UDAAP: The CFPB's Emerging and Evolving Doctrine
Wednesday, October 5, 2016 | 2:00 – 3:00 p.m. ET
As the Consumer Financial Protection Bureau (CFPB) continues to flex its enforcement muscles, regulated entities must be aware of and comply with the Dodd-Frank Act's prohibition against unfair, deceptive, or abusive acts or practices (UDAAP), or face the prospect of substantial penalties. The evolving interpretation of this relatively new and vaguely worded law, however, makes compliance challenging. During this program, our panel examines the statute and how it has been applied and interpreted. The discussion is led by Venable partner Allyson Baker, a former CFPB Enforcement Attorney who now represents banks and nonbanks in CFPB investigations.
CFPB Victory in CashCall Case – Owner Found Personally Liable
On August 31, 2016, the U.S. District Court for the Central District of California granted the CFPB's motion for summary judgment against CashCall, an online small-dollar consumer finance company. The Court sided with the CFPB, finding that CashCall, and not the Native American tribal entity it had contracted with, was the "true lender" on thousands of consumer loans. Without the preemption granted to tribal entities, the Court found that the loans made by CashCall violated usury and licensing laws in sixteen states and, therefore, were void or uncollectible under those laws. And, by attempting to collect on such loans, CashCall and its president and sole owner violated the Dodd-Frank Act's prohibition against unfair, deceptive, and abusive acts and practices (UDAAP).
In 2009, CashCall entered into an agreement with Western Sky Financial (Western Sky), a South Dakota company licensed to do business by the Cheyenne River Sioux Tribe (CRST) to fund and purchase consumer loans originated by Western Sky. Based on this arrangement, CashCall took the position that, because the loans were made by a tribal entity and contained a choice-of-law provision designating CRST law to govern the loans, state laws related to interest limits, and lender licensing did not apply. CashCall further argued that such laws also did not apply to CashCall when it later purchased the loans from Western Sky.
In response, the CFPB argued that although Western Sky was the lender identified on the notes evidencing the loans, CashCall was the "true lender" because it had the "predominant economic interest" in the loan transactions. The Court agreed with the CFPB, finding that, based on the totality of the circumstances, CashCall had the predominant economic interest in the loans and therefore was the true lender. Specifically, the Court focused on the following facts regarding CashCall's arrangement with Western Sky:
- CashCall maintained funds in an account for Western Sky's use equal to two days' worth of loan proceeds, based on the prior month's daily average.
- CashCall purchased all of Western Sky's loans.
- Although CashCall waited a minimum of three days prior to purchasing loans from Western Sky, it purchased every loan before any payments on the loan were made.
- CashCall guaranteed Western Sky a minimum monthly payment of $100,000, as well as a $10,000 administrative fee.
- CashCall assumed all economic risks and benefits of the loans immediately upon assignment.
- CashCall bore all default risk and regulatory risk and provided Western Sky a broad indemnity for all costs arising out of the arrangement.
Based on these factors, the court found that CashCall had the predominant economic interest in the loans, was the true lender, and was not entitled to take advantage of Western Sky's status as a tribal entity to preempt the application of state laws.
The Court then determined that the tribal choice-of-law provision in the loan agreements was not enforceable because the CRST, which was not the true lender here, had no substantial relationship to the loan transactions, and there was no other reasonable basis for the choice of CRST law. In the absence of an effective choice-of-law provision, the court found that the law of the state where each borrower resided governs each loan agreement.
Without the benefit of preemption, the loans, which bore annual interest rates of 80% or more, violated the usury laws in each of the sixteen states the CFPB identified, rendering the loans void. In addition, CashCall violated laws in fifteen of the sixteen states by failing to obtain a license authorizing it to lend to residents of those states.
After concluding that the consumers' home state laws governed the loan agreements, the Court turned to whether the defendants violated the Dodd-Frank Act's prohibition on UDAAP. Agreeing with the CFPB, it found that by attempting to collect the void loans, CashCall created the "net impression" that the loans were enforceable and that borrowers were obligated to repay them, which was "patently false."
Finally, because CashCall's owner and president, J. Paul Reddam, was a direct participant in and had authority to control CashCall's activities, and because he knew of or was recklessly indifferent to the misrepresentations, the Court held him personally liable for the violations. The court's decision thus follows the Ninth Circuit's application of the jurisprudence regarding individual liability for corporate violations under the FTC Act in CFPB v. Gordon. The decision did not, however, address the interplay between the imported individual liability analysis and the Dodd-Frank Act's "related person" provision.
The CFPB's victory comes at a time when other state and federal regulators are questioning the ability of a nonbank to make loans by partnering with an entity exempt from state law. Keep an eye out later this month for Venable's full analysis of this important case in the context of other recent events and inquiries into the use of preemption strategies in online lending.