On Monday, November 18, 2019, the Office of the Comptroller of Currency (“OCC”) announced that it is seeking public comment on a proposed rule to clarify the “valid when made” doctrine in the wake of a decision from the United States Court of Appeals for the Second Circuit, Madden v. Midland Funding, that undermined and largely rejected it. The Notice of Proposed Rulemaking (“NPRM”) can be found here. This rulemaking could restore certainty regarding the legality and enforceability of loans that comprise a significant component of lending activity.
The “valid when made” doctrine is a longstanding rule that a loan’s interest rate remains legal and enforceable as long as it was legal when the loan was made, regardless of whether a third party ultimately ends up holding the loan. In Madden, the Second Circuit undermined, and largely rejected, the doctrine and thus called into question the legality and enforceability of a large swath of the consumer debt. The loans challenged in Madden were originated by banks and subsequently sold, assigned, or otherwise transferred to non-bank entities.
The Second Circuit held that the non-bank loan holder was not entitled to the preemptive protection of the National Bank Act, which allows nationally chartered banks to export the interest rates of their home state without being subject to the usury limits of any other state in which the bank makes loans. The Madden decision introduced uncertainty and volatility to a large number of loan portfolios, given the recent spate of non-banks and private partnerships now in the business of buying loans and with loan pools from banks.
The OCC rulemaking promises to bring stability back to banks and non-bank partners alike by confirming the “valid when made” doctrine. According to the OCC proposal, “[t]his rule would clarify that when a bank sells, assigns, or otherwise transfers a loan, interest permissible prior to the transfer continues to be permissible following the transfer…. This rule would expressly codify what the OCC and the banking industry have always believed and address recent confusion about the impact of an assignment on the permissible interest.”
Some consumer advocates have pushed back on the OCC’s proposed rule responding to the Madden decision. Lauren Saunders, 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.”
In support of its proposed rule, the OCC stated in the NPRM that
Various provisions of federal banking law, taken together, show that Congress created an integrated federal scheme that permits national banks and federal savings associations to operate across state lines without being hindered by different state laws….While not expressly stated in these statutes, among the essential rights normally associated with the power to contract is the ability to subsequently assign some or all of the benefits of a contract to a third party.
While the OCC desires to restore the “valid when made” doctrine to settle loan industry uncertainty caused by Madden, it also made clear that the proposed rule will not be addressing the “true lender” issue. Even prior to Madden, several state regulators and consumer advocates argued that predatory lenders were engaging in “rent a charter” relationships with banks in order to gain the benefit of the banks’ ability to offer interest rates above states’ usury limits. These partnerships, opponents argue, inappropriately allow the non-bank partner to benefit from the rights and powers of the bank. Instead, the non-bank partner should be considered the “true lender” since the bank is not actively engaged in the lending program and does not receive the benefits or take the risks of a true lender.
The comment period on the proposed rule lasts sixty (60) days from when the NPRM is published in the federal register. Lenders and debtholders that have relied on the “valid when made” doctrine would be well advised to provide comment in response to the NPRM, to return stability to this important category of debt.