The relationship between certain peer-to-peer or marketplace lending platforms and the banks who actually make the loans to consumers leads to the often-debated question of “Who is the true lender?” Recent court decisions have made it more difficult to answer that question because courts have come to two different conclusions: One court supported the bank as the true lender, and another court found that the servicing partner was the true lender, not the bank. The consequences of these decisions for non-banks involved in these relationships are significant. If a bank is deemed not to be the true lender, then the third party risks losing the exportation advantage that the bank has and could be subject to substantial penalties and fines for violating a state’s usury laws.

Sawyer v. Bill Me Later, Inc.

On May 23, 2014, the U.S. District Court for the District of Utah dismissed a consumer class action against an online payment processer for alleged violations of California laws, including the Consumers Legal Remedies Act, the Business and Professions Code, and various usury provisions in the California Constitution. In Sawyer v. Bill Me Later, Inc., No. 2:11-cv-00988, 2014 U.S. Dist. LEXIS 71261 (D. Utah May 23, 2014), the plaintiff, a California consumer, purchased a computer online using Bill Me Later to finance the purchase price. Bill Me Later provided a real-time credit decision to determine whether the consumer qualified for financing.

In the Bill Me Later case, the plaintiff signed a contract with CIT Bank, a Federal Deposit Insurance Corporation (FDIC)–insured industrial bank located in Utah, acknowledging that CIT Bank was the lender and owner of the plaintiff’s account. WebBank, also an FDIC-insured bank chartered in Utah, subsequently acquired CIT Bank’s rights to the plaintiff’s account. The contract required the plaintiff to pay the entire loaned amount within 30 days or pay a 19.99 percent interest rate in connection with the remaining balance, together with any applicable late fees.

The plaintiff alleged that Bill Me Later structured its partnership with the bank to take advantage of the bank’s ability to lend at higher rates, without regard to the usury laws in a consumer’s home state. Under section 27 of the Federal Deposit Insurance Act, 12 U.S.C. § 1831(d) (2014), a bank that has a state charter and is federally insured may impose finance charges and late fees in accordance with usury laws in the state where the bank is located. See12 U.S.C. § 1831(d) (2014). However, if the third-party service provider or non-bank entity is deemed to be the “true lender,” the usury law in the consumer’s state may apply, depending on whether the choice of law provision of the contract is enforceable.

In Bill Me Later, the district court found the FDIC-insured bank, not Bill Me Later, was the “true lender.” Thus, section 27 preempted the plaintiff’s state law usury claims. In so holding, the court noted that the plaintiff failed to sufficiently allege facts that would indicate that Bill Me Later acted as the true lender. Specifically, the court pointed to the following facts as determinative in its analysis:

  1. The bank was a party to the consumer loan agreements.
  2. The bank funded the consumer loans and owned the credit accounts.
  3. The bank held the credit receivables for two days.
  4. The bank owned the consumer accounts and profited from the financial gain based on interest collected on the consumer loans.

Importantly, the court noted that, regardless of the true lender analysis, the plaintiff’s claims would have been preempted by section 27. The court reasoned that, under section 1876(c) of the Bank Service Company Act, 12 U.S.C. 1867(c) (2014), loans serviced by third parties, such as Bill Me Later, are subject to federal regulation and oversight to the same extent as if they were directly serviced by an FDIC-insured bank. Therefore, these loans are included in the definition of “any loan” under section 27 and are expressly preempted under federal law.

CashCall, Inc. v. Morrisey

In stark contrast to the Bill Me Later case, on May 30, 2014, the Supreme Court of Appeals of West Virginia’s decision in CashCall, Inc. v. Morrisey, No. 12-1274, 2013 W. Va. LEXIS 587 (W. Va. May 30, 2014), held that section 27 did not preempt claims against the defendant for violations of the West Virginia Consumer Credit Protection Act (WVCCPA). In CashCall, Patrick Morrisey, the Attorney General of West Virginia (Attorney General), alleged that CashCall, a California-based consumer finance institution, violated various provisions of the WVCCPA because its partner bank was not the true lender.

The alleged violations related to agreements between CashCall and First Bank and Trust of Millbank, South Dakota (FB&T), an FDIC-insured, South Dakota–chartered bank. CashCall agreed to purchase small, high-interest loans, with annual percentage rates between 59 percent and 96 percent, made by FB&T to consumers three days after the loans’ origination dates. The Attorney General alleged that the relationship between CashCall and FB&T allowed CashCall to evade West Virginia’s usury and consumer protection laws. CashCall removed the case to federal court, arguing that section 27 preempted the state law claims. However, the district court remanded the case to the state trial court because the Attorney General’s claims did not implicate section 27.

In characterizing CashCall as the true lender, the Supreme Court of Appeals of West Virginia emphasized the need to view the substance, rather than the form, of the loan transactions. Further, the court affirmed the trial court’s use of the “predominant economic interest” test to determine which party should be deemed to be the true lender. The predominant economic interest test discerns which party—the bank or the non-bank entity—has the prevailing economic interest in the consumer loan transaction in order to determine which is the true lender.

Unlike in Bill Me Later, the West Virginia court found CashCall to be the true lender for the following reasons:

  1. CashCall bore the economic burden and risk associated with the loan program.
  2. CashCall acquired the loans from FB&T for more than the amount financed by FB&T.
  3. CashCall had its owner and only stockholder personally guarantee all financial obligations to FB&T.
  4. CashCall agreed to indemnify FB&T for any losses, including claims asserted by borrowers.
  5. CashCall agreed only to purchase loans originating from FB&T if they complied with CashCall’s underwriting policies.
  6. For financial reporting purposes, CashCall treated the loans as if CashCall had funded them.

Because the court characterized CashCall as the true lender, section 27 did not preempt the state law claims for violations of the WVCCPA.

Pepper Points

  • Following the opinions in Bill Me Later and CashCall, the law relating to true lenders remains unsettled as to when section 27 expressly preempts state law usury claims. The bright-line test adopted by the Bill Me Later court follows the U.S. Court of Appeals for the Eighth Circuit’s decision in Krispin v. May Department Stores Co., 218 F.3d 919 (8th Cir. 2000). It does not delve into the economic substance of the relationship, which is a slippery slope for those non-bank lenders attempting to structure relationships that can survive this type of challenge.
  • The predominant economic interest test should be of particular concern to banks that securitize their assets or sell mortgage loans in table-funded transactions because, in those cases, the bank typically does not retain any interest in the loans being sold at or shortly after consummation. As the court made clear in Krispin, what happens after the loan is made should not be the concern of the court so long as the bank is the lender when the loan is consummated.
  • The recent decision by the FDIC and the Office of the Comptroller of the Currency that requires a 5 percent retention for loans sold may suggest a “safe harbor” for banks to maintain their true lender status.

Pepper has counseled many clients on issues involving banks and third-party service providers and would be glad to assist those who have questions about structuring these types of relationships.

Ashleigh K. Reibach