In 2015, the Second Circuit made news in the marketplace lending industry—and the market for bank-originated debt more broadly—when it held, in Madden v. Midland Funding, LLC, that a non-bank purchaser of bank-originated credit card debt was subject to New York State’s usury laws. 786 F.3d 246, 250-51 (2d Cir. 2015). That widely discussed case continues to generate interest.
One notable element of Madden was that it did not address principles that lenders and debt purchasers had previously taken as given. Nationally chartered and FDIC-insured banks are exempt under federal law from various state and local regulations—including state usury limits that are lower than those of the bank’s home state. Most have understood that, when banks sell debt to third-parties, the purchasers can seek the entire balance of the loan, including amounts that were above the state usury cap when applied. That understanding is based largely on the “valid-when-made” principle, a concept under longstanding contract law that “an assignee stands in the shoes of the assignor, including when those shoes charge interest.” See Charles M. Horn & Melissa R. H. Hall, The Curious Case of Madden v. Midland Funding and the Survival of the Valid-When-Made Doctrine, 21 N.C. BANKING INST. 1, 6-7 (2017). Without addressing “valid-when-made,” however, Madden concluded that preemption did not apply to the third-party debt buyer.
Critics have zeroed in on the Madden court’s failure to consider “valid-when-made” (which the defendants did not brief). Some have emphasized the contractual nature of the doctrine, arguing that if the issuing bank validly exported its home-state interest rate to a third party, at that point “valid-when-made” should kick in as a matter of contract law and allow assignees to charge the original interest rate, with no need to invoke additional preemption principles beyond basic rate exportation. Horn & Hall, supra, at 13-21. Other critics—most notably the Solicitor General at the time of the petition for certiorari—have focused on the preemptive character of the doctrine, describing the court’s failure to consider “validwhen-made” not as overlooking a principle of contract law, but as a failure “to understand how application of state usury laws… would impair the bank’s exercise of [its] powers.” See OSG Brief at 12, 2016 WL 2997343, at *11-12. Most have highlighted the importance of rateexportation to the functioning of credit markets. Regardless of how the doctrine is characterized, there is widespread criticism that the Madden court’s failure to consider the doctrine led it to an unwarranted result.
As of May of this year, no legislative or regulatory pronouncement on the issue seemed imminent. But a putative class action filed last month in the Eastern District of New York against non-bank defendants has the potential to address the issue. The complaint alleges that the New York usury cap applies to credit card debt that was pooled and sold in connection with a securitization. See Complaint, Cohen v. Capital One Funding, LLC, et al., 19-cv-03479 (E.D.N.Y. June 12, 2019). Because the debt is no longer held by the originating bank or a bank affiliate, the complaint says, New York’s usury limit is not preempted under Madden and is therefore usurious. The complaint does not discuss the “valid-whenmade” doctrine, although most presume it will be raised by the non-bank defendants. Thus, the case has the potential to test the practical impact of Madden. Defendants’ answer—due August 19, 2019—will be one to watch.