On November 18 and 19 of this week, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation issued Advanced Notices of Proposed Rulemaking (ANPRs) to clarify how state interest rate caps should apply when loans are sold across state lines.
The proposal from the OCC reaffirms the “valid when made” doctrine, on which many marketplace lenders have relied and which was central to the Second Circuit’s 2015 decision in Madden v. Midland Funding LLC, 786 F.3d 246 (2nd Cir. 2015). The Second Circuit’s decision contradicted the “valid when made” theory, whereby an obligation is considered valid under the law that applied at the time of origination. The Second Circuit held that a loan’s interest rate was no longer valid when resold to an entity in a state with a lower interest rate cap than where the loan was originally issued. In its proposed rule, the OCC “has concluded that when a bank sells, assigns, or otherwise transfers a loan, interest permissible prior to the transfer continues to be permissible following the transfer.” The OCC’s proposed rule would cut against Madden, allowing the interest rates attached to bank loans to remain valid once transferred to a bank’s fintech partner of investors.
The FDIC’s proposed rule parallels that of the OCC, but focuses on Madden’s relation to state-chartered banks. The FDIC’s proposed rule clarifies that the legal interest rate on a loan originated by a state bank remains legal even after the loan is sold to a non-bank. Speaking in a statement on Tuesday, FDIC Chairwoman Jelena McWilliams said “This proposed rule would correct the anomaly by establishing in regulations … that the permissibility of interest would be determined when a loan is made and is not impacted by subsequent assignment, sale, or transfer.” The draft regulations issued on Tuesday by the FDIC affirm that state banks are not bound by the interest rate caps of other states in which they operate. Further, the validity of the loans’ interest rates would be fixed at the time of origination.
Neither proposal addresses the issue of the “true lender” doctrine – whereby a court disregards the form of the lending configuration in favor of a searching examination of its substance, to determine which entity is the actual, rather than nominal, lender. Martin Gruenberg, former Chairman of the FDIC under the Obama Administration, criticized the FDIC’s failure to recognize the “true lender” issue, arguing that the policy would lead to venue shopping and “rent-a-charter” agreements. Gruenberg believes that the FDIC’s proposed policy would “effectively undermine an evaluation as to whether the bank is the actual or true lender of the loan and not a vehicle for a non-bank third party to benefit from state preemption.”
Consumer advocates echo sentiments similar to those highlighted by Gruenberg. Lauren Saunders, the associate director of the National Consumer Law Center, stated that the “OCC proposal will encourage predatory lenders to try to use rent-a-bank schemes with rogue out-of-state banks to evade state laws that prohibit 160% loans.” Other consumer advocates oppose the agencies’ proposals, saying they could open the door to predatory lending practices and regulated protection of ill-intentioned actors.
Notwithstanding such concerns, marketplace lenders will welcome the certainty that such a “Madden fix” would bring to their industry. In the past, the Madden ruling created uncertainty for those interested in purchasing online lenders’ loans; the OCC and FDIC proposals would work to remove that investor uncertainty. The OCC and FDIC both expressed concern that Madden reduces the value and liquidity of bank loan portfolios and negatively impacts safety and soundness.