In a recent decision that has sent shockwaves through the banking industry, a federal appellate court in New York has ruled that, for usury purposes, non-bank buyers of charged-off credit card debt are not allowed to step into the shoes of a national bank that originated and sold the debt. We think the ruling in Madden v. Midland Funding, LLC (May 25, 2015) is flat wrong because it contradicts 182 years of well-settled law, disrupts secondary markets, and interferes with the core powers of a national bank to sell its loans to third parties.

The Decision

Saliha Madden, a New York resident, opened a credit card account with Bank of America, a national bank. Bank of America assigned the account to FIA Card Services, N.A., a national bank located in Delaware. When Madden defaulted on the loan, FIA sold it to an unaffiliated debt collector. The collector sought to collect the loan from Madden at the 27 percent interest rate permitted by Delaware law. Madden filed a class action suit against the collector alleging violations of New York's criminal usury statute that prohibits interest rates exceeding 25 percent.

The district court ruled for the collector, based upon the National Bank Act's preemption of state usury laws for a national bank, which is permitted to charge any interest rate authorized by its "home" state. On appeal, the Second Circuit reversed. The appellate court reasoned that the collector was not "a national bank nor a subsidiary or agent of a national bank, or is otherwise acting on behalf of a national bank, and application of the state law on which Madden's claims rely would not significantly interfere with any national bank's ability to exercise its powers under the NBA." Since the NBA's federal preemption did not protect the collector, charging 27 percent interest on the loan violated New York's usury law.

Why the Decision is Wrong

The Second Circuit erred when it concluded that application of New York's usury law to the loan sold to the collector did not "significantly interfere" with the powers of a national bank. The NBA declares that a national bank has power "to make contracts" and to "carry on the business of banking by discounting and negotiating promissory notes…or other evidences of debt." "Negotiating" means selling, assigning and transferring.

Applying New York's usury statute to a loan sold by a national bank significantly interferes with the national bank's powers to make enforceable loan contracts and to sell those contracts. That's what banks do. In effect, the court held that a national bank's loan contracts may not be valid and enforceable in accordance with their terms by an assignee that is not an agent or affiliate of the national bank, and such an assignee commits criminal usury if it charges the contracted interest rate. This conclusion clearly interferes with a national bank's powers under the NBA, raising doubt about the enforceability of its loan contracts and decreasing the marketability and value of every loan in its portfolio.

When Congress gave a national bank the power under Section 85 of the NBA to export interest rates and preempt conflicting state statutes, it did not intend to have that power severely compromised if the national bank exercises its power under Section 24 of the NBA to sell its loans. If a state usury law is preempted when a national bank originates a loan, it remains preempted for the life of the loan, regardless of whether the national bank retains or sells the loan. In the 1978 case Marquette National Bank of Minneapolis v. First of Omaha Service Corp., the Supreme Court affirmed that the NBA preempted Minnesota's usury law, noting that a non-bank entity took assignment of delinquent credit card accounts from the national bank and, as part of collecting the accounts, collected interest on the loans.

The Second Circuit decision conflicts with other circuit court decisions and long established precedent. In the 1833 case Nichols v. Fearson, the Supreme Court recognized the "cardinal rule" of usury that "a contract which, in its inception, is unaffected by usury, can never be invalidated by a subsequent…transaction."

Concluding Thoughts

  • The court's decision seems result–oriented: bad facts (debt collectors) make bad law.
  • The decision calls into question the enforceability of loans that have been securitized.
  • The flawed reasoning of the decision would also apply to loans sold by state-chartered banks and federal savings banks.
  • The debt collector is seeking a rehearing before the full Second Circuit, which we hope grants that request.