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On Monday, June 27, 2016, the Supreme Court of the United States denied the petition for certiorari in Midland Funding LLC v. Madden, No. 15-610. The Supreme Court’s denial leaves intact the unusual – and troubling – decision by the U.S. Court of Appeals for the Second Circuit, Midland Funding, LLC v. Madden. In that case, the Second Circuit held that the application of state usury laws to nonbank assignees is not preempted by Section 85 of the National Bank Act (the “NBA”), but rather such assignees remain subject to state usury limits. The Second Circuit’s decision suggests that a nonbank assignee of a bank-originated loan might not be able to collect the amount of interest contracted for by the originating national bank if the rate of interest exceeds the usury rate otherwise applicable to the assignee. See our June 8, 2015 memo, Second Circuit Holds Application of State Usury Laws to Third-Party Debt Purchasers Not Preempted by National Bank Act.
To understand the import of the Madden decision, it is critical to appreciate the complex patchwork of restrictions that comprise usury law in the United States. In the U.S., usury laws are established by the individual states. All but six states impose some form of numeric usury limit, and the rates vary widely from state to state. A state typically imposes multiple usury limits which can vary depending on the nature of the borrower, the purpose of the loan, the amount of the loan, and the nature of the collateral. While usury is often thought of as a consumer issue, slightly less than half the states have usury limits that apply to at least certain forms of commercial purpose loans, too (although the permitted limits are often higher than for consumer loans). Some usury rates are fixed by statute, other usury rates are tied to an index (such as the Discount Rate), and others are set periodically by the state bank commissioner. Applicable usury rates for moderately sized consumer loans can be as low as a 6% fixed rate, or 5% plus the Discount Rate. How usury is calculated – in particular, what fees are deemed to be part of “interest” – also varies from state to state. States often take the position – either by statute or by judicial interpretation – that the usury limit applies to loans made to residents of that state, and cannot be avoided by a choice-of-law clause because such limit reflects a fundamental public policy, at least with respect to consumer loans. The penalties for usury range from the lender (or holder) forfeiting excess interest, to the loan being deemed unenforceable, or possibly the imposition of criminal penalties. As a result, lenders – in particular, consumer lenders – operating on a multistate basis face an enormous burden when complying with these state usury restrictions.
Banks are generally not subject to these limits when lending on a multistate basis. Section 85 of the NBA preempts borrower state usury law, permitting national banks to charge the rate of interest permitted by the law of the state where the bank is located notwithstanding another state’s usury law. This concept is known as “rate exportation.” A nearly identical statute was adopted in 1980 permitting rate exportation for state-chartered banks. In litigation running from 1978 through 1996, banks successfully defended their right to export interest rates and related fees across state lines. The ability to export rates and fees greatly simplifies the ability of banks to operate multistate loan programs without having to comply with the 50-state crazy quilt of usury laws.6 The ability to export rates across state lines has grown exponentially more important with rapid expansion of multistate lending over the past thirty years, starting with mail-based credit card lending in the ‘80s and now, internet-based lending.
Historically, whether a loan was deemed to be usurious is determined when the loan was originated. This concept – referred to as the “valid-when-made” doctrine – has been a fundamental tenet of usury law, and loan purchasers and assignees have long taken comfort that the loan is enforceable by its terms as long as the loan was not usurious when originated. In sum, the ability of banks to export interest rates across state lines allows banks to originate loans bearing a higher rate of interest than allowed by the borrower’s state law, and the valid-when-made doctrine permits the bank to sell the loan to a nonbank entity which can then collect the loan at the agreed upon rate of interest.
The Second Circuit’s decision in Madden raises the specter that assignees of bank-originated loans may no longer be able to rely on the valid-when-made doctrine when acquiring loans that have a nexus to the Second Circuit states (i.e., New York, Connecticut, and Vermont). Admittedly, the Second Circuit did not expressly address the valid-when-made doctrine in its opinion; however, the Second Circuit was briefed on the valid-when-made doctrine and simply chose to ignore the doctrine. Rather, the Second Circuit couched the issue as one of preemption, concluding that Midland Funding, the holder of the bank-originated loans, was not entitled to claim preemption of state usury laws as could the originating national bank.
At this point, the Madden case is on remand to the District Court for continued proceedings, including whether the Delaware choice of law clause should be honored (thereby preventing application of New York’s 16% usury limit), as well as Madden’s claims under the Fair Debt Collection Practices Act and her request for class certification. Midland Funding will undoubtedly argue (again) that the valid-when-made doctrine renders the loans non-usurious because the loans were originated by a national bank located in Delaware, where the rate the bank levied on Madden (27%) is permissible, and that New York’s usury law should incorporate the valid-when-made doctrine. Midland Funding will also be armed with the written legal analysis prepared by the Solicitor General and the Office of the Comptroller of the Currency (“OCC”) before the Supreme Court, where the Solicitor General and the OCC repeatedly stated that the Second Circuit’s decision was erroneous (but then ironically urged the Supreme Court not to grant the petition for certiorari). It is also hoped that the OCC will file as an amicus at the District Court proceedings, even though it chose not to do so in the prior Second Circuit proceedings.
The Madden decision has a number of important implications for lenders, assignees, and securitizers:
We hope that, upon remand, the District Court will recognize the absurd result suggested by the Second Circuit’s opinion – that is, that a loan seemingly can be usurious or non-usurious depending on who owns the loan at any given time – and that the District Court instead concludes that a loan originated by an out-of-state national bank in full compliance with the law of the state where the bank is located, and thus non-usurious when made, will remain non-usurious in the hands of any subsequent holder.
1 786 F.3d 246 (2nd Cir. 2015)
2 12 U.S.C. § 85.
3 In addition, some states recognize “usury savings clauses” whereby the parties agree that the loan is intended to comply with the usury limits, and thus the rate should be written down to the limit if usury is deemed to exist.
4 12 U.S.C. § 1831d
5 See Marquette National Bank v. First of Omaha Serv. Corp., 439 U.S. 299 (1978); Smiley v. Citibank (South Dakota), 517 U.S. 735 (1996).
6 Another advantage enjoyed by banks is that they are generally exempted or excluded from state loan licensing requirements.
7 See, e.g., Nichols v. Fearson, 32 U.S. (7 Pet.) 103, 109 (1833) (“a contract, which, in its inception, is unaffected by usury, can never be invalidated by any subsequent usurious transaction”); Gaither v. Farmers & Mechs. Bank of Georgetown, 26 U.S. (1 Pet.) 37, 43 (1828) (“[T]he rule cannot be doubted, that if the note be free from usury, in its origin, no subsequent usurious transactions respecting it, can affect it with the taint of usury.”).
8 Licensed lenders are almost always exempted from the usury restrictions of that state’s laws, but in turn are required to comply with any interest and fee restrictions typically imposed by the licensing statute.
9 218 F.3d 919 (8th Cir. 2000).
10 No. 1:16-cv-02578 (S.D.N.Y.).
11 CashCall, Inc. v. Morrissey, No. 12-1274, 2014 W. Va. LEXIS 587 (W. Va. May 30, 2014), cert. denied, 135 S.Ct. 2050 (Mem), 191 L.Ed.2d 956, 2014 WL 2404300, 2015 U.S. LEXIS 2991 (U.S., May 4, 2015). The true lender theory is the primary basis for the lawsuit against LendingClub in the Bethune case, mentioned previously. While the true lender theory has had limited success against bank-originated loans, the same theory has been more successful in assailing loans originated by tribal lenders that originate consumer lenders on behalf of third-party nonbank entities, and has resulted in settlements with a number of state attorneys general.