August 07, 2020

Fighting the Fix: Three States Sue the OCC for Codifying the Valid When Made Doctrine

4 min

In the midst of the economic fallout from a global pandemic, struggling consumer lenders saw a glimmer of good news when two federal banking regulators coordinated to bring clarity to the secondary loan market. A suit filed last week now threatens to rollback that effort.

Our previous articles, Elusive Madden Fix Part 1 and Part 2, explained the newly issued regulations from the Office of the Comptroller of Currency (OCC) and Federal Deposit Insurance Corporation (FDIC) that codified the valid when made doctrine for national banks and state banks, respectively. This doctrine holds that whether the interest rate charged on a loan is permissible is determined at the point in time when the loan is made, not at the point when it is sold or assigned. The OCC and FDIC rulemakings were a reaction to the Second Circuit's 2015 decision in Madden v. Midland Funding, LLC (Madden), and the agencies said amendments were simply reaffirming the pre-Madden status quo.

California, Illinois, and New York (together, States) disagree.

On July 29, 2020, the attorneys general for the States filed a complaint in the U.S. District Court for the Northern District of California (Complaint) challenging the OCC's final rule on Permissible Interest on Loans that are Sold, Assigned, or Otherwise Transferred (OCC Rule). The complaint focuses on national banks, federal savings associations, and the OCC's interpretation of the applicable statutes, but it also references the FDIC's parallel effort.

The States are seeking to declare that the OCC violated the Administrative Procedure Act (APA) and to have the Court set aside the OCC Rule. The States claim that the OCC failed three requirements of the APA, claiming that the OCC Rule is: (i) arbitrary and capricious, (ii) in excess of the OCC's statutory jurisdiction, and (iii) an agency action taken without the required procedure.

Although the States make eight separate arguments to support their claim, the bulk of the Complaint focuses on the alleged harms that will flow from the OCC Rule. The States are not fundamentally opposed to banks selling and assigning loans, but they are, however, worried about the expansion of the bank partnership origination model for consumer lending. These partnerships, the States allege, are merely vehicles through which non-bank lenders charge usurious interest rates that would be prohibited if not for the bank's involvement.

In the Complaint, they assert it is essential that the States maintain their consumer protection oversight of non-bank lenders. They believe the OCC Rule—which clarifies that a sale or assignment does not invalidate a loan that was legally permissible at the time it was made—is a regulation on the non-bank loan buyers and that it preempts the States' authority. The States reach that conclusion, however, by viewing a loan's interest rate as a right held by the person collecting the interest and not as a characteristic of the loan asset.

It is clear from the Complaint that the States view loans originated through bank partnerships as not made by the banks, regardless of the legal and economic structure of any particular loan program. The States call these programs "rent-a-bank schemes" that are "designed to evade the law," and see the OCC Rule as promoting bank partnership originations that impair the States' consumer protection and anti-usury efforts. But that position implies that the States should be focused more on how determine the true lender of loans originated through a bank partnership model, an issue that the OCC and FDIC are each addressing in a separate rulemaking.

Summarized below are the States' arguments for why the OCC Rule violates the APA and should be set aside. Note that for simplicity, although the OCC Rule and the Complaint address both national banks under the National Bank Act and federal savings associations under the Home Owners' Loan Act, the summaries below cite only to the statutes applicable to national banks.

  • The plain language of section 85 of the National Bank Act (Section 85) applies only to interest rates charged by national banks and not to the rates charged by assignees, transferees, or purchasers.
  • The statutory framework of the National Bank Act shows that Section 85 applies only to national banks.
  • The OCC Rule impermissibly preempts state law with respect to non-banks that acquire loans from national banks.
  • The OCC Rule effectively overturns Madden, which is not within the OCC's authority.
  • The OCC Rule departs from the OCC's own previous interpretations without adequate justification for the change.
  • The OCC failed to adequately consider the OCC Rule's effects, including facilitation of predatory lending and creation of a regulatory vacuum.
  • The OCC did not provide "substantial evidence" for its choice to preempt state law and did not "examine the relevant data" regarding the impact of Madden on the secondary loan market.
  • Under the Dodd-Frank Act, the OCC Rule is entitled only to a lower standard of deference than is usually accorded to federal agencies (i.e., Skidmore as opposed to Chevron).

We will be watching for the OCC's answer, which is due 60 days after the Complaint was filed. National banks and non-bank lenders should contact the authors for more information about the potential impact of this suit.