Bank Partnerships On Offense: Bank Sues State Regulator For Infringing on Bank Rights Under Federal Law

Colorado, long a leader in the fight for consumer protection, has taken two separate actions in the last three months to shut down the bank partnership model in its borders. In one of the actions, Meade v. Marlette Funding LLC, Julie Anne Meade, the administrator of the Uniform Consumer Credit Code (“UCCC”), asserts on behalf of the state and its residents that Marlette violated the Colorado Uniform Consumer Credit Code in marketing “Best Egg” consumer loans to Colorado residents. Cross River Bank, a New Jersey state-chartered bank that partners with Marlette to provide these loans and that was not named in the Administrator’s lawsuit as a defendant, subsequently filed a complaint for declaratory judgment and conjunctive relief against Meade in her official capacity as Administrator of the uniform Consumer Credit Code for Colorado. The complaint seeks a declaration to protect the bank’s federal, statutory and contractual rights, as, according to the bank, the Administrator’s activities directly threaten the bank’s “federally protected rights to extend and freely transfer validly-made loans on a nationwide basis, consistent with the Federal Deposit Insurance Act (“FDIA”) and centuries-old federal case law.”[1]

The complaint features prominently the bedrock legal concept that a loan that is “valid when made” remains valid throughout the life of the loan. This concept was undermined by the U.S. Court of Appeals for the Second Circuit in Madden v. Midland Funding. Before Madden, centuries of case law established that usury is determined at the time of loan origination – this is the “valid when made” concept. As far back as 1828, the U.S. Supreme Court held that if a loan note is free from usury in its origin, no subsequent usurious transactions with regard to that note can make that note usurious. Madden upended this concept in favor of a test that determined usury based on who holds the loan and what rate they impose. Madden negatively impacts bank partnership programs because a key aspect of virtually all bank partnership programs is the ability of the bank to sell the loans it originates to non-bank parties.

In filing its complaint, the bank noted that the Administrator made a strategic decision not to sue the bank, but that her enforcement action against Marlette would prohibit Cross River from selling any loans it makes to Colorado residents unless Cross River conforms the loans to Colorado limitations on interest and fees. The bank asserts that the Administrator’s action has damaged the bank, in that the bank receives less revenue in connection with loans already originated by the bank and sold to Marlette as well as its ability to originate loans in the future.

The complaint recites the ability of state-chartered banks to export the interest rates and fees associated with their home state, regardless of where the borrower resides. It also cites to the various guidance promulgated by the FDIC and other federal banking agencies regarding the ability of banks to work with third-party vendors to support the bank’s loan originations. The complaint alleges that Congress grants the FDIC the power to examine both the banks and its third-party partners, and that the FDIC is to evaluate the activities conducted by third-party vendors as if the bank performed them directly. Specifically, “(w)henever a depository institution that is regularly examined by an appropriate Federal banking agency, or any subsidiary or affiliate of such a depository institution that is subject to examination by that agency, causes to be performed for itself, by contract or otherwise, any services authorized …, whether on or off its premises

  • such performance shall be subject to regulation and examination by such agency to the same extent as if such services were being performed by the depository institution itself on its own premises, and
  • the depository institution shall notify each such agency of the existence of the service relationship within thirty days after the making of such service contract or the performance of the service, whichever occurs first.

Cross River further refers to numerous statements and guidance proposed by the FDIC on managing relationships with third parties as support for the idea that FDIC-insured state chartered banks are well within their federal powers to work with third-party vendors to execute banking functions. Cross River ultimately asserts that the Administrator’s lawsuit against Marlette violates both Section 27 of the FDIA, which preempts any state law regarding the terms, including interest rates and fees, on which a bank may originate loans, and the “valid when made” doctrine. Cross River thus seeks a declaration under federal law that its activities and Marlette’s activities in connection with the bank partner program comply with applicable federal law and that “any Colorado laws or regulations that interfere with federal law are preempted.” It also seeks an injunction barring the Administrator from enforcing preempted Colorado laws or regulations against the bank as well as its non-bank partners.

[1]             Complaint at Paragraph 1.

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Madden Court Applies New York Law; Allows Class Certification of FDCPA & UDAP Claims

The U.S. District Court for the Southern District of New York injected additional uncertainty into the debt buying and bank partnership markets with its remand decision in Madden v. Midland Funding. In Madden, the U.S. Court of Appeals for the Second Circuit – which includes Connecticut, New York, and Vermont – held that non-national bank entities that purchase loans originated by national banks cannot rely on the National Bank Act (“NBA”) to protect them from state-law usury claims. The Second Circuit’s decision in Madden undermined the “valid when made” theory on which assignees relied for many years and impeded the ability of national banks (and, by analogy, state-chartered banks) to sell the loan obligations they originate, thus reducing their ability to lend. One issue the Second Circuit did not decide is what state law should governing the underlying loan agreement – New York, the state where Madden lived, or Delaware, the state chosen as the governing law for the underlying agreement. Continue reading “Madden Court Applies New York Law; Allows Class Certification of FDCPA & UDAP Claims”

Bank Partnership Scores Win In Putative Class Action

LendingClub scored a significant victory in a lawsuit brought by a putative class of consumers who asserted that the marketplace platform partnered with a Utah bank to avoid application of such state interest rate limitations.

In Bethune v. LendingClub Corporation et al., Civil Case # 1:16-cv-02578-NRB (S.D.N.Y. April 6, 2016), Bethune claimed that LendingClub “improperly attempted to circumvent the application of relevant state usury laws … by contracting with … WebBank, a bank with a Utah state charter, to act as a ‘pass through’ for LendingClub’s loans.” Bethune argued that this structure, pejoratively referred to by consumer advocates as a “rent a bank scheme,” circumvented New York usury laws because Utah has no usury limitations and WebBank, as a Utah bank, could export Utah interest rates into all other states, including New York, pursuant to federal law. Bethune claimed that this “scheme” allowed LendingClub to offer him a loan in New York that exceeded New York’s criminal usury cap of 25% per year. He thus sued LendingClub and WebBank in the U.S. District Court for the Southern District of New York in a putative class action for usury law violations as well as UDAP and RICO claims.

LendingClub and WebBank countered that Bethune’s loan agreement included an arbitration provision, which bound him to arbitrate all disputes as an individual, and not on behalf of a class. Importantly, the arbitration provision included an opt-out provision that Bethune did not exercise. That is, he could have written LendingClub to state that the arbitration provision would not apply to the agreement, but he did not exercise this right. The loan agreement also provided that federal law and Utah law governed the agreement, and that the arbitrator would be the decider of all disputes arising from the loan agreement, including whether a dispute could be arbitrated. The court sided with LendingClub and WebBank and concluded that the loan agreement contained “clear and unmistakable evidence” that the parties to the agreement delegated the question of arbitrability of disputes under the loan agreement to the arbitrator. In an effort to derail arbitration, Bethune asserted that the loan agreement was “unconscionable” and the court should thus set aside the arbitration provision. The court was not moved by this argument, however, because Bethune did not address how the arbitration provision itself was specifically unconscionable. Rather, he attempted to bootstrap his desire to avoid arbitration to his bald assertion that the usury rate was “unconscionable.” The court thus granted the motion to compel arbitration on an individual basis, effectively undercutting Bethune’s lawsuit.

Bethune v. LendingClub Corporation et al. Civil Case # 1:16-cv-02578-NRB (S.D.N.Y. January 30, 2017)

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. Continue reading “California District Court Issues Favorable Bank Partnership Decision”

Connecticut Small Loan Statute Changes Impact Bank Partnerships

Effective July 1, 2016, amendments to Connecticut’s small loan statutes impact entities that partner with banks to originate loans in the Nutmeg state. Under the amendments, nonbank lead generators, most servicers and most nonbank purchasers of certain “small loans” of $15,000 or less with an annual percentage rate that exceeds 12% are subject to licensure. The amendments define “generating leads” as(A) engaging in the business of selling leads for small loans; (B) generating or augmenting leads for small loans for other persons for or with the expectation of compensation or gain; or (C) referring consumers to other persons for a small loan for or with the expectation of compensation or gain for such referral.

FDIC Seeks Feedback on Third-Party Guidance

The Federal Deposit Insurance Corporation seeks feedback on the guidance it gives to its member banks that work with outside partners to originate loans, including vendors involved in bank partnerships. On July 29, the Federal Deposit Insurance Corporation requested comments on its proposed third-party lending guidance that outlines the risks that may be associated with third-party lending as well as the expectations for a risk-management program, supervisory considerations, and examination procedures related to third-party lending. Under the proposed guidance, third-party lending is an arrangement in which a bank relies on an outside source to perform a significant aspect of the lending process, such as originating loans for third parties, originating loans through third parties or jointly with third parties, and originating loans using platforms developed by third parties. The draft guidance supplements and expands on previously issued guidance and would apply to all FDIC-supervised institutions that engage in third-party lending programs. Comments on the guidance will be accepted until September 12, 2016.

Consumer Bank Partnerships In Jeopardy in Maryland

In late June, the Maryland Court of Appeals, Maryland’s highest court, affirmed in  Maryland Commissioner of Financial Regulation v. CashCall, Inc. that a non-bank partner cannot promote loans originated by a bank unless the nonbank partner is licensed as a credit services business and the loans comply with substantive Maryland law. Court of Appeals, No. 80, September Term 2015 (June 23, 2016), affirming Court of Special Appeals, No. 1477, September Term 2013 (October 27, 2015).  The decision hampers the ability of nonbank partners to market loans on behalf of a bank in Maryland unless they acquire a credit services business license. Continue reading “Consumer Bank Partnerships In Jeopardy in Maryland”

Solicitor General Issues Brief in Madden

In response to the U.S. Supreme Court’s request, the Solicitor General submitted its brief in connection with the petition for certiorari in Madden v. Midland Funding, giving insight into the government’s view of national bank preemption. The brief addresses the question of whether the National Bank Act, which preempts state usury laws regulating the interest a national bank may charge on a loan, continues to have preemptive effect after the national bank has sold or otherwise assigned the loan to another, nonbank entity. The Solicitor General rejected the analysis of the U.S. Court of Appeals for the Second Circuit in Madden, characterizing the appellate court’s conclusion that  applying state usury laws to assignees of national banks does not significantly interfere with the bank’s power to sell its loans as an “unduly crabbed conception of (National Bank Act) preemption.” Although the Solicitor General noted that the Madden decision was incorrect, and that state usury laws should not apply to loans made by national banks, it urged the Supreme Court to reject the petition for certiorari because Madden would be a “poor vehicle for resolution” of the question presented.

Solicitor General Brief in Madden

 

Treasury Issues Online Marketplace Lending White Paper

The U.S. Department of Treasury issued its much-anticipated marketplace lending white paper. The white paper, Opportunities and Challenges in Online Marketplace Lending, makes several recommendations to encourage safe growth and access to credit through the continued developments of online marketplace lending, including:

1. Support for more robust small business borrower protections and effective oversight;

2.  Ensuring a sound borrower experience and back-end operations;

3.  Promotion of a transparent marketplace for borrowers and investors;

4.  Expanding access to credit through partnerships that ensure safe and affordable credit;

5. Supporting the expansion of safe and affordable credit through access to government-held data; and

6.  Facilitate interagency coordination through the creation of a standing working group for online marketplace lending.

Treasury consulted with staff from other agencies including the Consumer Financial Protection Bureau (CFPB), Federal Deposit Insurance Corporation (FDIC), Board of Governors of the Federal Reserve System (FRB), Federal Trade Commission (FTC), Office of Comptroller of the Currency (OCC), Small Business Administration (SBA), and Securities and Exchange Commission (SEC).

The white paper is available online here.

2016 Consumer Financial Services Conference

Hudson Cook LLP recently held its Consumer Financial Services Conference. I presented on two panels. The PowerPoint presentations for each follow:

BANK PARTNERSHIP AND THE VALID WHEN MADE DOCTRINE: UPDATE ON MADDEN V MIDLAND

Panelists:
Cathy Brennan, Partner, Hudson Cook, LLP, Hanover, MD
Meghan Musselman, Partner, Hudson Cook, LLP, Hanover, MD
Joseph Vitale, Partner, Schulte Roth & Zabel LLP, New York, NY

Description of Panel:
In the recent decision in Madden v. Midland Funding, LLC, the U.S. Court of Appeals for the Second Circuit held that National Bank Act preemption of state usury laws did not apply to accounts owned and serviced by Midland Funding, LLC, a non-bank debt buyer, even though a national bank originated the account. The panel will discuss how the decision undermines the “valid when made” theory and impedes the ability of national banks to sell loans they originate, thus reducing their ability to lend. The panel will also discuss the impact on anyone involved in a bank partnership model of lending and on those purchasing loans or lines of credit. Panelists will also discuss strategies for addressing the challenges presented by Madden, including licensing and deal structure responses.

Madden Panel

MERCHANT CASH ADVANCE AND SMALL BUSINESS LENDING SESSION: REGULATORY DEVELOPMENTS INCLUDING ISO AND BROKER ISSUES AND GOVERNMENT ADVOCACY

Panelists:
Cathy Brennan, Partner, Hudson Cook, LLP, Hanover, MD
Shawnielle Predeoux, Associate, Hudson Cook, LLP, Hanover, MD
Tom Sullivan, Executive Director, Coalition for Responsible Business Finance, Washington, DC

Description of Panel:
Panelists discuss recent activity by federal regulators and industry efforts to advocate for increased access to capital for merchants. Discussion also includes legal developments and best practices for working with independent sales organizations and brokers.

MCA Panel