The Colorado attorney general (AG) has won the first round of a prominent fight over bank-model lending. On June 9, 2020, a Colorado state court summarily adjudicated the so-called Madden issue in favor of the AG, ruling that a nonbank acquirer of a bank-originated loan does not acquire with the loan the right to charge interest at the rate permitted by the bank’s home state. Notably, the court declined to consider recent regulatory guidance addressing Madden because it has not yet taken effect, opening the door to a motion for reconsideration.
In what have become known as the Colorado bank partnership litigations, the AG is attacking two bank-model lending programs in which nonbanks act as marketing and servicing agents for banks; the banks underwrite and make the loans, and the nonbanks later purchase loans from the banks. The AG contends that Colorado’s usury limits apply to the loans post-assignment, asserting two distinct theories: one based on the Second Circuit’s well-known 2015 decision in Madden v. Midland Funding, and the other based on the so-called true lender theory.
The June 8 ruling, made in response to a summary adjudication motion, focuses on the Madden issue and whether Section 27 of the Federal Deposit Insurance Act (Section 27) allows nonbank acquirers of bank loans to charge the same interest rates the banks can charge through their federal interest rate exportation authority. The court followed Madden and rather summarily rejected the defendants’ arguments, including that Madden ignores the “valid when made doctrine” recently affirmed by the Office of the Comptroller of the Currency (OCC), and that the decision would violate the dormant commerce clause and the contracts clause of the U.S. Constitution.
The court also refused to consider the “Madden fix” rules issued by the OCC and the Federal Deposit Insurance Corporation (FDIC) on the grounds that they are “not yet law,” leaving open the possibility of a reconsideration motion after the rules take effect. The court’s order also references a forthcoming summary judgment ruling that will address the valid-when-made issue further. Given the recent rule finalized by the OCC, it is possible the court will reconsider its decision.
Why It Matters
While the court’s order is a setback for the bank model, it is far from the final word on these issues. In addition to being ripe for a reconsideration motion after the Madden fix rules take effect, the court’s decision is a nonprecedential trial court order in a case that almost certainly will go up on appeal. Nevertheless, the AG’s win could encourage other state regulators or private plaintiffs to bring similar claims, further clouding the viability of the bank model and impacting capital markets.
More broadly, this decision solidifies the hostility Colorado regulators and now courts have toward the bank partnership model. Most fintech lenders do not lend in the state, which drives up costs for consumers and small businesses that have reduced access to credit, especially in low-income areas. Many investors in fintech assets also have Colorado on their “no go” list with other states that have hostile precedents to the bank partnership model, such as Maryland and West Virginia. The federal government is attempting to level the playing field with the OCC and FDIC rulemakings, but time will tell whether courts will defer to the OCC and FDIC interpretations.
Many bank partnerships have been recast as participation sales as a response to Madden and other cases that focus on the sale of the loan to a nonbank. Under this model, the loan remains with the bank and a participation interest is sold to the fintech platform, which is either 100% or some holdback amount to reflect that the bank has “skin in the game.” A court has not held that a bank acting under the participation model has effectively sold the loan and that the platform is charging an unpermitted interest rate such as in Madden. Still, participation interest models have their challenges, such as being able to sell into securitization trusts under the “true sale” rubric.