In earlier client OnPoints, we have provided a comprehensive review of recent developments in the U.S. affecting the marketplace lending industry, including the potentially far-reaching Madden v. Midland Funding, LLC case from the Second Circuit involving the preemption of state usury laws.1 We previously discussed how the Second Circuit’s decision, if allowed to stand by the U.S. Supreme Court (the “Supreme Court” or “Court”), could significantly impair the practices of not only marketplace lenders, but also the practices of all purchasers of debt who seek to enforce the interest rates on loans purchased from FDIC-insured banks. On June 27, the Supreme Court denied certiorari in the Maddencase and therefore, the Second Circuit’s decision, which in essence held that the purchaser of a loan from a national bank was not entitled to federal preemption of New York’s usury laws, will remain in effect.
The Aftermath of Madden
The Solicitor General’s (“SG”) brief on Midland’s petition for certiorari, which was joined by the Comptroller of the Currency, the principal regulator of national banks, lays out a compelling case against the Second Circuit’s decision (even though the SG, for other reasons, did not recommend that the Supreme Court hear the case). First, the SG brief noted that the Second Circuit failed to recognize that the National Bank Act (“NBA”)—and the common-law principles it implicitly incorporated when enacted—permits a national bank to sell its loans and convey to an assignee the right to enforce the interest rate that was lawfully and initially charged by the bank. Second, the SG argued that the Second Circuit relied on an exceptionally narrow view of federal preemption, mistakenly believing that the New York law was not preempted because the loan originator had no control over (or financial stake in) the loan purchaser’s conduct and efforts to collect the debt owed by the borrower. According to the SG, the Second Circuit failed to consider that the originator is involved in the regular business of selling loans and that its decision would effectively prevent the bank from fully exercising its federal right to sell loans to others at interest rates permitted under the NBA; in other words, the originator does have an economic stake in the transaction because if it cannot sell loans, it must keep them on its balance sheet. The SG’s brief then argued that the proper interpretation is that the NBA defers to the maximum interest rate of the state in which the bank is located, and precludes any other states from imposing a lower maximum. Though not recommending that certiorari be granted, the brief made clear that the SG believed the Second Circuit’s decision to be incorrect.
But what does all of this mean? In short, the Court’s decision means that marketplace lenders and loan purchasers will be vulnerable in the three states subject to the jurisdiction of the Second Circuit—New York, Connecticut, and Vermont—potentially causing them to limit purchases of loans to borrowers in those states at rates in excess of the applicable usury limits. If other circuits decide to follow the precedent in Madden, the impact would be even more widespread. At the same time, the decision could trigger a restructuring of the relationships between marketplace lenders and their funding banks (similar to Lending Club’s restructuring of its relationship with WebBank) to provide the issuing bank with “skin in the game” to distinguish the business arrangement from the facts of Madden.
Concerns of Marketplace Lenders
As a result of the Court’s decision, regulators in certain states may now seek increased regulation of the marketplace lending industry to protect their consumers from being subject to usurious interest rates under state law, despite the fact that the loans were not usurious when made by an originating funding bank. Additionally, the Court’s decision may lead to uncertainty as to the validity of loans, since consumers will now be able to cite Madden to prevent enforcement of loans with interest rates in excess of state usury limits. For example, a putative class-action lawsuit was filed in the state of New York in the United States District Court on April 6 against a major marketplace lender seeking to prohibit said lender from enforcing the interest rate on loans that exceed the rates permitted pursuant to New York’s usury laws. Moreover, as noted above, since the Second Circuit’s decision, some institutional purchasers of marketplace loans have declined to purchase loans to borrowers in the three Second Circuit states that carry interest rates in excess of the respective state usury limits.
With the Court’s denial of certiorari to hear the Madden case, and in light of the increased focus on marketplace lending by federal and state regulators, the marketplace lending industry is currently plagued by uncertainty. Will marketplace lenders change their lending practices to distinguish their lending models from the facts in Madden? Will regulators propose increased regulations impacting the marketplace lending industry? Will circuit courts confirm or overrule the precedent established in Madden? Although it is unclear what the near future holds, we look forward to following developments in the marketplace lending industry in the coming months and will provide continued updates throughout.