A federal district judge rejected states' challenge to the Office of the Comptroller of the Currency (OCC) and Federal Deposit Insurance Corporation (FDIC) rules that the permissible interest rate for a loan is determined when the loan is made, not when it is sold or assigned. The February 8, 2022 outcomes in California v. Office of the Comptroller of the Currency and California v. Federal Deposit Insurance Corp. are a win for banks, bank partnership models, and secondary buyers. OCC and FDIC adopted these rules to address the uncertainty surrounding the bank partner lending model and secondary loan markets created by the Second Circuit Court of Appeal's 2015 decision in Madden v. Midland Funding, LLC.
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 analyzes the legality of a loan based on the circumstances at the moment of origination. The decision riled credit markets and created significant uncertainties for secondary markets and non-bank lenders nationwide.
Consequently, as we explained in our previous articles Elusive Madden Fix Part 1 and Part 2, the OCC and FDIC adopted the so-called Madden-fix rules in June 2020 to return to the pre-Madden status quo and apply the valid-when-made doctrine to the preemption of state usury laws. However, opponents of the rules characterize them as encouraging "rent-a bank" schemes that undermine state usury laws and harm consumers.
Thus, it came as no surprise when, a month later, California, Illinois, and New York sued the OCC and Acting Comptroller of the Currency Michael J. Hsu, alleging that the adoption of the Madden-fix rule violated the Administrative Procedure Act (APA). Yet, the judge rejected the states' arguments in their entirety.
First, the judge held that, because the OCC was interpreting the substantive meaning of Section 85 of the National Bank Act, which establishes national bank preemption, rather than making a preemption determination under 12 U.S.C. § 25b, the OCC was not required to follow the procedure in § 25b. Second, the judge concluded that the Second Circuit's decision in Madden did not clearly hold that Section 85 was unambiguous, so the Madden decision does not preclude the OCC's rulemaking. Third, the judge held, under Chevron step one, that Section 85 does not speak directly to the issue at hand, which he defined by asking, "What happens to the interest rate initially set on a loan originated by a national bank if that loan is subsequently transferred?" Fourth, under Chevron step two, he concluded that the OCC's interpretation of Section 85 is reasonable. Finally, the judge rejected the states' arguments that the Madden-fix rule was arbitrary and capricious because the OCC failed to consider the rule's impact on rent-a-bank schemes and the impact of the true lender doctrine on the rule, and because the rule ran counter to evidence that Madden did not create uncertainty, finding that the OCC had considered these issues and had evidence to the contrary.
In a related suit, California, Illinois, New Jersey, New York, North Carolina, Massachusetts, Minnesota, and the District of Columbia sued the FDIC over its Madden-fix rule, also alleging that the FDIC's Madden-fix rule violated the APA. The judge was similarly unpersuaded by these states' arguments.
First, the judge held that the FDIC did not exceed its authority in implementing the Madden-fix rule because the rule regulates neither the transferee's conduct nor changes to the interest rate after the transfer. Second, the judge concluded that Section 27 of the Federal Deposit Insurance Act (the equivalent of Section 85 for state-chartered banks) does not address the issue at hand and that the FDIC's interpretation of Section 27 is reasonable. Finally, applying the same reasoning as in the OCC decision to the FDIC's administrative record, he rejected the states' arguments that the Madden-fix rule was arbitrary and capricious.
As acknowledged in the Madden-fix decisions, the OCC and FDIC chose not to address the separate but related true lender issue in the Madden-fix rulemakings. In recent years, bank partner lending models in the United States have faced legal challenges based on the theory that the non-bank partner (and not the bank) is the true lender in the transactions and therefore bank preemption of state licensing and usury laws should not extend to the non-bank partner.
However, the OCC did undertake a separate rulemaking to address the issue. In October 2020, the OCC issued a final rule (the "True Lender Rule") to clarify how to determine when a bank "makes a loan" and is the true lender for that loan. The True Lender Rule specified that a bank makes a loan when the bank, as of the date of origination, is named as the lender in the loan agreement or funds the loan and that the "true lender" is the bank named as the lender in the loan agreement.
The True Lender Rule, however, was short-lived. Eight months later, it was overturned under the Congressional Review Act, eliminating the OCC's ability to issue another rule in "substantially the same form" unless specifically authorized by a subsequent law.
The FDIC has not attempted to adopt a similar rule. Therefore, although the district court's recent rulings leave in place the OCC and FDIC's Madden-fix rules, the risk that a non-bank partner could be found to be the true lender and in violation of state licensing and usury laws remains.
The states have 60 days from the entry of judgment to file a notice of appeal.
Related Articles:
The Elusive Madden Fix Part 2: FDIC Codifies "Valid When Made" for Loans by State Banks
Fighting the Fix: Three States Sue the OCC for Codifying the Valid When Made Doctrine
Challenges in Expanding Financial Services to the U.S. Market
The OCC Draws a Bright Line for Determining the True Lender
FinTech Compliance Resources and Policy Perspectives
Online Lending Legal and Policy Issues Resources (Lend360 Winter 2020)