The Elusive Madden Fix Part 1: OCC Codifies "Valid When Made" for Loans by National Banks and Federal Savings Associations

4 min

Last week, the Office of the Comptroller of the Currency (OCC) issued a final rule to address the legal uncertainties caused by the Second Circuit Court of Appeal's decision in Madden v. Midland Funding, LLC (Madden). The rule makes clear that non-bank financial companies that purchase or take assignment of loans lawfully originated by national banks and federal savings associations are permitted to charge the same interest rate as charged by the banks that made the loan. Adopting the rule as proposed in November 2019, the regulatory text specifically provides that "interest on a loan that is permissible under 12 U.S.C. 85 [or 12 U.S.C. 1463(g)(1)] shall not be affected by the sale, assignment, or other transfer of the loan." The rule is effective 60 days after publication in the Federal Register.

In Madden, the Second Circuit held that a New York-based secondary market purchaser of bank credit card debt could not continue to charge the contract rate of interest imposed by the bank that initially extended the credit. The court held that while the interest rate was permissible for the bank under preemption laws, it was not permissible for the non-bank debt buyer because the rate exceeded the New York state usury limit.

The Second Circuit's decision cast aside the long-standing "valid when made" doctrine, under which a court would analyze the legality of a loan based on the circumstances at the moment of origination. Although, to date, the Second Circuit is alone in rejecting this doctrine—directly affecting only New York, Connecticut, and Vermont—the ruling riled credit markets and created significant uncertainties for secondary markets and non-bank lenders nationwide.

The OCC rule fixes this issue for loans originated by national banks and federal savings associations. The OCC says the rule "enhance[s] legal certainty" that will, in turn, "facilitate responsible lending by banks, including in circumstances when access to credit is especially critical." In issuing the rule, the OCC addressed the following comments:

  • Legal authority to issue the rule: The OCC has "ample authority" to issue the regulation without relying on federal preemption under section 25b of the National Bank Act (NBA). The OCC explains that NBA section 85 (12 U.S.C. 85) authorizes national banks to (1) lend money, pursuant to a loan contract, with an interest term that is consistent with the laws of the state in which the bank is located, and (2) subsequently transfer that loan and assign the loan contract. Upon assignment of a contract, the assignee "steps into the shoes of the national bank assignor." The OCC has the authority to clarify by rule that under section 85, an assigned loan should not be considered usurious when a third party enforces the contract. Furthermore, the Madden Court did not impair the OCC's authority to issue the rule, because the Second Circuit did not "unambiguously foreclose the OCC's interpretation" or rely on section 85. The OCC also notes that section 85 is outside the scope and, therefore, the limits on federal preemption under section 25b, which provides that "[n]o provision of [25b] shall be construed as altering or otherwise affecting the authority conferred by section 85."

    The OCC explains that the rule is consistent with the long-standing common law "valid when made" doctrine. In addition, the OCC highlights that the ability to transfer loans has long been an essential funding tool for banks, allowing them to manage liquidity and enhance safety and soundness. The rule restores the certainty undermined by Madden and eases liquidity challenges, particularly in times of economic stress.

    Section 4(g) of the Home Owners' Loan Act provides the OCC the same authority with respect to federal savings associations.

  • Policy implications of issuing the rule: Commenters on the proposed rule said it would facilitate predatory lending, particularly through third-party relationships with marketplace lenders. In the rule, the OCC reiterates its opposition to predatory lending and notes that OCC guidance, including guidance on managing third-party relationship risks, allows national banks and federal savings associations to appropriately manage predatory lending risks.

The rule does not, however, address the "true lender" issue, as many had hoped it would. The distinction between the "valid when made" and "true lender" issues is complicated and often confused. The OCC decided not to wade into the true lender fray, emphasizing that the rule is "narrowly tailored to address the specific legal uncertainty created by Madden."

While the OCC rule applies only to national banks and federal savings associations, the Federal Deposit Insurance Corporation (FDIC) is currently finalizing a proposal that would apply to loans originated by state-chartered banks. Together, these actions will ensure that "valid when made" doctrine is codified for all state and federally chartered depository institutions.

Please contact the authors with any questions.