On June 27, Delaware Gov. Jack Markell signed into law House Bill 289, legislation that places a number of severe limitations on short-term loans made by a Delaware licensed lender. These limitations will apply to both brick-and-mortar lenders, as well as Internet lenders operating under the Delaware Licensed Lender Act. The new limitations become effective on January 1, 2013.

The most notable restriction under the new law is a prohibition against any individual receiving more than five short-term consumer loans in a 12-month period from a Delaware lender. Importantly, this prohibition applies to the initial loan and any extensions to such loans, commonly referred to as rollovers. Any loan made in violation of this new restriction is void with no right to collect any principal, interest, fees or other charges. To ensure that this limit is met, the legislation establishes a database to be set up by the Office of the State Bank Commissioner to track short-term consumer borrowing information on each borrower. Delaware lenders, prior to making short-term loans, must review the database to determine whether a borrower is eligible for the loan under the five-loan limit. Then, after making a short-term loan, lenders must “accurately and immediately” report the borrower’s information to the database to ensure future compliance with the five-loan limit. The operation of the database will be funded by a fee added to all short-term consumer loans that may not be charged in whole or in part to a borrower. Each year the Delaware banking commissioner must review the database and provide to state legislators a summary of the short-term consumer lending transactions from the prior year.

The legislation also raises the limit as to what constitutes a “short-term consumer loan” to include loans up to $1,000 from the current limit of $500, thereby making a larger universe of loans subject to the five-loan limit as well as the other limitations set forth in the statute.

With respect to workout agreements, the law now requires that payments must be in equal installments over a period of not less than 90 days. Importantly, “no other fee, interest charge, or other charge” may be assessed. Consumers now will have an incentive to enter into workout agreements, since they in effect will be getting an interest free loan during the period of the workout.

Two additional prohibitions bear mentioning. First, the offering, making, assisting, brokering or acting as an agent for a third party to obtain a loan in contravention of the law’s five-loan limit is prohibited. Second, the legislation makes disguising a short-term loan as a revolving line of credit a violation of the law as well as making or assisting a borrower in obtaining a revolving line of credit for the purposes of avoiding the requirements of the new law.

Proponents of the legislation believe that the restriction on the number of loans that consumers may obtain will be beneficial to Delaware citizens and will protect them from what are viewed as predatory lending practices of the short-term consumer loan industry. Critics of the legislation note that consumers’ access to a valuable credit resource – for some borrowers, their only available credit option – will be limited.

Pepper Points

The legislation was adopted by large margins in both the houses of the General Assembly despite a vigorous lobbying campaign by the payday lending industry opposed to the bill. Delaware borrowers who are shut off from obtaining a loan from a Delaware licensed lender have many opportunities to borrow short-term loans from online lenders and this legislation will do nothing to prevent that from occurring. While Delaware has, since the passage of its Financial Center Development Act legislation, been viewed as a favorable venue for both financial institutions and non-depository lenders, this legislation is the first to place significant restrictions on Delaware lenders’ ability to offer competitive products in the marketplace. Hopefully, the Delaware General Assembly will be satisfied with limiting its efforts to restrict these types of loans to non-depository lenders and steer clear of imposing any further limits on the state’s vibrant financial services industry that employs thousands of Delawareans.