The United States Supreme Court recently declined to review the Second Circuit’s controversial opinion in Madden v. Midland Funding. As a result, uncertainty remains for non-bank purchasers of commercial paper on the secondary market regarding the enforceability of certain interest rates.
In Madden, the Second Circuit held that the National Bank Act did not prevent a borrower from bringing state law usury claims against a loan purchaser even though the loan was not usurious when originated by the initial lender (a national bank).1 The Second Circuit decision drew significant criticism from many prominent industry groups which urged the Supreme Court to review and reverse.
On June 27, 2016, the Supreme Court denied review. Until the law is further developed, both loan sellers and buyers need to understand the Second Circuit’s decision and implications arising from the Supreme Court’s refusal to review. Loan purchasers in Massachusetts will want to consider how transactions in the Commonwealth could be affected if borrowers attempt to use Madden to challenge the enforceability of loan documents based on a usury claim.
In Madden, a borrower residing in New York entered into a credit card account with a national bank. The agreement included an interest rate permissible under the law of Delaware, the home state of the originating bank. After default, the bank sold the paper to Midland Funding, LLC, which in turn relied on its affiliate to service the debt. When the affiliate attempted to collect interest at the rate set by the terms of the loan (27%), the borrower sued in the United States District Court for the Southern District of New York claiming that the purchaser and servicer had violated New York criminal and civil usury laws in attempting to collect.
The purchaser and originator responded that the National Bank Act preempted claims under New York usury law against the assignee of a national bank and, also, that Delaware law controlled due to the choice of law provision in the borrower’s agreement. The District Court agreed on the preemption issue and did not reach the choice of law issue. The borrower then appealed to the Second Circuit, which vacated the District Court’s judgment. The Second Circuit concluded that the National Bank Act ceased to preempt state law once the national bank had assigned the loan to a non-bank entity. The purchaser and servicer then petitioned the Supreme Court for review, arguing that the Second Circuit’s opinion threatened to “wreak havoc on the national banking system and the Nation’s credit markets.”2 Others joined the petitioners in advocating for review, citing “potentially catastrophic” consequences to the secondary and primary loan markets.3
Until another opportunity presents itself to the Supreme Court to provide clarity on the preemption issue, loan sellers and purchasers will need to consider the implications of Madden including:
- Scope: Madden is controlling only in the Second Circuit, which consists of Connecticut, New York and Vermont. Non-bank purchasers of commercial paper from national lenders will be prevented by Madden from arguing preemption in defending against similar claims by borrowers in any litigation commenced in the Second Circuit. Purchasers facing litigation in any other Circuit will face no similar barrier. Indeed, such purchasers will be able to point to wide-spread criticism of the Madden decision including, for example, in the brief of the United States Solicitor General labelling the Second Circuit’s decision erroneous.4
- Tightened Credit: The uncertainty created by Madden in New York may lead to tightened access to credit for some borrowers, since national banks may have more difficulty transferring their loans to non-banks. While predictions of “havoc” and “catastrophe” may have been overstated, the continued validity of the decision will have consequences for borrowers and lenders.
- Madden Litigation Will Continue: The Supreme Court’s refusal to review does not guarantee a victory for the borrower. Indeed, the Second Circuit ordered the case remanded to the District Court where the purchaser and servicer will argue that Delaware law should control and that the rate charged is clearly permissible under the laws of Delaware. Even if the lower court were to apply New York law, the purchaser may still pursue the “valid when made” doctrine, which recognizes the continued validity of a loan in the hands of a purchaser as long as it was valid when created by the originator.
- Criminal Usury in Massachusetts: The Massachusetts criminal usury statute, set forth at Mass. General Laws Chapter 271, Section 49, prohibits interest greater than twenty percent unless prior notice is provided to the Massachusetts Attorney General’s Office. Regulated lenders are specifically exempt from compliance with Section 49. If the First Circuit were ever to adopt the holding of Madden, then any non-regulated lender acquiring a loan from a regulated lender would need to grapple with how to comply with Section 49. At the very least, the non-regulated lender would want to file a notice filing with the Attorney General’s office before acquiring the paper; but query whether that alone would suffice to avoid violating the statute if the filing did not precede the making of the initial loan.
In sum, in declining to review Madden, the Supreme Court missed an opportunity to clarify the law in the Second Circuit and nationally. As a result, at least in the Second Circuit, a borrower is not precluded by the National Bank Act from bringing state law usury claims against a loan purchaser even when the loan was not usurious when made by the originating national bank. Non-regulated lenders in Massachusetts will want to consider carefully the effect of Madden on their ability to enforce all terms in acquired loan documents and to avoid inadvertent violation of the criminal usury statute.