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Over the last two years the financial industry has seen an uptick in litigation and enforcement actions aimed at banks and their non-bank lending partners. These actions have primarily challenged the validity of the bank partnership model that is used by many non-bank lenders to generate consumer and small dollar business loans.

Bank and Non-Bank Lender Partnerships

Although the structure of a bank and their non-bank lending partners can take many forms, the typical relationship involves the non-bank lender identifying loan opportunities for the bank, which then originates the loan and either immediately assigns the loan to their non-bank partner or another third-party. By partnering with banks, non-bank lenders avoid certain regulatory and licensing requirements in states where their bank partners operate.  In return, banks are able to utilize their relationships with their non-bank lending partners to generate leads for additional loans.

In many circumstances, banks are not subject to state usury laws in every state in which they operate. Instead, banks get the benefit of the state usury law in the bank’s “home state.”  For example, if the state where the bank is headquartered has a usury law of 20%, the bank gets the benefit of that usury rate for all loans it makes in any state in which it operates, even if the usury rate in one of those states is less than 20%.  This is known as “federal interest rate exportation.”

Under the traditional bank partnership model, the loans originated in the name of a bank by their non-bank lending partner would be subject to the “home state” usury law. However, recent litigation and regulatory enforcement actions have challenged the validity of those arrangements.  Specifically, those actions challenge whether the loans should be subject to the usury interest rate limitations in the state where the consumer is located and not the bank’s “home state,” because the non-bank lender, not the bank, is the “true lender.”

Colorado’s Uniform Consumer Credit Code Administrator Takes Action

In January 2017, the Colorado’s Uniform Consumer Credit Code (“UCCC”) Administrator, Julie Meade, filed two substantially similar complaints in Colorado state court against Marlette Funding, LLC, and Avant of Colorado, LLC. The complaints alleged violations of the UCCC based on the theory that Marlette and Avant were the “true lender,” not their bank partners, in a series of loans made to Colorado consumers, which loans contained interest rates that exceeded Colorado’s usury laws.

The complaint against Marlette asserts that Marlette utilized its relationship with New Jersey chartered Cross River Bank to subvert Colorado usury laws in making loans to Colorado consumers. The complaint alleges that it acted as the “true lender,” because, among other things, (i) it picked which loan applicants received loans; (ii) it raised the capital used to fund the loans; (iii) it paid all the costs, including marketing and legal costs, incurred by Cross River Bank, associated with originating the loans; (iv) it purchased the loans from Cross River Bank within two days of their origination; (v) Cross River Bank had no liability to Marlette under the loans sold; and (vi) Marlette was required to indemnify Cross River Bank concerning any claim that alleges the lending program violates the law.

Similarly, the complaint against Avant alleges that it, not its Utah based bank partner, WebBank, was the “true lender” in the loan transactions at issue. Supporting that assertion, the complaint alleges that (i) Avant was responsible for all costs and expenses, including costs incurred in evaluating loan applications; (ii) WebBank had no risk of loss if any of the loans defaulted; (iii) Avant was responsible for developing and implementing a Bank Secrecy Act and Truth in Lending Act policy related to the lending program; and (iv) WebBank sold the loans to Avant shortly after they were originated.

Avant removed the case to federal district court in Colorado, which removal was challenged by the UCCC Administrator. On March 1, 2018, the district court adopted the magistrate judge’s recommendation to remand the action to state court.  The federal court held that the UCCC Administrator’s claims were not completely preempted by the Federal Deposit Insurance Act, because the claims were not asserted against a state bank, nor was WebBank even a party to the lawsuit.  Although the district court held that federal preemption did not exist to keep the case in federal court, the district court did state that Avant still may have a preemption defense in state court to the state law claims if it can prove that WebBank was, in fact, the “true lender.”  The case is now pending in Colorado state court.

Massachusetts Consumers File Suit Against Bank and Its Non-Bank Lending Partner

In October 2017, NRO Boston, LLC, and its owner, Alice Indelicato, filed a lawsuit against Celtic Bank and its non-bank partner, Kabbage, Inc., in Massachusetts federal court, alleging violations of Massachusetts’ criminal usury laws. Specifically, the complaint alleges that Kabbage and Celtic Bank’s lending program constituted a criminal enterprise designed to evade the criminal usury laws, by attempting to portray Celtic Bank as the “true lender” when, in fact, the “true lender” was Kabbage.  The complaint further alleges that Kabbage was the “true lender” because it originates, underwrites, funds and assumes all risk of loss for the loans, and the loans are immediately assignable to Kabbage after their origination.  The plaintiffs argue that the loans are void because they allegedly charge interest in excess of what is permitted by Massachusetts’ criminal usury laws.  The defendants challenged the lawsuit arguing that a mandatory arbitration provision required dismissal of the action.  The parties eventually entered into a stipulation whereby the plaintiff was required to file a demand for arbitration by March 25, 2018.

The CashCall and Madden Decisions

The above-described “true lender” lawsuits all explicitly or implicitly rely on the reasoning in CashCall, Inc. v. Morrisey, No. 12-1274, 2014 WL 2404300 (W.Va. May 30, 2014), and Madden v. Midland Funding, LLC, 787 F.3d 246 (2d Cir. 2015), for the argument that the non-bank lending partners are the “true lenders,” and are not entitled to utilize the bank’s federal interest rate exportation authority to circumvent state usury laws.

In CashCall, the court held that non-bank CashCall, not its bank partner First Bank & Trust of Milbank, was the “true lender” for certain loans made to West Virginia consumers.  To reach that conclusion, the court relied on a “predominate economic interest” test that analyzed which party shouldered the most economic risk in the transactions and, therefore, should be deemed the “true lender.”

In Madden, non-bank Midland Funding, LLC, purchased a consumer’s defaulted credit card debt from a national bank located in Delaware.  The New York consumer challenged Midland’s ability to enforce the debt arguing that Midland should not be able to rely on “federal exportation” to circumvent state usury laws since it was not the original lender nor was it a bank.  The Second Circuit Court of Appeals agreed with the consumer and held that preemption of state usury laws under the National Bank Act does not extend to non-bank purchasers of debt. This decision calls into question the “valid-when-made” doctrine, which has historically held that the determination of whether a debt is valid in the hands of a subsequent purchaser is determined based on the circumstances existing when it was made (i.e., according to the original lender’s rights, not the rights of the subsequent purchaser).  In this context, pursuant to that doctrine, the question should be whether the interest rate on the credit card debt was permissible when the credit card debt was created, not whether the current holder, Midland, would be able to charge that interest rate now.

Broad Reaching Implications

The CashCall, Madden, and other related actions threaten the traditional bank partnership model that the financial industry relies on to originate, buy, sell, and transfer loans.  The uncertainty these cases create continues to increase with the expansion of fintech companies that rely heavily, if not exclusively, on their bank partnerships to exist.  Many banks and non-bank lenders have started altering their business models and even pulling out of markets like Colorado for fear of being the next defendant in the UCCC Administrator’s cross-hairs.

Legislative Fix Coming?

There is currently at least one bill pending in the House and Senate that, if passed, would address both the “true lender” issue and the consequences of the Madden decision.

H.R. 4439 (or the “true lender” bill) would amend the Bank Service Company Act, and others, to add language providing that the geographic location of service provider for an insured deposit 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.” It would also amend Section 85 of the National Bank Act to add language providing that a loan or other debt 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 debt], regardless of any later assignment.”

H.R. 3354 (or the “Madden” bill) would amend the Home Owners’ Loan Act, the Federal Credit Union Act, and the Federal Deposit Insurance Act, which provide rate exportation authority to their respective institutions, 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.

What to Do in the Meantime?

Until a legislative fix occurs, this area of the law will remain unsettled, which will likely lead to additional lawsuits and enforcement actions. As such, banks and non-bank lenders that enter into relationships to facilitate lending programs must be aware of the risks to those programs.  Those risks vary depending on state law remedies available to consumers or regulators upon a finding of a violation of state usury laws or other consumer protection laws.  For instance, in the Kabbage case, relying on remedies under Massachusetts’ criminal usury code, the plaintiffs are seeking an order holding that the underlying loans are void.  In the Avant and Mallette cases, the UCCC Administrator is not requesting that the entire loan be set aside, but is requesting that the court set aside any excess interest rate found to violate Colorado usury law and to award the consumers a civil penalty in the greater amount of the overall finance charge or ten times the amount of the excess charge.

Given the risks, banks and non-bank lenders should evaluate the usury and other relevant consumer protection laws in the states where they offer loans to better understand potential risks in the event of litigation or regulatory action. They should also evaluate their loan programs to ensure that the non-bank participant does not control and fund most of the program and that the bank has risk of loss related to the loans.

Bottom Line: Non-bank lending programs that rely on bank partnerships to enjoy the benefit of the bank’s interest exportation authority is not without risk.  However, the risks can be mitigated through evaluation and modification of lending programs to ensure that the “true lender” is the bank and not the non-bank partner.