On February 27, the U.S. District Court for the Southern District of New York issued a ruling in Madden v. Midland Funding, LLC,1 holding that New York's fundamental public policy against usury overrides a Delaware choice-of-law clause in the plaintiff's credit card agreement. The court allowed the plaintiff to proceed with Fair Debt Collection Practices Act ("FDCPA") claims (and related state unfair or deceptive acts or practices claims) against the defendants, a debt buyer that had purchased the plaintiff's chargedoff credit card debt and its affiliated debt collector. The court did not allow plaintiff's claims for violations of New York's usury law to proceed, as it held that New York's civil usury statute does not apply to defaulted debts and that the plaintiff cannot directly enforce the criminal usury statute. The court also granted the plaintiff's motion for class certification.
The ruling follows remand from the Second Circuit, which held in May 2015 that a nonbank entity taking assignment of debts originated by a national bank is not entitled to preemption of state usury laws under the National Bank Act.2 The Second Circuit's decision rattled the markets for consumer and commercial debt, as well as the market for marketplace loans, and has been criticized--including by the Solicitor General and the Office of the Comptroller of the Currency--for failing to consider the Valid-When-Made Doctrine, a longstanding principle of usury law, which holds that if a loan is not usurious when made, then it does not become usurious when assigned to another party. In June 2016, the U.S. Supreme Court denied the defendants' petition for a writ of certiorari.3
On remand, the defendants moved for summary judgment, arguing that the Delaware choice-of-law clause in the credit card agreement authorized them to charge interest in accordance with Delaware law, which does not impose a usury ceiling. Addressing the enforceability of this clause, the court found it unnecessary to decide whether a "reasonable relationship" existed between the parties, the transaction, and Delaware. Even if it did exist, the court reasoned, "to apply Delaware law would violate a fundamental public policy of New York," i.e., New York's prohibition against usury.4
Thus, the court applied New York law. It agreed with the defendants that New York's 16%-per-year civil usury limit was inapplicable to defaulted debts like the one at issue. However, based on a review of New York state and federal court decisions, it concluded that "although the issue may ultimately have to be settled by the New York Court of Appeals," several recent state court cases have held that "New York's criminal usury cap applies to prevent a creditor from collecting interest above 25% on a defaulted debt."5
The court also declined to follow a "rule of validation" that would mandate application of the law of "the state whose usury statute would sustain the contract in full or else impose the lightest penalty for usury from the set of all states that have a substantial relationship to the contract."6
However, the court did not address the Valid-When-Made Doctrine.
The defendants argued that even if New York's criminal usury limit applied, it was not enforceable by a private actor or federal court. The court agreed, granting summary judgment to the defendants on both the plaintiff's civil and criminal usury claims. However, with respect to other claims, the court found that the plaintiff was not "seeking to base a defense to liability on the criminal usury cap," or trying to "enforce the criminal law." "Rather, Plaintiff claims that because Defendants sought to collect interest at a usurious rate, their collection letters overstated the amount of interest they were entitled to collect in violation of various provisions of the FDCPA." The plaintiff could do so, according to the court, because "predicating FDCPA claims on violations of state usury laws is a well-established theory of FDCPA liability."7
Therefore, because it found that New York law applied, and the plaintiff predicated her FDCPA and New York UDAP claims on a violation of New York's criminal usury cap, the court denied the defendants' motion for summary judgment on those claims.
Finally, while the court narrowed the class definition proposed by the plaintiff, it granted the plaintiff's motion for class certification, certifying the following two classes of consumers:
- "A Rule 23(b)(2) injunctive and declaratory relief class comprising all persons residing in New York who were sent a letter by Defendants attempting to collect interest in excess of 25% per annum regarding debts incurred for personal, family, or household purposes, whose cardholder agreements: (i) purport to be governed by the law of a state that, like Delaware's, provides for no usury cap; or (ii) select no law other than New York. This class covers only claims arising out of ... violations [of New York's prohibition on deceptive acts or practices] from November 10, 2008 through [February 27, 2017]."; and
- "A Rule 23(b)(3) damages class comprising all persons residing in New York who were sent a letter by Defendants attempting to collect interest in excess of 25% per annum regarding debts incurred for personal, family, or household purposes, whose cardholder agreements: (i) purport to be governed by the law of a state that, like Delaware's, provides for no usury cap; or (ii) select no law other than New York. This class comprises two subclasses: (a) for claims arising out of ... violations [of New York's prohibition on deceptive acts or practices] from November 10, 2008 through [February 27, 2017]; and (b) for claims arising out of FDCPA violations from November 10, 2010 through [February 27, 2017]."8
The court noted that the number of consumers included in the class action "may be ... higher than 49,780."9
Now that the district court has addressed the choice of law issue remanded to it by the Second Circuit, there are a number of significant implications for debt buyers, secondary market purchasers and marketplace lenders. Fundamentally, this decision does not change the status quo with respect to the risks related to the ability of loan purchasers to enforce interest rates on loans that are in excess of the statutory usury ceilings in New York, Connecticut and Vermont that were created by the initial Second Circuit decision. However, the possibility of an easy resolution to the Madden "problem" now appears to be off the table given the court's decision to apply New York rather than Delaware law, although one is left to wonder whether an opportunity remains for the court to consider the applicability of the ValidWhen-Made Doctrine under New York law. Also, the court's interpretation of New York usury law suggests an odd patch work of rules applicable to New York loans, with performing loans being subject to a 16% usury ceiling under the civil usury statute, while defaulted or nonperforming loans are effectively subject to only the 25% usury ceiling provided by the criminal usury law, although that ceiling itself cannot be directly enforced by a private right of action, while indirect enforcement via the FDCPA and state UDAP law is possible.
It remains to be seen whether this decision will provide impetus for Congress to address the issue, perhaps through legislation similar to the bill introduced by Representative Patrick McHenry (R-NC) last year and expected to be reintroduced in Congress in 2017. Likewise, we note that along with the recent introduction of legislation in New York to substantially expand the scope of licensing and regulation of marketplace lending in the state, this decision puts further focus on the burdens of state regulation for loan products that are offered nationwide through the Internet, likely increasing interest in a potential special purpose bank charter under consideration by the Office of the Comptroller of the Currency.
Finally, marketplace lenders that rely on arrangements with bank partners to originate loans should continue to carefully monitor further developments in the Madden case as well as in other cases now pending that challenge the role of bank partners as the "true lender." Lenders likewise should continue to evaluate potential changes to the structure of their partnership arrangements in light of these cases and other legislative, regulatory and enforcement developments.