On August 31, 2016, the U.S. District Court for the Central District of California granted the CFPB's motion for summary judgment against CashCall, an online small-dollar consumer finance company. The Court sided with the CFPB, finding that CashCall, and not the Native American tribal entity it had contracted with, was the "true lender" on thousands of consumer loans. Without the benefit of tribal preemption, CashCall's loans were deemed to be void under the usury laws in sixteen states, and the court held that by attempting to collect on those loans, CashCall had violated the Dodd-Frank Act's prohibition on unfair, deceptive, and abusive acts and practices (UDAAP).
Nevertheless, three weeks later, in deciding a case called Beechum, the same California District Court dismissed a class action suit alleging that a non-bank entity violated usury laws through its partnership with an originating bank. Citing an exemption in California usury law for banks, the court refused to engage in a true lender analysis or to consider the underlying facts of the defendants' arrangement.
The CFPB's victory on a true lender analysis, followed immediately by a rejection of a similar approach in the same court, provides complicated lessons for non-bank lenders relying on an exempt partner for origination. The CFPB's case against CashCall relied heavily on cases that questioned the more popular bank partner model, suggesting that the CFPB could apply this approach beyond tribal lending. Furthermore, validation of the CFPB's UDAAP theory, which relies on an underlying violation of state law, increases the risk of such partnerships and presents a conundrum: how do you avoid deceptive representations involving a legal question—such as whether a loan is valid and enforceable—when the underlying legal question is unresolved? At the same time, the Beechum case only adds to the confusion around legal treatment of partner models and shows that "true lender" is hardly a uniformly applied theory.
This article discusses the impact of the CFPB v. CashCall case and the outcome in Beechum and other recent "true lender" cases, and provides some takeaways for lenders looking to reduce risk in this fractured regulatory landscape.
CFPB v. CashCall
In 2009, CashCall entered into an agreement with Western Sky Financial (Western Sky), a South Dakota company licensed to do business by the Cheyenne River Sioux Tribe (CRST), to fund and purchase consumer loans originated by Western Sky. Potential borrowers electronically signed a loan agreement through Western Sky's website, which listed Western Sky as the lender, and informed the borrower, in bold type, that the agreement was "subject solely to the exclusive laws and jurisdiction of the Cheyenne River Sioux Tribe, Cheyenne River Indian Reservation." In addition, the "Governing Law" section of the agreement stated that the loan agreement was governed by the Indian Commerce Provision of the U.S. Constitution and laws of the CRST, that Western Sky had no presence in South Dakota or any other states of the United States, and that the agreement and Western Sky were not subject to the laws of any state of the United States.
Based on this arrangement, CashCall took the position that, because the loans were made by a tribal entity and contained a choice-of-law provision designating CRST law to govern the loans, state laws related to interest limits and lender licensing did not apply. CashCall further argued that such laws also did not apply to CashCall when it later purchased the loans.
On December 16, 2013, the CFPB filed a lawsuit against CashCall and related defendants, alleging that they engaged in UDAAP by servicing and collecting full payment on loans that, according to the CFPB, state-licensing and usury laws had rendered wholly or partially void or uncollectible. In June 2016, the parties filed cross-motions for summary judgment, leading to this decision.
The CFPB argued that although Western Sky was the lender identified on the notes, CashCall was the "true lender" because it had the "predominant economic interest" in the loan transactions. The Court agreed with the CFPB, finding that, based on the totality of the circumstances, CashCall had the predominant economic interest in the loans, and therefore was the true lender. Specifically, the Court focused on the following facts regarding CashCall's arrangement with Western Sky:
- CashCall maintained funds in an account for Western Sky's use equal to two days' worth of loan proceeds, based on the prior month's daily average.
- CashCall purchased all of Western Sky's loans.
- Although CashCall waited a minimum of three days prior to purchasing loans from Western Sky, it purchased every loan before any payments on the loan were made.
- CashCall guaranteed Western Sky a minimum monthly payment of $100,000, as well as a $10,000 administrative fee.
- CashCall assumed all economic risks and benefits of the loans immediately upon assignment.
- CashCall bore all default risk and regulatory risk and provided Western Sky a broad indemnity for all costs arising out of the arrangement.
The Court then determined that the tribal choice-of-law provision in the loan agreements was not enforceable because the CRST, which was not the true lender here, had no substantial relationship to the loan transactions, and there was no other reasonable basis for the choice of CRST law. In the absence of an effective choice-of-law provision, the court found that the law of the state where each borrower resided governs each loan agreement.
Without the benefit of preemption, the loans, which bore annual interest rates of 80% or more, violated the usury laws in each of the sixteen states the CFPB identified, rendering the loans void. In addition, CashCall violated laws in fifteen of the sixteen states by failing to obtain a license authorizing it to lend to residents of those states.
The court then turned to whether the defendants violated the Dodd-Frank Act's prohibition on UDAAP. Agreeing with the CFPB, it found that by attempting to collect the void loans, CashCall created the "net impression" that the loans were enforceable and that borrowers were obligated to repay them, which was "patently false."
Scope of Impact
Although the CFPB's case involved the invalidation of CashCall's attempts to rely on tribal preemption, the case also has implications for the more widely used bank-partner model. While some observers caution against reading the decision to apply to arrangements based on bank preemption, the CFPB's argument was built on cases applying a true lender analysis to arrangements between banks and nonbank lenders. In approving the CFPB's motion for summary judgment, the court also cited to a number of these cases. In particular, both the CFPB and the court cite repeatedly to CashCall v. Morrissey, in which the West Virginia Attorney General sued CashCall, alleging that it had violated West Virginia licensing and usury laws, notwithstanding its partnership with a bank.
When West Virginia sued CashCall in 2008, the company argued that it was not subject to state licensing and usury laws because the bank—not CashCall—made all of the loans to West Virginia residents. Mirroring the Central District of California's analysis, the West Virginia court found that CashCall was the true lender, based on a predominant economic interest test. The court found that, similar to its arrangement with Western Sky, CashCall funded a substantial reserve account at the bank; paid the bank a minimum monthly fee; purchased all loans without recourse; and provided a broad indemnity clause covering all of the bank's potential losses.
Thus, while it is true that the CFPB's case against CashCall dealt only with tribal preemption issues, had CashCall been partnering with a bank instead of a tribal entity for the loans that were the subject of the lawsuit, the CFPB could have prevailed on the basis of nearly identical arguments. The CFPB specifically calls out this relationship in its argument for summary judgment, noting that CashCall previously relied on a bank partner model and stating that "CashCall replaced the rent-a-bank scheme with the tribal-lending scheme."
True Lender Confusion
Following directly on the heels of the CFPB's true lender victory, the same District Court declined to engage in a true lender analysis in analyzing loans made by a bank and purchased by a student loan servicer.
In CFPB v. CashCall, instead of considering any one of the sixteen states' usury laws and precedent, the court first looked to the substance of the agreement between CashCall and the tribal lender. Only after determining, based on extensive review of the relationship between the parties, that CashCall was the true lender, did the court turn to the usury laws of the sixteen states. In part because CashCall did not provide "any meaningful briefing" on the issue, the court concluded that CashCall's loans were void or uncollectible under the laws of the sixteen states.
By contrast, the Beechum court looked first to California's usury precedent, in particular, an oddly contradictory wrinkle in the approach to the parties' intent when an exemption to the usury law is implicated. As the court states, where the form of a transaction makes it appear non-usurious, California law instructs a court to determine whether the intent of the parties is consistent with the form. The trier of fact must "pierce the veil of any plan designed to evade the usury law and in doing so … disregard the form and consider the substance." Nevertheless, as the court notes in the very next paragraph, California precedent also states that "when a loan meets the requirements for a statutory exemption to the usury law, courts will not look beyond those requirements to determine whether the underlying transaction … betrays an intent to evade the usury law."
California law provides an exemption from usury for loans made by banks and other depository institutions. Thus, having determined that the student loan servicer's bank partner was the lender on the face of the loan agreements, the court held that the loans were exempt from usury, and refused to engage in a true lender analysis to "consider the substance" of the underlying transactions.
Other Recent True Lender Outcomes
The differing outcomes in the cases discussed above are consistent with the fractured legal landscape for bank partner models generally. Among others, the full spectrum of recent cases includes:
- August 31, 2016 – CFPB v. CashCall: U.S. District Court for the Central District of California uses true lender analysis to reject tribal lender partner arrangement.
- May 30, 2014 – CashCall v. Morrisey: West Virginia Supreme Court of Appeals upholds use of true lender analysis in rejecting bank partner arrangement.
- June 23, 2016 – CashCall v. Maryland: Maryland Court of Appeals holds CashCall liable for failure to obtain license, not to make loans as the true lender, but to perform broker activities on behalf of the bank partner.
- May 23, 2014 – Sawyer v. Bill Me Later: U.S. District Court for the Central Division of Utah holds that (1) bank partner was the true lender; and (2) even if bank were not the true lender, plaintiffs' claims were preempted by federal banking law.
- September 20, 2016 – Beechum: U.S. District Court for the Central District of California holds bank partner arrangement meets California usury exemption, refuses to engage in true lender analysis.
The CFPB has embraced a "true lender" approach to exempt-partner origination models that uses a predominant economic interest theory, as illustrated in its own case, CFPB v. CashCall, and the prior CashCall v. Morrisey. To reduce the risk of a similar outcome, lenders should:
- As necessary, consider restructuring relationships to avoid the non-exempt party bearing the entire risk/interest of transactions. For example, some marketplace lenders have already revised their agreements to ensure their bank partners' retain "skin in the game" by tying the banks' compensation more closely to the borrowers' ongoing payment performance.
- Certain jurisdictions have rejected an exempt partner model, through either a true lender analysis or other theory, including West Virginia and Maryland. Lenders should:
- Ensure they stay informed as to which jurisdictions present the highest risk;
- As necessary, restructure agreements as described above; and
- Consider forgoing loan opportunities in such jurisdictions, obtaining state licenses to transition to direct lender model, or reduce risk through belt-and-suspenders (bank partner and licensing).