Usury

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Resolving an ambiguity in the California Finance Lender’s Law (CFLL), the California Supreme Court unanimously held that borrowers may use the unconscionability doctrine to challenge the interest rate on consumer loans of $2,500 or more, despite the fact that the CFLL has deregulated interest rates on such loans.  Although unconscionability claims of this nature will be difficult to prosecute, the decision creates heightened risk for nonbank consumer lenders doing business in California, particularly when lending at high rates.  Furthermore, because the decision could be followed in other states or applied in other contexts, such as small business lending, it also could impact loans made under other statutes that have deregulated interest rates, as opposed to statutes that affirmatively authorize interest rates established by contract.

In addition to copycat lawsuits by private plaintiffs alleging their interest rates are unconscionable, high-rate lenders could even face enforcement actions challenging their rates.  In California, it is possible that the state’s Attorney General, local prosecutors, or the California Department of Business Oversight (which has regulatory and supervisory jurisdiction over CFLL licensees) will pile on.

On October 16, 2018, from 12 p.m. to 1 p.m. ET, Ballard Spahr attorneys will hold a webinar, “The Sky is Not The Limit: California Supreme Court Re-Regulates Deregulated Interest Rates.”  The webinar registration form is available here.

See our legal alert for a fuller discussion of the California Supreme Court’s decision.

 

 

A group of 21 state attorneys general have sent a letter to the Senate majority and minority leaders as well as to the chairman and ranking member of the Senate Banking Committee urging them to reject H.R. 3299 (“Protecting Consumers’ Access to Credit Act of 2017”) and H.R. 4439 (“Modernizing Credit Opportunities Act”).

H.R. 3299, known as the “Madden fix” bill, was passed by the House in February 2018.  It attempts to address 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 purchases 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) allows the national bank to charge.  The bill would amend Section 85, as well as the provisions in the Home Owners’ Loan Act (HOLA), the Federal Credit Union Act, and the Federal Deposit Insurance Act (FDIA) that provide rate exportation authority to, respectively, federal savings associations, federal credit unions, and state-chartered banks, to provide that a loan that is made at a valid interest rate remains valid with respect to such rate when the loan is subsequently transferred to a third party and can be enforced by such third party even if the rate would not be permitted under state law.

H.R. 4439 was referred to the House Financial Services Committee in November 2017.  It is intended to address a second source of uncertainty for some loans that are made by banks with substantial origination, marketing and/or servicing assistance from nonbank third parties and then sold shortly after origination.  These loans have been challenged by regulators and others on the theory that the nonbank agent is the “true lender,” and therefore the loan is subject to state licensing and usury laws.

The bill would amend the Bank Service Company Act to add language providing that the geographic location of a service provider for an insured depository institution “or the existence of an economic relationship between an insured depository institution and another person shall not affect the determination of the location of such institution under other applicable law.”  The bill would amend the HOLA to add similar language regarding service providers to and persons having economic relationships with federal savings associations.

It would also amend Section 85 of the NBA to add language providing that a loan or other debt is made by a national bank and subject to the bank’s rate exportation authority where the national bank “is the party to which the debt is owed according to the terms of the [loan or other debt], regardless of any later assignment.  The existence of a service or economic relationship between a [national bank] and another person shall not affect the application of [the national bank’s rate exportation authority] to the rate of interest rate upon the [loan, note or other evidence of debt] or the identity of the [national bank] as the lender under the agreement.”  The bill would add similar language to the provisions in the HOLA and FDIA that provide rate exportation authority to, respectively, federal savings associations and state-chartered banks.

The state AGs assert in their letter that the bills “would legitimize the efforts of some non-bank lenders to circumvent state usury law” and “would constitute a substantial expansion of the existing preemption of state usury laws.”  As support for their argument that Congress did not intend to allow nonbank entities to use NBA preemption, they cite to the OCC’s recent bulletin on small dollar lending in which the OCC stated that it “views unfavorably an entity that partners with a bank with the sole goal of evading a lower interest rate established under the law of the entity’s licensing state(s).”

While the context for the OCC’s statement was “specific to short-term, small-dollar installment lending,” we have expressed concern as to its implications for all banks that partner with third parties to make loans under Section 85.  As we noted, the statement also seems at odd with the broad view of federal preemption enunciated by the OCC with respect to the Madden decision.

While the enactment of legislation reaffirming the valid-when-made doctrine and addressing the “true lender” issue would be helpful, we have advocated for the OCC’s adoption of a rule providing that (1) loans funded by a bank in its own name as creditor are fully subject to Section 85 and other provisions of the NBA for their entire term; and (2) emphasizing that banks that make loans are expected to manage and supervise the lending process in accordance with OCC 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 national bank (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.

In two enforcement actions pending in Colorado state court, the Administrator of the Uniform Consumer Credit Code for the State of Colorado is employing the “true lender” theory and the Second Circuit’s Madden decision to challenge two bank-model lending programs.

 

We have blogged twice (here and here) about the conclusion in RD Legal Funding that Title X of Dodd-Frank is unconstitutional because it provides that the sole director of the CFPB can be removed only for cause.  This post addresses the issue that took up 95 pages of the 101-page opinion—whether RD Legal Funding violated UDAAP and usury laws because purported asset purchases were in fact disguised loans.  Before enforcement authorities or plaintiffs’ attorneys get too excited that the court found against RD Legal Funding on this issue, the unusual facts of the case and the basis for the court’s opinion need to be examined.

RD Legal Funding purchased at a discount, for immediate cash payments, benefits to which consumers were ultimately entitled under the NFL Concussion Litigation Settlement Agreement (the “NFLSA”) and the September 11th Victim Compensation Fund of 2001 (the “VCF”).  In both situations, the court indicated, consistent with the complaint, that the consumer’s right to a benefit and the amount of the benefit had been determined.  The party responsible for payment (the NFL or the U.S. Government) was unquestionably willing and able to make the required payment.  The only question was when payment would be made.  Of course, this scenario differs greatly from the typical situation where a litigation funding company purchases an interest in a claim in ongoing personal injury or other litigation. Indeed, an industry trade group, siding with the CFPB and NY AG against RD Legal Funding, made exactly this point:

The pre-settlement legal funding transactions referenced in ALFA’s amicus curiae brief differ in a crucial respect. (See ALFA Br.)   In those transactions, the pre-settlement legal funding agreements are entered into before the claim is resolved.  The ALFA Member’s right to repayment is contingent on the consumer’s ultimate success on his or her claim. (ALFA Br. 5.)

Opinion at p. 53.

For some reason, the CFPB and NY AG did not argue, and the court did not determine, that the payment of settlement benefits and subsequent payment to RD Legal Funding were assured and, hence, the advances functioned the same as loans.  Accordingly, and because the decision was on a motion to dismiss, where all factual allegations are required to be accepted as true, the RD Legal Funding decision did not address whether benefit payments were certain.

Rather, the decision was based on the court’s determination that the purported benefit assignments in question were void.  In the case of the NFLSA benefits, the underlying settlement agreement expressly provided that any “assignment, or attempt to assign … any rights or claims relating to the subject matter of the Class Action Complaint will be void, invalid, and of no force and effect.” (Opinion at 20).  As to the VCF benefits, the court pointed to three requirements under the federal Anti-Assignment Act, 31 U.S.C. § 3727, for the assignment of claims against the United States.  It then observed that “neither party has argued that the RD Entities complied with the Anti-Assignment Act’s three requirements under Section 3727(b).” (Opinion at 41).  (The court did not address why the assignments to RD Legal Funding could not function as valid assignments of the proceeds of VCF benefits and why such assignments could not be enforced against the VCF beneficiaries.)

After concluding that the assignments before it were void, the court leaped to the conclusion that, as a result, the transactions were necessarily disguised loans.  The basis for this conclusion was never articulated by the court.  Just because the underlying transactions are problematic does not mean that they meet the New York definition of usurious loans.

Remarkably, the decision never addressed the New York (or any other) definition of the term “loan.” It ignored that, for over 150 years, New York courts have declared that “there can be no usury unless the principal sum advanced is repayable absolutely.” Pomeroy v. Ainsworth, 22 Barb. 118 (1856).  Even the NY AG has recognized this principle.  In a February 2005 press release regarding litigation financing reforms, the Attorney General stated:

The cash advances provided by these firms are not considered “loans” under New York State law because there is no absolute obligation by a consumer to repay them. The contracts provide that, in the event the consumer receives no recovery from his or her claim, the consumer owes no money to the cash advance firm.

Maybe in the instant case, if it had confronted the issue, the court would have concluded that the assignments provided the requisite certainty of payment.  In most other cases, however, this certainty will be lacking.

But even putting aside this glaring omission, it is clear that the decision applies to a narrow range of transactions, where the assignments of the underlying claims are void for some reason.  That is not the case when the anticipated proceeds of lawsuit claims are sold on a non-recourse basis.  See Williams v. Ingersoll, 89 N.Y. 508, 518-521 (1882). (binding authority in New York holding that the proceeds of personal injury claims may be assigned).  Critically, “[i]f the assignments are valid … the entire basis of the Government’s jurisdictional theory under the CFPA [that the transactions are loans’ would fall apart.”  (Opinion at 19).

In two closely-watched enforcement actions pending in Colorado state court, the Administrator of the Uniform Consumer Credit Code for the State of Colorado is employing the “true lender” theory and the Second Circuit’s decision in Madden v. Midland Funding, LLC to challenge two bank-model lending programs.  Specifically, the Administrator asserts that the origination of the loans by state-chartered banks should be disregarded under the “predominant economic interest” test employed by some district courts in true lender cases, and that the banks’ power to export interest rates under federal law does not follow loans they assign to their program partners.  For these reasons, the Administrator contends that the loans are subject to Colorado usury laws despite the fact that state interest rate limits on state bank loans are preempted by Section 27 of the Federal Deposit Insurance Act (FDIA).

Although these cases were filed in January 2017, little has happened on the merits to date.  The cases were removed to federal court by the program sponsors and remanded a year later.  The banks involved in the programs filed separate declaratory relief actions in federal court, but those cases were dismissed without prejudice on abstention grounds.  The banks then filed motions to intervene in the state court actions, and the program sponsors moved to dismiss the state court cases.  The motions to dismiss argue that the usury claims are preempted by the FDIA, that Madden was wrongly decided and should not be followed, and that the banks are the “true lenders” as a matter of federal law, and also under state law if it applies.

On June 22, 2018, the state court heard oral argument on the motions to dismiss and to intervene in both cases.  The Court allowed argument for nearly two hours, and provided no clear indication on how it would rule before taking the motions under submission.  We will continue to follow the cases closely and report on additional developments.

 

 

 

 

By a vote of 245-171, the House passed H.R. 3299, the “Madden fix” bill (whose official title is the “Protecting Consumers’ Access to Credit Act of 2017.”)  In Madden, the Second Circuit ruled that a nonbank that purchases loans from a national bank could not charge the same rate of interest on the loan that Section 85 of the National Bank Act allows the national bank to charge.

The bill would add the following language to Section 85 of the National Bank Act: “A loan that is valid when made as to its maximum rate of interest in accordance with this section shall remain valid with respect to such rate regardless of whether the loan is subsequently sold, assigned, or otherwise transferred to a third party, and may be enforced by such third party notwithstanding any State law to the contrary.”

The bill would add the same language (with the word “section” changed to “subsection” when appropriate) to the provisions in the Home Owners’ Loan Act, the Federal Credit Union Act, and the Federal Deposit Insurance Act that provide rate exportation authority to, respectively, federal and state savings associations, federal credit unions, and state-chartered banks.  (A Senate bill with identical language was introduced in July 2017 by Democratic Senator Mark Warner.)

The House passed the bill despite strong Democratic opposition, with only 16 Democrats voting for the bill and 170 voting against.  As a result, the bill is expected to face an uphill battle in the Senate even though it can be passed with only 60 votes.

While adoption of a “Madden fix” would eliminate the uncertainties created by the Second Circuit’s Madden decision, it would not address a second source of uncertainty for some loans that are made by banks with substantial marketing and servicing assistance from nonbank third parties and then sold shortly after origination. These loans have been challenged by regulators and others on the theory that the nonbank marketing and servicing agent is the “true lender,” and therefore the loan is subject to state licensing and usury laws.  In November 2017, a bipartisan group of five House members introduced a bill (H.R. 4439) that is intended to address the “true lender” issue.

 

 

A bipartisan group of five House members introduced a bill (H.R. 4439) last month that is intended to address the so-called “true lender” issue, which creates risk with respect to some loans made by banks with substantial marketing and servicing assistance from nonbank third parties, and then sold shortly after origination. These loans have been challenged by regulators and others on the theory that the nonbank marketing and servicing agent is the “true lender,” and therefore the loan is subject to state licensing and usury laws.

This bill is a welcome accompaniment to the “Madden fix” bills that have been introduced in the House and Senate to eliminate the uncertainties created by the Second Circuit’s decision in Madden v, Midland Funding.  (The House bill was passed by the House Financial Services Committee last month.)  In Madden, the Second Circuit ruled that a nonbank that purchases loans from a national bank could not charge the same rate of interest on the loan that Section 85 of the National Bank Act allows the national bank to charge.

Both “Madden fix” bills would amend Section 85, as well as the provisions in the Home Owners’ Loan Act, the Federal Credit Union Act, and the Federal Deposit Insurance Act that provide rate exportation authority to, respectively, federal savings associations, federal credit unions, and state-chartered banks, to provide that a loan that is made at a valid interest rate remains valid with respect to such rate when the loan is subsequently transferred to a third party and can be enforced by such third party even if the rate would not be permitted under state law.  (The same “Madden fix” provision is in the Appropriations Bill (H.R. 3354) passed by the House in September 2017.)

As we have previously observed, the enactment of legislation reaffirming the valid-when-made doctrine, like the adoption of the OCC’s proposal to create a fintech charter, would help some companies avoid Madden’s negative impact.  However, it would not help nonbank companies deal with the risk of a court or enforcement authority concluding that the nonbank company, rather than its bank partner, is the “true lender.”  Treating a nonbank as the “true lender” would subject the nonbank to usury, licensing, and other limits to which its bank partner would not otherwise be subject.

The “true lender” bill would amend the Bank Service Company Act to add language providing that the geographic location of a service provider for an insured depository institution “or the existence of an economic relationship between an insured depository institution and another person shall not affect the determination of the location of such institution under other applicable law.”  The bill would amend the Home Owners’ Loan Act to add similar language regarding service providers to and persons having economic relationships with federal savings associations.

It would also amend Section 85 of the National Bank Act to add language providing that a loan or other debt is made by a national bank and subject to the bank’s rate exportation authority where the national bank “is the party to which the debt is owed according to the terms of the [loan or other debt], regardless of any later assignment.  The existence of a service or economic relationship between a [national bank] and another person shall not affect the application of [the national bank’s rate exportation authority] to the rate of interest rate upon the [loan, note or other evidence of debt] or the identity of the [national bank] as the lender under the agreement.”  The bill would add similar language to the provisions in the Home Owners’ Loan Act and Federal Deposit Insurance Act that provide rate exportation authority to, respectively, federal savings associations and state-chartered banks.

While we might have preferred to see additional language in the bill’s findings that makes it even clearer how the bill is intended to apply (such as citations to cases that are examples of the analysis the bill seeks to correct or a direct statement that the lender’s identity should not be determined by who holds the predominant economic interest), the bill is certainly a very positive development as drafted.

A bill to provide a “Madden fix” and three other bills relevant to mortgage lenders were included among the more than 20 bills approved by the House Financial Services Committee on November 15, 2017.   With the exception of H.R. 3221, “Securing Access to Affordable Mortgages Act,” the bills received strong bipartisan support.

The “Madden fix” bill is H.R. 3299, “Protecting Consumers’ Access to Credit Act of 2017.”  In Madden, the Second Circuit ruled that a nonbank that purchases loans from a national bank could not charge the same rate of interest on the loan that Section 85 of the National Bank Act allows the national bank to charge.  The bill would add the following language to Section 85 of the National Bank Act: “A loan that is valid when made as to its maximum rate of interest in accordance with this section shall remain valid with respect to such rate regardless of whether the loan is subsequently sold, assigned, or otherwise transferred to a third party, and may be enforced by such third party notwithstanding any State law to the contrary.”

The bill would add the same language (with the word “section” changed to “subsection” when appropriate) to the provisions in the Home Owners’ Loan Act, the Federal Credit Union Act, and the Federal Deposit Insurance Act that provide rate exportation authority to, respectively, federal and state savings associations, federal credit unions, and state-chartered banks.  The bill was approved by a vote of 42-17.  (A bill with identical language was introduced in July 2017 by Democratic Senator Mark Warner.)

Adoption of a “Madden fix” would eliminate the uncertainties created by the Second Circuit’s Madden decision.  However, it would not address a second source of uncertainty for banks that lend with assistance from third parties—the argument that the bank is not the “true lender” and accordingly cannot exercise the usury authority provided to banks by federal law.  As we have previously urged, the OCC and its sister agencies should adopt rules providing that loans funded by their supervised financial institutions in their own names as creditor are fully subject to federal banking laws (and not state usury laws).  The OCC and FDIC have previously emphasized that their supervised entities must manage and supervise the lending process in accordance with regulatory 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.

The other approved bills relevant to mortgage lenders are:

  • H.R. 3221, “Securing Access to Affordable Mortgages Act.” The bill would amend the Truth in Lending Act (TILA) and the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 to exempt a mortgage loan of $250,000 or less from the higher-priced mortgage loan and general property appraisal requirements if the loan appears on the creditor’s balance sheet for at least three years.  The bill would also exempt mortgage lenders and others involved in real estate transactions from incurring penalties for failing to report appraiser misconduct.  The bill was approved by a vote of 32-26.
  • H.R. 1153, “Mortgage Choice Act of 2017.” The bill would amend TILA by revising the definition of “points and fees” to exclude escrowed insurance and fees or premiums for title examination, title insurance, or similar purposes, whether or not the title-related charges are paid to an affiliate of the creditor.  The bill would direct the CFPB to issue implementing regulations within 90 days of the bill’s enactment. The bill was approved by a vote of 46-13.
  • H.R. 3978, “TRID Improvement Act of 2017.”  The bill would amend RESPA to require that the amount of title insurance premiums reflect discounts required by state law or title company rate filings. The amendment would override the TRID rule approach to the disclosure of the lender’s and the owner’s title insurance premiums if there is a discount offered on the lender’s policy when issued simultaneously with an owner’s policy.  In such cases, instead of requiring the disclosure of the actual owner’s policy premium and the actual discounted lender’s policy premium, the TRID rule currently requires the disclosure of the full, non-discounted amount of the premium for the lender’s policy, and an amount for the owner’s policy equal to the full amount of the owner’s policy premium, plus the amount for the discounted lender’s policy premium, less the full amount of the lender’s policy premium.  The bill was approved by a vote of 53-5.

The Minnesota Attorney General announced that she has filed a lawsuit in state court against two pension advance companies.

According to the AG’s press release, the companies often solicited borrowers through their own websites or websites of “lead generators” who marketed “pension loans” or “loans that can fit your needs.”  The press release states that the transactions required military veterans and senior citizens to assign portions of their monthly pension payments for up to ten years in exchange for much smaller cash amounts (usually less than $5,000) on which the AG claimed the companies typically charged annual percentage rates of 200 percent.

The lawsuit is reported to allege that the companies violated Minnesota lending laws by making loans to Minnesota borrowers without being licensed as a lender and sought to evade Minnesota law by falsely characterizing the transactions as pension “purchase agreements” rather than loans.

In February 2017, the CFPB and the New York Attorney General filed a lawsuit in which they alleged that a litigation settlement advance product offered by the defendant was a usurious loan that was deceptively marketed as an assignment.  In August 2015, the CFPB and the New York Department of Financial Services filed a lawsuit against two pension advance companies in which the CFPB and NYDFS made similar allegations regarding the advances made by the companies.

The Minnesota AG’s lawsuit and the CFPB/NY lawsuits not only indicate that pension advance companies and litigation funding companies have become targets of regulatory enforcement actions, but also suggest that merchant cash advance providers and other finance companies whose products are structured as purchases rather than loans could face heightened scrutiny from state and federal regulators.

 

The Minnesota Supreme Court recently ruled that two for-profit postsecondary education schools had charged usurious interest rates on student loans and could not charge rates greater than 8% without obtaining a lending license.

Minnesota’s general usury law caps interest rates at 8% for written contracts but allows a lender to charge up to 18% on a “consumer credit sale pursuant to an open end credit plan.”  In State of Minnesota v. Minnesota School of Business, et al., the Minnesota Attorney General sought to enjoin the schools from making private student loans that typically had interest rates between 12% and 18%, alleging that the loans were subject to the 8% cap.  The schools did not pay out money to the student and instead credited the loan amount against the student’s outstanding tuition balance.  The credit was not available to the student for any other purpose.  The student repaid the loan through monthly payments pursuant to a schedule that had a fixed date by which the entire loan and accrued interest had to be paid in full, and no additional funds were available if the student paid off the loan early.

At issue was whether the loans qualified as a “consumer credit sale pursuant to an open end credit plan” on which Minnesota allowed up to 18 percent interest to be charged.  (The decision states that the parties agreed that the loans “were consumer credit sales.”)   Although the Supreme Court found that the definition of “open end credit plan” under Minnesota law only incorporated the Truth in Lending Act and Regulation Z definition of “open-end credit plan” in effect in 1971 and not as subsequently amended to expressly require revolving credit, it found that revolving credit was nevertheless an essential part of the 1971 definition.

Reversing the Minnesota Court of Appeals, the Supreme Court concluded that the loans were not made pursuant to an open-end plan.   It found that the repayment schedule on the schools’ loans, which provided for a fixed end date, was consistent with a closed-end plan and also observed that the schools had required students to sign a form containing an acknowledgment that a loan was not an “extension of credit under an open-end consumer credit plan.”  According to the Supreme Court, the schools had “structured their loans to give themselves the benefit of open-end credit plans, charging interest in excess of 8 percent-without providing their students the benefit of revolving credit.”

Having found that the schools had charged usurious interest rates, the Supreme Court concluded that to charge rates higher than 8 percent on loans that were not made pursuant to an open-end credit plan, the schools needed to obtain a Minnesota lending license.

The opinion states that the schools did not contest “that they were [engaged] in the business of making loans” for purposes of the lending license statute.  Thus, it appears that the schools did not attempt to argue that, in extending credit to students to finance tuition, they were not acting as lenders making “loans” subject to Minnesota’s general usury law but instead were acting as sellers of goods or services extending credit to buyers to which the time-price doctrine applies.  Sellers making closed-end credit sales should consult with counsel as to how they can avoid the 8 percent rate cap by taking advantage of the time-price doctrine under Minnesota law.