The Colorado regulator facing a lawsuit from two banks seeking to work with nonbank partners filed a motion to dismiss the case, arguing that the banks lack standing to sue and that the federal preemption defense asserted does not by itself give rise to a federal question.

What happened

The dispute began when WebBank and Cross River Bank requested that a Colorado federal court enjoin enforcement actions brought by the state's administrator of the Uniform Consumer Credit Code against their nonbank lending platforms, from which market and service loans were originated by the banks.

The administrator's enforcement action argued that the nonbank partners are the "true lenders" of such loans and the banks could not validly assign their ability to export interest rates as state banks under federal law, citing Madden v. Midland Funding.

WebBank and Cross River's complaints argued that the National Bank Act preempts the administrator's actions and that the loans were legal under the "valid when made" rule, requesting a declaration to protect their federal statutory and contractual rights. The marketplace lending model embodied by the banks and their nonbank partners is not subject to the state lending laws of individual borrower's home states, the banks told the court.

Administrator Julie Ann Meade responded with a motion to dismiss the complaints, advancing four arguments for the court to toss the lawsuits.

First, she argued that the court lacks subject matter jurisdiction because the federal question arose in the context of an affirmative defense. "The well-pleaded complaint rule provides that a federal preemption defense does not, by itself, give rise to federal question jurisdiction," the defendant wrote. While an exception exists for state usury claims asserted directly against a national bank, Cross River and Web Bank are state-chartered institutions, the administrator said. This federal/state detail is likely a tough argument for Colorado, since the state cited a case involving federal law (Madden) against banks that are state-regulated and lend in Colorado under a different statute.

The second argument was that the banks also lack standing to bring suit against the administrator because the underlying enforcement action was taken against the nonbank partners—not Cross River or WebBank. Although the banks claimed to have suffered harm as a result of the administrator's enforcement action, "The alleged injuries identified by [the banks] belong to [the nonbanks] or are too attenuated to constitute standing," the defendant wrote.

For the third argument, the administrator examined the act's exportation provision. Interest exportation under the statute does not apply to state-chartered banks and does not extend to bank subsidiaries, affiliates or agents, according to the motion to dismiss, with no clear intent that Congress intended to preempt state laws that would otherwise apply to nonbanks.

The federal legislature could have provided in the act that banks' interest exportation rights preempt state laws as applied to nonbanks, but it did not, and adding support to the proposition that only banks currently have exportation rights, legislation was introduced in Congress last year to amend the act to extend such rights to nonbanks, the defendant said. As with the first argument, since the banks export their rates to other states under an alternate federal statute, the Federal Deposit Insurance Act (FDIA), it would appear that this argument will fall flat.

"Given that state usury claims against bank subsidiaries, affiliates and agents are not preempted, such claims certainly are not preempted when asserted against third parties who purchase bank loans," the administrator argued. "Third-party purchasers act on their own behalf and have an even more remote claim to a bank's interest exportation rights than bank subsidiaries or agents."

The recent Second Circuit decision in Madden sets forth this exact proposition, the defendant said. "Thus, the language of the relevant banking statutes, supported by case law, compels the conclusion that Congress unambiguously intended to grant interest exportation rights only to banks," the administrator wrote. "Those rights do not preempt state law as applied to nonbank purchasers." Again, the state of Colorado appears to be arguing that the Madden case (a National Bank Act case) should apply to banks that claim preemption under the FDIA. This argument, if adopted, would be unprecedented and serve to extend the Madden case to the entire marketplace lending third-party bank model.

Abstention principles provided the fourth argument for the defendant. The nonbank entities removed the underlying enforcement action to federal court, but the administrator's remand motion to state court remains pending. If that motion is granted, then the federal court should—in light of the Younger v. Harris abstention doctrine—dismiss the case, the defendant said.

Alternatively, the federal district court could decline jurisdiction under the Declaratory Judgments Act. The banks filed their lawsuit after the administrator's complaint was filed against the nonbank partners and after those defendants removed the case to federal court. "[T]hus, the [banks'] complaint appears to be used for the purpose of 'procedural fencing' or 'to provide an arena for a race to res judicata,'" the motion to dismiss argued, requesting the banks' complaints be dismissed with prejudice.

To read the motion to dismiss in Cross River Bank v. Meade, click here.

To read the complaint, click here.

Why it matters

This round of motions by the state of Colorado attempts to dismiss the case on procedural, and not substantive, grounds. If successful, the state would be able to further limit the industry's activities in Colorado. If unsuccessful, the marketplace lenders and their banking partners might have claimed an important victory in defending their business model. The industry is anxiously watching.