Financial Industry Alert
March.05.2020
The Second Circuit’s decision in Madden v. Midland Funding, LLC was announced in 2015. Since that time, there have been a number of cases brought based on the Second Circuit opinion, as well as recent regulatory proposals seeking to essentially overturn the decision. Below is an update on where the key cases and regulatory actions stand today.
Brief Background
National and state-chartered, FDIC-insured banks are not subject to certain state-law usury limits thanks to federal preemption. Fintech-bank partnership models often depend on the enforceability of loans originated by those banks after sale of the loans to a third party that is not a bank and that could not independently invoke federal preemption. Enforceability of the loans is critical to the financing model of the fintech platform that has partnered with the bank originator.
The continued preemption of state usury laws after sale or assignment to a non-bank is rooted in the statutorily protected authority of banks to sell loans without significant interference from state law, as well as the long-standing principle that a loan that is valid when made does not become usurious through sale or assignment. The Second Circuit’s decision in Madden v. Midland Funding, LLC, however, suggested that state usury limits apply in certain circumstances once a bank sells or assigns its loans to a non-bank.
The Credit Card Securitization Cases – Chase and CapOne
Relying on Madden, plaintiffs have filed two putative class actions related to the securitization of credit card receivables. Petersen v. Chase Card Funding, LLC, was filed in the Western District of New York and Cohen v. Capital One Funding, was filed in the Eastern District of New York. In each case, the actions were filed against the non-bank depositor and the securitization trusts (along with their trustees) that bought and securitized receivables from credit card accounts originated by the bank. Both complaints, citing Madden, assert that federal law does not preempt the application of state usury law to credit card receivables once they are sold to non-bank entities. The complaints construe Madden to establish “that national banks could not sell or assign their ability to charge otherwise usurious interest rates to non-national bank third parties.”
Motions to dismiss were filed in both cases. The magistrate judge hearing the Petersen motion to dismiss recently recommended dismissal, concluding that New York’s usury statutes were preempted because they “would prevent Chase USA’s ability to sell or assign the receivables from its credit card accounts” to third-party, non-bank entities.
The magistrate judge explained that “[b]ecause Madden contains language favorable to both sides in this case, it does not unequivocally answer the question of whether Petersen’s usury claims are preempted.” Looking at the issue afresh, the magistrate judge reasoned that application of New York’s usury laws in this context is preempted because applying them would significantly interfere with the bank’s power to sell or assign the receivables generated by its credit card accounts.
The magistrate judge’s recommendation remains subject to the parties’ objections and the district court’s confirmation.
The Petersen plaintiffs filed objections on February 5. Defendants’ response to the objections are due Wednesday, March 4. A district court ruling is expected shortly thereafter. Meanwhile, the Cohen v. Capital One Funding case appears to be in a holding pattern waiting for the outcome of Petersen.
The Online Lending Platform Cases – Marlette and Avant
The other major set of fintech cases is proceeding in Colorado state court. The Administrator of Colorado’s Uniform Consumer Credit Code filed separate actions against Marlette Funding LLC and Avant, Inc., relying in part on Madden. Both defendants are online lending platforms that facilitate, and later purchase, loans originated by state-chartered, FDIC-insured banks. The Administrator maintains that under Madden, federal law does not preempt application of Colorado usury law to those loans because “banks cannot validly assign” their “interest rate exportation rights.”
The Colorado state court overseeing both actions denied motions to dismiss filed by Marlette and Avant. The court concluded that if Colorado’s allegations were true (which remains an open question), they would establish that Marlette and Avant were the “true lenders” for purposes of state usury law, defeating their federal preemption defense. The court declined to engage with the merits of Colorado’s Madden arguments. Instead, the court simply suggested that Madden would not be relevant if Marlette and Avant were the “true lenders” of their loans at the outset.
After the court denied the motions to dismiss, Colorado amended its complaints in both cases to add as defendants the trustees for several trusts to which Marlette and Avant transferred loans in connection with securitizations, along with one limited liability company that purchased loans from Avant. Colorado alleges that the trustees and limited liability company, like Avant and Marlette, are subject to state usury law to the extent they seek to enforce the loans. The trustees and limited liability company moved to dismiss the claims for lack of personal jurisdiction. The state court denied those motions.
Trials in both cases are now set: Meade v. Marlette is scheduled to start April 13 and Meade v. Avant is scheduled to start May 18.
In the interim, in In re Rent-Rite, a bankruptcy court judge in the District of Colorado rejected Madden’s reasoning as unsound. A state-chartered, FDIC-insured bank had entered into a promissory note to a Colorado corporation with an interest rate that exceeded Colorado’s usury caps but was valid thanks to federal preemption. The bank had then assigned the promissory note to a non-bank entity, which had attempted to collect interest. The debtor in the bankruptcy (which had acquired property pledged as security for the note) filed a usury claim against the non-bank assignee in an adversary proceeding, alleging that Colorado’s usury laws were no longer preempted after assignment of the note. The bankruptcy court disagreed, concluding that preemption continued after assignment under the longstanding “‘valid-when-made’ rule.” In so holding, the court expressly “disagree[d] with Madden.”
OCC/ FDIC Proposed Rulemaking
Finally, the OCC and FDIC both issued notices of proposed rulemaking seeking to end the “uncertainty regarding the ongoing validity of the interest term” on loans sold or assigned by national and state banks to third-party, non-bank entities. The proposed rules explicitly target Madden and would expressly preempt state usury laws that purport to affect the interest rates on loans that are transferred by the originating national or state bank. The proposed rules do not address which entity is the “true lender” when a bank makes a loan and assigns or sells the loan or receivables to a third party. Comments were due on the OCC rule by January 21, 2020, and on the FDIC rule by February 4, 2020.
If these rules go into effect, they will strengthen the likelihood that courts outside the Second Circuit will not follow Madden. Courts are likely to give deference to the policy expressions of the OCC and the FDIC that are reflected by the rules, although a court will not necessarily be bound by the rules. The FDIC and OCC’s concerted action would certainly encourage at the very least a healthy skepticism toward Madden and its restrictions on federal preemption. Even within the Second Circuit, the FDIC’s and OCC’s hostility to Madden could spur the Second Circuit, in a future case, to revisit and overrule the Madden precedent, or limit the precedential force of the Madden opinion to its particular facts.