With just two sentences and fewer than 70 words, the Office of the Comptroller of the Currency (OCC) has attempted to finally resolve the Madden issue. While this is a positive and massively important step for fintechs and lenders that rely on bank partnerships, there likely won't be full clarity until after the new rule is challenged.
On October 27, 2020, the OCC issued a final rule (True Lender Rule) to clarify how to determine when a bank "makes a loan" and is the true lender for that loan. The Rule adds section 12 CFR 7.1031 to the OCC's rules for activities and operations of national banks and federal savings associations. The operative text is brief and straightforward:
A bank makes a loan when the bank, as of the date of origination (1) is named as the lender in the loan agreement or (2) funds the loan.
If, as of the date of origination, one bank is named as the lender in the loan agreement for a loan and another bank funds that loan, the bank that is named as the lender in the loan agreement makes the loan.
Since early 2019, the OCC has been working to resolve the legal uncertainties caused by the Second Circuit Court of Appeals decision in Madden v. Midland Funding, LLC (Madden). The so-called Madden issue actually involves two separate legal questions applicable to bank partnership loan originations. First, when a bank makes a valid loan and sells it to a partner that could not itself make that same loan, does the sale cause the loan to be invalid? Second, how do you determine which party in a partnership lending model is making the loan?
These questions lead to what are called the valid when made doctrine and the true lender issue. State regulators focus on these questions because they allege that lending partnerships are generally vehicles through which nonbank lenders charge usurious interest rates that would be prohibited if not for the bank's involvement. In other words, state regulators assert that in a partnership arrangement often the bank is not really the one making the loan.
In May 2020, the OCC issued a final rule codifying the valid when made doctrine (Valid When Made Rule). The OCC said that the ability to transfer loans is an essential funding tool for banks, allowing them to manage liquidity and enhance safety and soundness. If selling a loan could cause it to become invalid, that would impair a bank's ability to exercise its lending powers. Therefore, the Valid When Made Rule provides that "interest on a loan that is permissible under [the bank's authority] shall not be affected by the sale, assignment, or other transfer of the loan."
Codifying the valid when made doctrine, however, does not address the entire issue created by Madden. If the bank in a partnership origination model is not the party making the loan, then the loan is not, in fact, valid when made. In July 2020, the OCC proposed this rule (Proposed Rule) to resolve the issue by simply stating that a bank is the true lender if it is named as the lender or funds the loan. The only change from the Proposed Rule to the True Lender Rule is the second sentence, which clarifies that if two different banks are involved, one as the funder and the other named as the lender, then the named lender is the bank that makes the loan.
The simplicity of the True Lender Rule makes it easy for all parties, including the bank's supervisor, to determine the lender for any loan. Consumer groups and state regulators, however, think the simplicity ignores the economic reality of lending through bank partnerships. In the preamble to the True Lender Rule, the OCC addresses public comments submitted in response to the Proposed Rule. It is clear from the discussion that there are strong objections to the OCC's approach. California, Illinois, and New York have already sued to block the Valid When Made Rule, and it is likely they will take similar action against the True Lender Rule.
The public comments and the OCC's responses—which foreshow the arguments that will be raised in a court challenge to the True Lender Rule—are summarized below.
- Section 85—Commenters assert that the True Lender Rule contravenes 12 U.S.C. 85, which relates to the interest rates that national banks can charge under the National Bank Act (NBA). This same argument was made in the complaint filed by states that are suing to block the Valid When Made Rule. This shows that state regulators view these issues as inherently connected. However, the OCC points out that the True Lender Rule is only an interpretation of the statutes that authorize banks to lend—12 U.S.C. 24, 371, and 1464(c) (covering national banks and federal savings associations)—and it does not address section 85 at all.
- Regulating Nonbanks—Commenters state that the OCC lacks authority to exempt nonbanks from compliance with state law and lacks the authority to preempt state laws that determine whether a loan is made by a nonbank lender. The OCC response is that the rulemaking does not do any of those things, but rather that it simply interprets federal banking law. The OCC further states that if a nonbank partner is the true lender, the relevant state (and not OCC) would regulate the lending activity.
- Unreasonable—Commenters assert that the OCC's interpretation departs from federal case law, which holds that state true lender laws apply to lending relationships between banks and nonbanks. The OCC notes that federal case law is inconsistent on this point, and that the True Lender Rule provides "a simple, bright-line test" that is clear, predictable, and easily administered.
- Predatory Lending and Rent-a-Bank—Commenters assert that the OCC failed to consider the rule's effect of facilitation of predatory lending and that it reverses the OCC's policy against rent-a-bank schemes. The OCC explains that national banks are still bound by consumer protection laws, including fair lending, and that providing legal certainty will expand access to good credit. Furthermore, the OCC states that the rule solves the rent-a-bank issue by ensuring that the bank in a partnership bears the legal and regulatory obligations as the maker of the loans.
- Administrative Law—Commenters argue that the OCC did not comply with the substantive and procedural provisions in 12 U.S.C. 25b and that the True Lender Rule is arbitrary and capricious, in violation of the Administrative Procedure Act (APA). Section 25b applies whenever the OCC seeks to preempt state consumer financial law. The OCC position is that the True Lender Rule does not preempt state law; instead the rule only interprets a bank's authority to lend under federal banking law. Furthermore, the OCC argues that the APA does not require the agency to follow a wait-and-see approach. Instead, OCC has the authority to address problems that may materialize because of a lack of clarity in its own rules.
Based on the comments to the True Lender Rule, it is obvious what claims states would likely make in a court challenge. Even in states that do not directly challenge the rulemaking, courts may still be called on to resolve ambiguities in the True Lender Rule. For example, the OCC expressly states that the rule does not preempt state consumer financial law. What happens, however, if a state consumer financial regulator finds that under its laws and regulations the nonbank partner of a national bank is the true lender for a loan? Can both parties be the true lender for a single loan?
Ever since the Madden ruling, lenders working in bank partnerships have been looking to Congress or regulators to provide some clarity. While that decision directly impacted only a few states, it created uncertainty in the entire nonbank lending marketplace. The OCC's True Lender Rule goes a long way toward restoring certainty, but until the likely challenges are decided, fintechs and other lenders that rely on bank partnerships will need to continue considering the origination risks.