After a period of relative calm in relation to developments affecting the marketplace lending sector, on February 27, 2017 Judge Cathy Seibel of the U.S. District Court for the Southern District of New York issued her decision in the Madden v. Midland case on the matters which the U.S. Court of Appeals for the Second Circuit had remanded for consideration. The decision raises new questions, leaves certain issues open and fails to provide the panacea many investors and lenders had desired.
HOW WE GOT HERE
The plaintiff Madden initially filed a complaint in 2011 against Midland Funding, LLC and Midland Credit Management, Inc., alleging various claims premised on violations of New York's usury laws. The original district court opinion in 2014 dismissing the plaintiff's claims was appealed to the Second Circuit, which in 2015 found that the National Bank Act did not preempt the application of state usury laws to non-bank assignees, reversing the district court and remanding the case for consideration of the choice of law issue outlined below. In June of last year, the U.S. Supreme Court denied Midland's petition for certiorari, leaving the district court to hear the remanded issues.
Madden is a New York resident who had opened a credit card account with a national bank, which account was subsequently transferred to another national bank which had its principal place of business in Delaware and which had provided the plaintiff with written notice indicating that the relevant cardholder agreement was to be governed by the laws of the State of Delaware. Subsequently, the defendant acquired the account following default and sought to enforce payment, with interest collected at a rate of 27% per annum. Delaware provides no usury cap, so a finding that Delaware law governed the relationship would mean that Madden's claims would fail. Accordingly, the district court took up the question of whether Delaware law should prevail-leading to a dismissal of the action-or whether New York law should be deemed to govern the consumer credit arrangement.
The decision first looks at usury limitations in New York, finding that the civil usury rate cap of 16% annually does not apply in the case of defaulted obligations, but rather that the criminal usury cap of 25% annually would be relevant. Judge Seibel dispels Midland's assertions that such a cap does not apply following default, examining both prior state and federal decisions. Notably, though, Judge Seibel expressly indicates that New York state courts may need to weigh-in on the question.
Having found that the civil usury cap was inapplicable and noting that New York did not provide a private right of action in relation to violations of the criminal usury cap, Judge Seibel granted Midland's motion for summary judgment in relation to those claims.
In so far as the remaining claims for violations of the Fair Debt Collection Practices Act ("FDCPA") and comparable New York state law would be premised on violations of the New York criminal usury statute, Judge Seibel next turned to the critical choice of law issue. After providing a detailed examination of prior case law, the decision concludes that application of Delaware law would violate a fundamental public policy of New York and, accordingly, that New York law should apply to the claims. Having determined that New York law was the proper law to consider, Judge Seibel denied Midland's motion in relation to the FDCPA and the New York claim under the General Business Law ("GBL") regarding deceptive acts and practices.
Finally, the court certified the FDCPA and GBL claims to proceed as a class action, though the court narrowed the class to comprise only New York residents sent a letter by Midland attempting to collect interest in excess of 25% per annum for consumer debts if the relevant cardholder agreement either purported to be governed by Delaware law or the law of another state with no usury cap or by no law other than New York law.
In failing to find that Delaware law should apply, the decision deals a blow to the marketplace lending industry which had hoped that the district court ruling would provide a neat solution to the Second Circuit's decision in the case. Allowing the case to proceed as a class action means that non-bank parties should continue to be cognizant of usury limitations in New York and the potential adverse implications of collecting upon or acquiring loans with an interest rate in excess of the applicable usury rate.
Further, the decision's failure to respect the given contractual choice of law in relation to New York residents opens the door for additional claims. Under the approach taken by the court, claims could potentially be brought if a non-bank lender seeks to collect interest in excess of 25% for defaulted obligations (as many credit products provide for) against a New York resident under a contract purported to be governed by the law of another state. In that context, the decision raises difficult diligence issues for parties looking to purchase defaulted debt. Similar claims grounded in FDCPA violations could potentially be brought in relation to other jurisdictions on similar theories and, of course, the ability to proceed as a class action may make such suits more likely.
On the positive side of the ledger, the dismissal of the usury violation claims is helpful in so far as the remedy for such violations can be having the related debt declared void. While FDCPA and GBL violations allow for monetary damages, such damages may be less than the principal amounts in question. In addition, the decision suggests a key question for further consideration by the New York state courts: whether New York law prevents a creditor from collecting interest in excess of the criminal usury rate in the case of defaulted debts; the existence of such a limit is the predicate for the present remaining claims.
The lingering uncertainty created by the decision may provide an impetus for a legislative fix at the federal level. Congressman Patrick McHenry of North Carolina had introduced a bill in the last Congressional session to overturn the Second Circuit's Madden decision. As the new administration considers financial regulatory reform, inclusion of such a provision is again front and center.
Despite the adverse (from the perspective of investors and lenders)-and to some degree, unexpected outcome at the district court level, the decision largely preserves the status quo: usury remains a concern in the Second Circuit jurisdictions of New York, Connecticut and Vermont and non-bank parties need to continue to structure around the issue. We will continue to monitor developments with respect to the case.