restatement, we encourage you to also listen to the episode of the Consumer Finance Monitor Podcast released today with Ballard Spahr’s Alan Kaplinsky (who is on the ALI Board of Advisers to the new Restatement) and special guest Steven Weise from the ALI Council.

The American Law Institute (“ALI”) is expected to approve the Restatement of the Law, Consumer Contracts (the “Restatement”) tomorrow, May 17, 2022 at ALI’s 2022 Annual Meeting in Washington, DC.  The Restatement culminates an 11-year project by ALI to address how contractual terms are adopted, modified, and enforced in contracts between businesses and consumers.  The Restatement of the Law, Consumer Contracts, sets forth a series of rules that are intended to represent the current black letter law for consumer contracts.  The foundational principal behind the new Restatement is that consumer contracts are asymmetrical in nature, with sophisticated business parties entering into numerous identical transactions with unsophisticated consumers.  While acknowledging there are benefits to standard form contracting, the new Restatement diverges from the Restatement Second of Contracts in some key areas, including changes in terms, assent, parol evidence, and defenses to enforceability.  The new Restatement only covers these and a few other select common law contract issues, and, will override the Restatement Second of Contracts where there is a conflict between the two.  Because courts often look to Restatements of the Law to guide their decision making, all companies that contract with consumers will need to familiarize themselves with the new Restatement as it may require immediate changes to consumer contracts.

According to the ALI, Restatements of the Law are primarily addressed to courts and reflect the common law as it presently stands or might appropriately be stated by a court.  In contrast, Principles of the Law, another category of ALI publications, are intended to be aspirational statements of best practices.  The distinction is important because the controversy surrounding the new Restatement emanates from numerous instances where many believe the Restatement’s Reporters (the authors) have attempted to set forth black letter authority on issues for which there is a dearth of relevant case law and that goes beyond what most courts have actually held.  Some critics have also pointed out that much of the case law relied upon consists of federal court decisions, which are not binding authority on state courts. This is problematic because Restatements are expected to present the common law as developed on the state level.

Interestingly, there has been almost universal criticism of the new Restatement throughout the project from both consumer- and business-affiliated interests.  In 2019, 23 State Attorneys General urged ALI members to reject the draft Restatement, concluding it “represents an abandonment of important principles of consumer protection in exchange for illusory benefits.”  This past January, a coalition of general counsels of major corporations and representatives of leading trade associations (including those in the financial services industry) wrote to the ALI urging it not to approve the Restatement on the grounds that it is conceptually flawed and riddled with major public policy changes that are completely at odds with the common law that has actually been adopted by courts.  Previously-released episodes of our Consumer Finance Monitor Podcast, available here and here, include substantive discussions of many of these criticisms and responses from the ALI.  Some of these concerns have been addressed by the ALI in the current draft, including clarifications concerning mutual assent that seem to have appeased criticism from consumer groups.

The new Restatement is broken down into nine sections and also includes an appendix summarizing the black letter law.  Section 1 provides definitions used throughout the document, a statement regarding the scope of the project, and an outline of the substantive issues.  The other sections, like other Restatements of the Law, begin with a succinct statement of the black letter law on a particular issue, followed by commentary from the Reporters and “illustrations” presenting various use cases.  Each section concludes with detailed Reporters’ Notes, with include citations to the cases underlying their conclusions and analysis.  The sections include:

§ 2. Adoption of Standard Contract Terms

§ 3. Adoption of Modification of Standard Contract Terms

§ 4. Discretionary Obligations

§ 5. Unconscionability

§ 6. Deception

§ 7. Affirmations of Fact and Promises that Are Part of the Consumer Contract

§ 8. Standard Contract Terms and the Parol Evidence Rule

§ 9. Effects of Derogation from Mandatory Provisions

Potential issues abound for any company that contracts with consumers.  Just a few examples include:  

  • The need to ensure clear notice to consumers of key contractual terms and any subsequent modifications of those terms in clickwrap or other online agreements §§ 2, 3).
  • The elevation of deception (§ 6) as a universal, black letter common law defense to a consumer contract term.  While many businesses are already subject to state and federal consumer statutes prohibiting deceptive acts or practices, the Restatement holds that material terms of a contract may be unenforceable even where the actions of the business do not satisfy the elements of fraud.
  • While the common law of many states considers a contract or term unconscionable only where it is both substantively and procedurally unconscionable (with the degree of each determined on a sliding scale), the new Restatement holds that it is sometimes sufficient to only prove one of these factors to challenge a contract (§ 5b).  This opens the door for consumers to strike down contracts and terms on the grounds that they are unsophisticated and didn’t understand what they were agreeing to, thereby rendering the contract or term procedurally unconscionable.
  • In addressing contract terms that are substantively unconscionable in limiting consumer redress (§ 5), the Reporters acknowledge that the Supreme Court held in AT&T Mobility LLC v. Concepcion, 563 U.S. 333 (2011), that the Federal Arbitration Act preempts state law and allows arbitration agreements with class action waivers, but then state they take no position on preemption and cite to a handful of cases in concluding that arbitration clauses can be unconscionable under state common law. 
  • In § 8, the Restatement dilutes the parol evidence rule in holding that standard consumer contract terms that contradict or unreasonably limit prior affirmations or promises of a business do not constitute a final expression of the agreement.  While the Reporters state in the comments that the parol evidence rule still applies, the black letter law and illustrations open the door for courts to entirely ignore merger and integration clauses in striking down contract terms on the basis of prior written or oral understandings of the parties.

It remains to be seen how the new Restatement will be received by courts in light of the controversy surrounding it and the apparent paucity of case law supporting some of its conclusions.  However, once adopted, the Restatement will create new potential defenses for consumers and a litigation risk for any business that has not reviewed its consumer contracts for compliance with the black letter law as formulated by the Restatement.  Beyond reviewing specific forms of contracts, companies should review their entire process for entering into consumer contracts, as well as the methods used for modifying them.  The good news is the use cases provided in the illustrations should be helpful in developing and refining best practices to address these risks.  Additionally, the case citations throughout the various sections represent a generally comprehensive collection of precedent, useful for any litigator addressing claims or counterclaims that are colored by the Restatement’s formulation of the black letter law of consumer contracts.

With ALI’s members poised to approve the new Restatement, providers need to understand the Restatement’s impact on their consumer agreements, particularly those entered into online.  After reviewing the rationale for the new Restatement and ALI’s approach to developing the rules it contains, we look at the issues covered by each section, such as the rules that deal with assent to contract terms, change in terms, unconscionability, and deception.  We also discuss how businesses can use the Restatement to their benefit and ALI’s next steps for finalizing the draft.

Alan Kaplinsky, Ballard Spahr Senior Counsel and a member of the ALI Board of Advisers to the new Restatement, leads the conversation.

Click here to listen to the podcast.  (Today’s release is in place of our regular Thursday podcast episode release this week.)

In Wednesday’s edition of Consumer Law & Policy Blog, Professor Jeff Sovern laments that during Director Rohit Chopra’s recent testimony before the Senate Banking Committee and the House Financial Services Committee, neither he nor any member of the Committees mentioned “arbitration” as an action item on the CFPB’s agenda. Professor Sovern expresses hope that the arbitration issue will nevertheless appear on the CFPB’s regulatory agenda when it is soon published. Don’t hold your breath, Professor Sovern!

There are many reasons why it would be foolish for the CFPB to revisit arbitration:

  1. Director Chopra already has a very robust agenda for the CFPB. Among other things, that includes rulemakings under Section 1071 of Dodd-Frank (small business loan data collection) and Section 1033 of Dodd-Frank (consumer access to data). Both of these rulemakings are very complex and controversial. The CFPB does not have the bandwidth and resources to take up arbitration which would also undoubtedly be complex and controversial. 
  2. Director Chopra’s term may end in 2024. It would not make practical or political sense for him to launch another arbitration rulemaking which would never be completed within his term in office. The CFPB’s original arbitration rulemaking took five years from beginning to end and it ended up very badly for the Bureau since Congress passed a joint resolution to repeal the rulemaking under the Congressional Review Act. Even if Congress had not done that, a lawsuit would have been filed against the CFPB to invalidate the arbitration rule. 
  3. Under the Congressional Review Act, the CFPB is disabled from promulgating a similar arbitration rule. The Bureau would not be able to ban class action waivers in arbitration provisions. It also seems doubtful that the CFPB would ban consumer financial services arbitration altogether, both because they may be barred from doing that by virtue of the Congressional Review Act and because the CFPB’s earlier study of arbitration did not support an all-out ban of arbitration. Indeed, the data in that earlier study showed that individual arbitration is faster, cheaper and more beneficial for consumers than class action litigation.
  4. In order to propose a new arbitration rule, the Bureau could not rely on the study it conducted prior to proposing its original arbitration rule. Instead, the CFPB would need to go back to square one and initiate a new study which would take years to complete and without being assured of success. 
  5. Federal agencies are generally loathe to interfere with bills pending before Congress. The House recently passed the FAIR Act which would ban all consumer arbitration. Since Congress is already dealing with the issue, it would be presumptuous and improper for the CFPB to interfere.