Where do marketplace lenders and secondary loan market participants find themselves on the issue of preemption of state usury laws after the June 27 denial of the petition for a writ of certiorari in Madden v. Midland by the U.S. Supreme Court?
In Madden v. Midland, the US Court of Appeals for the Second Circuit refused to follow the “valid-when-made” rule when considering the scope of federal preemption of state usury laws under the National Bank Act. The court held that the NBA did not bar the application of state usury laws to a national bank’s assignee. In considering the applicability of the National Bank Act to a loan in the hands of a non-bank assignee, the Second Circuit considered a number of cases upholding preemption of state usury laws under the National Bank Act but invoked a seemingly new rule for applying section 85 of the National Bank Act (permitting a national bank to charge interest at the rate permitted by its home state). The Second Circuit concluded that preemption is only applicable where the application of state law to the action in question would significantly interfere with a national bank’s ability to exercise its power under the National Bank Act. The court reasoned further that where a national bank retained a “substantial interest” in the loan, the application of the state usury law would conflict with the bank’s power authorized by the National Bank Act.
Madden v. Midland involved a debt collection matter where Madden, who lived in New York, objected to Midland’s attempt to apply a 27% interest rate to Madden’s credit card debt. Midland had acquired the credit card debt from a subsidiary of Bank of America after the debt had become delinquent and charged-off. Midland had successfully asserted at the lower court that it too was allowed under the section 85 of the National Bank Act to charge interest at the rate allowed by the laws of the state where the assignor bank was located when the loan was originated. The Second Circuit reversed the decision and held that the National Bank Act did not bar the state law usury claim that the rate at which post-assignment interest could accrue was governed by New York law[1]. However, it did not decide on the usury question and instead remanded to the District Court the issue of the validity of the Delaware choice of law provision contained in the Change In Terms, which was the contract applicable to the credit card debt.
The Second Circuit decision issued in May of 2015 was an unexpected divergence from a long standing principle that has facilitated loan sales in a variety of contexts. Before Madden v. Midland, buyers and sellers of debt relied on the apparently settled principle that, if a loan was valid when made, it could not become usurious upon assignment. In addition, many marketplace lenders without their own lending licenses have relied on the “valid-when-made” rule in their loan origination programs by contracting with national or state banks to originate loans for them.
In May of 2016, the U.S. Solicitor General and the Office of the Comptroller of the Currency filed a brief at the request of the U.S. Supreme Court. The brief criticized the Madden decision and argued that the Second Circuit’s preemption analysis was incorrect. It emphasized the impact the court’s ruling could have on the ability of national banks to fully exercise the power to convey to an assignee the right to charge the maximum interest rate allowed under the national bank’s home state. However, it was also the Solicitor General’s position that Supreme Court review of the case was not warranted for several reasons, including that there was no conflict among the circuits on the preemption issue in question as the preemption cases from the other Circuits did not address the specific question presented in the Madden case. Further, the Solicitor General criticized the parties for failing to adequately present the full range of preemption arguments, suggesting that the court of appeal’s failure to appreciate the scope of a national bank’s powers under section 85 of the National Bank Act and the importance of the “valid when made” rule, may have been attributable to the lack of clarity in the briefing. The Solicitor General also pointed to the interlocutory nature of the decision and the fact that there was still a state law issue to be decided by the District Court as yet another reason for not supporting the U.S. Supreme Court taking the case.
Although Madden v. Midland applies directly only to cases where a national bank is selling or assigning a loan, the policy underlying the decision to limit the exporting authority under the NBA might also be applied to a state bank’s rate exportation powers under Section 27 of the Federal Deposit Insurance Act (the state bank equivalent to section 85 of the National Bank Act). Secondary market participants and marketplace lenders now wait for the decision from the District Court on remand. If the court upholds the Delaware choice of law provision, market participants may manage the impact of the Madden v. Midland decision by electing a favorable choice of law provision in the underlying debt contract. That at least will provide an option for continuing to work with national banks despite the Madden case. Unfortunately, that solution will not work for buyers and sellers of existing loans, although presumably such parties are not too inconvenienced by a limit on the post-assignment interest that can be charged on a loan after substantial interest has already accrued, particularly if they have purchased the debt at a substantial discount. Other lenders may continue to rely on the state banks’ ability to export interest rates. In that situation, lenders should choose state banks whose state has a generous interest rate cap and is outside the Second Circuit.
The group impacted most by the Madden v. Midland decision appear to be marketplace lenders who acquire a loan shortly after origination and therefore have essentially all accruing interest at risk of challenge. One alternative option adopted by one on-line marketplace lender picking up on the “substantial interest” distinction in the Madden decision, is to require the bank loan originator to maintain an on-going economic interest in all loans after sale and receive certain payments on the loans only when borrowers made payments.
What remains following the Supreme Court’s refusal to hear Madden v. Midland is an outlier Second Circuit on the issue of the “valid-when-made” rule, and the blueprint for how to apply preemption under the National Bank Act as provided by the Solicitor General in its brief, a brief that as noted above clearly considers the Madden v. Midland decision to be wrong. Unfortunately, until such time as the right case comes along, market participants will have to make adjustments to accommodate the decision as necessary to address its impact on their particular situation.
[1] Notably, Madden conceded that Midland could collect the principal and all of the interest that accumulated during the period that the national bank held the debt, even though that rate was higher than Midland could have charged.