California District Court Issues Favorable Bank Partnership Decision

The U.S. District Court for the Central District of California issued an opinion supporting the bank partnership model, less than a month after a judge in the same district issued a decision that questioned the concepts on which the bank model is based.

In Beechum v. Navient Solutions Inc., the court granted a motion to dismiss a lawsuit brought by Jamie Beechum and others against Navient Solutions, the Student Loan Marketing Association and the SLM Corporation. The consumer-plaintiffs obtained private student loans in 2003 and 2004 from Stillwater National Bank and Trust Company, a national bank. The bank subsequently sold the loans to a securitization trust established to hold the loans, while Navient Solutions, the Student Loan Marketing Association and the SLM Corporation serviced the loans. Beechum and others sued, claiming that the nonbank entities were the true lenders on the loan.

The consumer-plaintiffs argued that, as California residents, interest could not be imposed on them at a rate that exceeded 10% per year absent some other authority (such as a California Finance lender license). The defendants countered that California law does not limit interest rates a bank may impose. The consumer-plaintiffs urged the court to review the substance of the transaction rather than its form. The court, however, declined to do so, noting that the cases cited by the consumer-plaintiffs to do so provided that a court may consider the “substance” over the “form” and the parties’ intent when assessing whether a transaction satisfies the elements of usury or falls under a common law exemption to the usury prohibition – not when assessing whether the transaction or a party to it fall under t a constitutional or statutory exemption from the usury prohibition. In other words, no court case holds that the applicability of a statutory or constitutional exemption to the usury provision is a question of fact and is based on the “substance” of a transaction.”

Indeed, the court pointed to two California cases that directed courts to look only to the face of the transaction to assess whether it falls under a statutory exemption from the usury prohibition and not loon to the intent of the parties. Consequently, the court found that it would only look at the face of the transactions at issue to assess whether the loans were exempted from the usury prohibition. Because a bank originated the loans, they were, in fact, exempt from California’s usury cap. The court, thus, granted the motion to dismiss.

Beechum contrasts with Consumer Financial Protection Bureau v. CashCall, Inc., in which a different judge in the same district adopted the “predominant economic interest” test for determining “the true lender” in a case involving a tribal model of installment lending. Participants in the bank partnership space should also pay attention to the decision, as use of this particular test makes it more likely that a court will strike down a bank partnership. The relevant language from that opinion follows:

In identifying the true or de facto lender, courts generally consider the totality of the circumstances and apply a “predominant economic interest,” which examines which party or entity has the predominant economic interest in the transaction. See CashCall, Inc. v. Morrisey, 2014 WL 2404300, at *14 (W.D. Va. May 30, 2014) (affirming the lower court’s application of the “predominant economic interest” test to determine the true lender, which examines which party has the predominant economic interest in the loans); People ex rel. Spitzer v. Cty. Bank of Rehoboth Beach, Del., 846 N.Y.S.2d 436, 439 (N.Y. App. Div. 2007) (“Thus, an examination of the totality of the circumstances surrounding this type of business association must be used to determine who is the ‘true lender,’ with the key factor being ‘who had the predominant economic interest’ in the transactions.); cf. Ga. Code Ann. § 16-17-2(b)(4) (“A purported agent shall be considered a de facto lender if the entire circumstances of the transaction show that the purported agent holds, acquires, or maintains a predominant economic interest in the revenues generated by the loan.”) The key and most determinative factor is whether Western Sky placed its own money at risk at any time during the transactions, or whether the entire monetary burden and risk of the loan program was borne by CashCall. See, e.g., Eastern, 381 F.3d at 957 (“[T]he touchstone for decision here is whether licensed or unlicensed parties were placing their own money at risk at any time during the transactions.”); Morrisey, 2014 WL 2404300 at *7 (in reaching its conclusion that CashCall was the true or de facto lender, the lower court found that “numerous provisions of CashCall’s agreements with FB & T placed the entire monetary burden and risk of the loan program on CashCall, and not on FB & T.”). Indeed, as the Ninth Circuit stated in Eastern, “a lender is one who puts money at risk.” Eastern, 381 F.3d at 957.

Based on the totality of the circumstances, the Court concludes that CashCall, not Western Sky, was the true lender. CashCall, and not Western Sky, placed its money at risk. It is undisputed that CashCall deposited enough money into a reserve account to fund two days of loans, calculated on the previous month’s daily average and that Western Sky used this money to fund consumer loans. It is also undisputed CashCall purchased all of Western Sky’s loans, and in fact paid Western Sky more for each loan than the amount actually financed by Western Sky.

Moreover, CashCall guaranteed Western Sky a minimum payment of $100,000 per month, as well as a $10,000 monthly administrative fee. Although CashCall waited a minimum of three days after the funding of each loan before purchasing it, it is undisputed that CashCall purchased each and every loan before any payments on the loan had been made. CashCall assumed all economic risks and benefits of the loans immediately upon assignment. CashCall bore the risk of default as well as the regulatory risk. Indeed, CashCall agreed to “fully indemnify Western Sky Financial for all costs arising or resulting from any and all civil, criminal or administrative claims or actions, including but not limited to fines, costs, assessments and/or penalties . . . [and] all reasonable attorneys fees and legal costs associated with a defense of such claim or action.”

Accordingly, the Court concludes that the entire monetary burden and risk of the loan program was placed on CashCall, such that CashCall, and not Western Sky, had the predominant economic interest in the loans and was the “true lender” and real party in interest. The Court will now apply the principles set forth in Restatement § 187(2), in light of the Court’s determination of the real parties in interest to the loan agreement, i.e., CashCall and the borrower.

The court cites the CashCall, Inc. v. Morrisey case as a “Western District of West Virginia” federal case. It is actually a West Virginia Supreme Court case.

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