In Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015), cert. denied, No. 15-610, 2016 U.S. LEXIS 4211 (U.S. June 27, 2016), Madden was a New York resident who opened a credit card account with Bank of America. The bank consolidated its credit card program into another national bank, FIA Card Services. When Madden failed to pay her credit card debt, FIA Card Services charged off the debt, and then sold the debt to Midland Funding, LLC, a debt purchaser/debt collector. Midland Funding sought to recover debt payments from Madden that carried a 27% interest rate. Madden filed suit against Midland Funding, alleging violation of the New York criminal usury law prohibiting interest rates exceeding 25%.
District court decision protects debt collector, based on preemption. The district court entered judgment for Midland Funding. The district court held that the National Banking Act, which permits national banks to charge any interest rate allowed by the law of the state where the bank is located, applied to FIA Card Service’s contract with Madden, and that FIA Card Services properly assigned its interest to Midland Funding. Because the National Banking Act preempts state law, the district court held that Midland Funding, a Delaware corporation, could charge the Delaware interest rate even though it was in excess of the New York usury ceiling.
Second Circuit finds no preemption. On appeal, in a decision that sent chills down the spine of the banking industry, the Second Circuit reversed the district court. The Second Circuit reasoned that Midland Funding is not “a national bank nor a subsidiary or agent of a national bank, nor 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 National Banking Act.” Because it wasn’t a national bank, Midland Funding was not afforded National Banking Act preemption, and thus violated the New York usury law. Midland Funding filed a petition for a writ of certiorari.
Solicitor General weighs in. In an intriguing twist, the United States submitted a brief highly critical of the holding of the Second Circuit, yet still urged the Supreme Court to deny the petition for review. The brief of the U.S. Solicitor General and the Office of the Comptroller of the Currency contended that the Second Circuit misunderstood section 85 of the National Bank Act. The brief argued that section 85 of the NBA allows a national bank to export the highest interest rate permitted by the national bank’s home state, that federal preemption “carries with it the power to use the loans once originated for their usual commercial purposes, which include assignment of such loans to others,” and that the NBA would be “significantly impaired” by the Second Circuit’s holding.
Notwithstanding these contentions, the Solicitor General ultimately called for denial of the petition for Supreme Court review. First, the Solicitor General argued that on remand Midland Funding may still win despite the Second Circuit’s interlocutory error. Second, the Solicitor General argued that the parties may have inadequately presented the preemption arguments. Third, the Solicitor General argued that no circuit split is present on the issue.
The Supreme Court had previously decided the issue. The government’s brief claims that there is no circuit split, but the United States Supreme Court decided the issue nearly two centuries ago when it endorsed the longstanding common-law principle that a debt may be enforced by an assignee if it was “valid-when-made” by the assignor. In Nichols v. Fearson, 32 U.S. 103, 8 L. Ed. 623 (1833), the High Court held that a loan cannot become usurious by virtue of subsequent transfer. The Court stated that “a contract, which, in its inception, is unaffected by usury, can never be invalidated by any subsequent transaction” and that this principle was a “cardinal rule”. The “valid-when-made” principle has not only been embraced by the Supreme Court, but is inherent in the NBA, which strongly supports the assignment of debt originated by a national bank. Federal courts—including the Fifth and Eighth Circuits—have followed the principle. Perhaps the best decision is from the Seventh Circuit, where Judge Posner applied his trenchant economic analysis to support the “valid-when-made” principle. Olvera v. Blitt & Gains PC, 431 F.3d 285, 2005 U.S. App. LEXIS (7th Cir. 2005). In short, not only has the Supreme Court itself already dealt with the “valid-when-made” issue, but the holding in Madden creates an unequivocal circuit split.
Negative consequences of the decision. Although the Solicitor General and the OCC issued a brief highly critical of the Second Circuit decision, they then made a contradictory recommendation based upon a suspect foundation. Therefore, the Madden decision is left in place and the precedent stands. The decision is limited to the Second Circuit—Connecticut, New York and Vermont—and may only be used as a non-binding argument against the “valid-when-made” principle in any other circuit. Well-articulated briefs prepared for Madden, including the critique of the Solicitor General, are now available to appropriately argue the merits in the lower courts of other circuits. Importantly, the Solicitor General hinted that the United States will uphold the “valid-when-made” principle whether or not an interest in loans originated and sold by a national bank is retained by that bank.
Nonbanks can no longer safely buy loans from banks that employ NBA preemption for charging interest rates in the Second Circuit. Such loans may be uncollectible. This will cause nonbank assignees to refuse purchasing certain loans made in the Second Circuit. It will also cause problems for securitization trusts that purchase loan assets from national banks. Marketplace lenders may become hesitant to originate loans in the Second Circuit. Businesses will begin to restructure legal relationships, such as keeping an increased amount of loans on bank balance sheets or appointing the bank as the master servicer to create factual bases for preemption distinct from Madden. As time passes, the real ramifications of the decisions will be presented.
A parting thought. The Supreme Court’s denial of review is very unfortunate. The Second Circuit decision focuses on federal preemption under the NBA. Remarkably, it doesn’t even mention the common-law “valid-when-made” principle, which can be applied independent of federal preemption. The Solicitor General and the OCC saw this point, yet still argued against Supreme Court review, based on a faulty finding that there was no conflict in the circuits.