In a defeat for authorities seeking to crack down on Internet payday lenders, a California appellate court affirmed dismissal of a complaint filed by a state financial regulator against five Indian tribe-affiliated lenders.

Following an investigation, the Commissioner of the California Department of Corporations (now the California Department of Business Oversight) filed a complaint against Ameriloan, United Cash Loans, US Fast Cash, Preferred Cash, and One Click Cash alleging the defendants provided short-term payday loans over the Internet in violation of California law. Specifically, the complaint – which sought injunctive relief, restitution for consumers, and civil penalties – claimed the defendants charged excessive loan fees, failed to provide customers with required written notices, and engaged in deferred deposit transactions, commonly referred to as payday loans, without a state license.

The two owners of the five companies – Miami Nation Enterprises (MNE) and SFS, Inc. – sought to dismiss the complaint based on tribal immunity as wholly owned corporations of the Miami Tribe of Oklahoma and the Santee Sioux Nation, respectively.

Both federally recognized Indian tribes submitted declarations about the companies’ relationship to their tribes and the economic benefits the tribes derived from operating the business. For example, MNE’s board of directors consists of tribe members, while a wholly owned subsidiary processes and approves loan applications pursuant to underwriter criteria proposed by MNE. Profits from MNE and its subsidiary directly or indirectly fund government services for tribe members, the Miami Tribe said, and the “cash advance business is a critical component of the Miami Tribe’s economy and governmental operations.”

But the Commissioner pointed to the day-to-day operations of the cash advance businesses to argue that the lenders were actively operated and controlled by nontribal third parties – not the tribes themselves or tribally owned corporations. The government also pointed to information obtained from the Federal Trade Commission that MNE and SFS received just one percent of the gross revenues from the cash advance and loan business, while the nontribal company retained the net cash flow, characterizing the relationship as a “rent-a-tribe” scheme.

The case turned on one question, the California Court of Appeal said: whether MNE and SFS and the businesses they operate function as “arms of the tribe.” The court focused its inquiry on whether the tribal entities were sufficiently related to their respective tribes to be protected by tribal sovereign immunity.

“There can be little question that MNE and SFS, considered initially by themselves and without regard to the payday lending activities at issue in this enforcement action, function as arms of their respective tribes,” the court wrote, noting that MNE was created directly under tribal law with the express intent to be covered by tribal sovereign immunity. “[W]e believe the tribe’s method and purpose for creating a subordinate economic entity are the most significant factors in determining whether it is protected by a tribe’s sovereign immunity and should be given predominant, if not necessarily dispositive, consideration.”

“[T]he Miami Tribe of Oklahoma and MNE are closely linked through method of creation, ownership, structure, control and other salient characteristics; and, although the operations of MNE are commercial rather than governmental…extension of immunity to it plainly furthers federal policies intended to promote tribal autonomy,” the panel said. The court reached a similar conclusion with regard to SFS, adding that “because the reservation is in a severely depressed region, those profits are essential to maintaining a functioning tribal government able to provide necessary services to the tribe’s members.”

The tribes’ relationship to the cash advance and short-term loan businesses was a “slightly more complicated” issue for the court. While day-to-day operations are handled by a third-party, nontribal entity, “MNE and SFS have final decisionmaking authority to approve or disapprove any loans,” and the operations are “subject to the oversight and control” of MNE and SFS, the court said.

“In other words, MNE and SFS are not merely passive bystanders to the challenged lending activities,” the court wrote. “A tribal entity engaged in a commercial enterprise that is otherwise entitled to be protected by tribal immunity does not lose that immunity simply by contracting with non-tribal members to operate the business.”

The panel emphasized that whether or not the tribes negotiated good or poor management agreements was irrelevant. “In the end, tribal immunity does not depend on our evaluation of the respectability or ethics of the business in which a tribe or tribal entity elects to engage,” the court wrote, affirming dismissal of the Commissioner’s complaint. “Absent an extraordinary set of circumstances not present here, a tribal entity functions as an arm of the tribe it if has been formed by tribal resolution and according to tribal law, for the stated purpose of tribal economic development and with the clearly expressed intent by the sovereign tribe to convey its immunity to that entity, and has a governing structure both appointed by and ultimately overseen by the tribe.”

To read the decision in California v. Miami Nation Enterprises, click here.

Why it matters: The ruling was a blow to regulators seeking to crack down on the allegedly illegal payday lending businesses conducted by arms of Indian tribes (click here for our previous newsletter). Rejecting the Commissioner’s argument that the lenders were engaged in “egregious, deceptive and exploitive practices prohibited by California law,” the court said the relevant inquiry for tribal immunity was not the equities involved but a pure jurisdictional question. However, the court noted that its outcome was not a stamp of approval for the cash advance and short-term loan businesses. “[W]e obviously take no position in the policy debate over the general undesirability or predatory nature of online payday loans and express no view on the merits of the Commissioner’s allegations that the cash advance and short-term loan services offered by the tribal entities violate [state law],” the panel wrote.