In a closely watched case pending in the United States District Court for the Central District of California, the CFPB obtained a significant victory against CashCall Inc. (“CashCall”) and its affiliates.  The Court’s decision to grant the CFPB summary judgment on the issue of liability is noteworthy because it could have significant ramifications on a variety of lending arrangements and will likely embolden the CFPB in future enforcement actions.

In CFPB v. CashCall, et al., No. CV 15-7522-JFW, the CFPB alleged that Defendants engaged in unfair, deceptive and abusive acts and practices in violation of the Consumer Financial Protection Act of 2010 (“CFPA”), 12 U.S.C. § 5536(a)(1)(B).  The CFPB specifically targeted a business arrangement between CashCall and Western Sky Financial (“Western Sky”), a South Dakota limited liability company licensed to do business by the Cheyenne River Sioux Tribe (“CRST”).  Under the parties’ business arrangement, Western Sky originated loans online and over the phone to customers across the country and then subjected the loan agreements “to the exclusive laws and jurisdiction of the Cheyenne River Sioux Tribe, Cheyenne River Indian Reservation.”  These loans contained interest rates that greatly exceed state usury laws.  CashCall, while a separate entity, funded Western Sky’s operations.  Additionally, CashCall purchased every Western Sky loan almost immediately after origination.

In its decision, the Court initially analyzed whether CashCall or Western Sky was the “true lender.”  Considering the “totality of the circumstances,” the Court determined that CashCall was the “true lender” since “the entire monetary burden and risk of the loan program” was with CashCall as opposed to Western Sky.

Having determined that CashCall was the true lender, the Court next concluded that the CRST choice of law provision found in the loan agreements should be disregarded.  Specifically, by reference to the Restatement (Second) of Conflict of Laws § 187(2), the Court concluded: 1) the CSRT had no substantial relationship to the parties or the transaction and there is no other reasonable basis for the parties’ CRST choice of law; and 2) application of the laws of the CRST would be contrary to a fundamental policy of the borrowers’ home states which had a materially greater interest in the issues at hand.  Accordingly, the Court concluded that under the Restatement (Second) of Conflict of Laws § 188, the laws of the borrowers’ home states should apply.

Under applicable state laws, Western Sky’s loans were usurious, rending the loan agreements void or relieving borrowers of their obligations to pay any usurious charges.   Additionally, CashCall’s failure to obtain a consumer lending license in several states also voided those loan contracts.  By servicing and collecting on these loans, CashCall created the impression that these loans were enforceable and borrowers were obligated to repay them in accordance with their stated terms.  According to the Court, “that impression was patently false – the loan agreements were void and/or the borrowers were not obligated to pay” under their state laws.

The Court’s holding, and in particular the “true lender” determination, raises questions about the validity and enforceability of other lending arrangements.  Parties that use tribal entities and federally insured banks to secure favorable interest rates without regard to state usury laws must be aware that these arrangements are being targeted by federal and state regulators, especially when an institution funding and closing loans does not bear a substantial financial risk relative to those loans.  Parties engaged in similar lending arrangements must carefully assess the terms to ensure that they will not become the next target of the CFPB or a class action lawsuit.

This decision is also noteworthy because it gives credence to the notion that violations of state law, in this case state usury laws, can constitute per se violations of the federal consumer protection laws, here the CFPA.  Commentators have recognized that this decision may embolden the CFPB to identify other ways to “federalize” state law violations.