3. Recharacterization
• Merchant Cash & Capital v. Edgewood Group, LLC
• Platinum Rapid Funding Group Ltd. v. VIP Limousine Services, Inc.
• Standish v. P. Rodney Jackson & LAC, LLC (In re Albertson)
4. Recharacterization
• Merchant Cash & Capital v. Edgewood Group, LLC
• Footnote 5
• Transaction “looks substantially like a loan”
• Fixed ACH transaction failed to specify the percentage of
future receivables purchased
5. Recharacterization
• Platinum Rapid Funding Group Ltd. v. VIP Limousine Services, Inc.
• Repayment based on a percentage of daily receipts
• Period of repayment was indeterminate
• Any calculation of an interest rate would require
“unwarranted speculation”
6. Authorization to Pull Credit
• Heaton v. Social Finance, Inc.
• SoFi settles California class action for $2.4 million
• Obtained consent for “soft” credit pulls, but allegedly did
both “soft” and “hard” credit pulls, in violation of the Fair
Credit Reporting Act.
• The FCRA applies anytime we pull a consumer credit report
on an individual (such as the guarantor of a business loan or
MCA).
7. True Lender Issues
Bank partnerships must be structured to avoid a successful challenge
that the Bank is not the true lender.
A true lender challenges asserts that at the time the loan was originated,
the lender on paper – the bank – was not the actual lender. Rather, the
actual lender was some other entity, usually not a bank, that used the
bank as a way to avoid usury limitations or licensing requirements.
8. True Lender Issues
Some bank partnership programs, particularly those offering subprime
consumer credit, have faced such challenges.
A true lender claim is based on allegations that the Bank is not actively
engaged in the partnership; the bank does not receive the benefits or take
the risks of a true lender; and the partner receives the majority of the
profits.
If a true lender challenge is successful, the Partner could face significant
penalties for failing to be licensed as a lender and the loans could be
considered usurious in some jurisdictions.
9. Madden Muddies the Water
Prior to the decision in Madden v. Midland Funding LLC, most courts that
considered partnerships found that the bank was the true lender.
In Madden, the U.S. Court of Appeals for the Second Circuit - which
includes Connecticut, New York, and Vermont - has held that non-national
bank entities that purchase loans originated by national banks cannot rely
on the National Bank Act (“NBA”) to protect them from state-law usury
claims.
10. Madden Muddies the Water
The decision in Madden undermines the “valid when made” theory on
which assignees have relied for many years. It also impedes the ability of
national banks (and, by analogy, state-chartered banks) to sell the loan
obligations they originate, thus reducing their ability to lend.
A true lender challenges asserts that the lender on the loan documents is
not the true lender at the time the loan was originated. A Madden
challenge looks to whether the current holder of an obligation originated
by a bank has the authority to continue charging the rates and fees
available to the bank at the time those rates and fees are imposed.
11. Recent Bank Partnership Decisions
In Beechum v. Navient Solutions Inc., consumer-plaintiffs argued that, as
California residents, interest could not be imposed on them at a rate that
exceeded 10% per year absent some other authority (such as a California
Finance lender license).
The defendants countered that California law does not limit interest rates
a bank may impose.
12. Recent Bank Partnership Decisions
The court looked only at the face of the transaction to assess whether it
falls under a statutory exemption from the usury prohibition and not look
to the intent of the parties. Consequently, the court found that it would
only look at the face of the transactions at issue to assess whether the
loans were exempted from the usury prohibition. Because a bank
originated the loans and was exempt from California’s usury cap, the
court dismissed the lawsuit.
13. Recent Bank Partnership Activity
In 2015, the Colorado attorney general filed suit against a financial
company, Freedom Stores Inc., which allegedly arranges closed-end
loans with Military Credit Services for service members through a bank
partnership arrangement with Bank of Lake Mills.
Freedom settled with Colorado in May 2016 and agreed to restitution to
consumers, a payment to the state, and to abandon the bank partnership
model in Colorado.
14. Recent Bank Partnership Activity
Colorado regulator takes the position that its laws apply to Colorado
residents, and, thus, has actively challenged bank partnerships in the
state. Marlette Funding and Avant have both been the subject of regulator
inquiries on its bank program in Colorado.
Colorado regulator takes the position that consumer loans offered by
online lenders in Colorado should not exceed the rates permitted to a
supervised lender (i.e. 21% APR). The criminal usury cap in Colorado,
which applies to commercial loans, is 45% per year.
15. Recent Bank Partnership Decisions
In late June 2016, the Maryland Court of Appeals, Maryland’s highest
court, affirmed in Maryland Commissioner of Financial Regulation v.
CashCall, Inc. that a non-bank partner cannot promote loans originated by
a bank unless the non-bank partner is licensed as a credit services
business and the loans comply with substantive Maryland law.
This decision does not apply to business-purpose bank partnerships.
16. Recent Bank Partnership Decisions
Edwards v. Macy’s Inc.: Federal law preempted a lawsuit raising state law claims
under an unfair deceptive acts and practices (“UDAP”) statute against a national
bank and its non-bank partner. Edwards specifically attempted to rely on Madden
in connection with her claims against Macy’s.
The Edwards court distinguished its facts from Madden, noting that although
Macy’s is not a bank or a subsidiary of a bank, Macy’s was acting on behalf of the
Bank in carrying out the Bank’s business. The Edwards court concluded that “the
language could not be clearer: Macy’s was to provide marketing, credit
processing, collections and customer service related to (the debt cancellation
program), and it was compensated for doing so. Macy’s was, therefore,
conducting those activities on (the Bank’s) behalf.”
17. Recent Bank Partnership Decisions
To the extent that a bank partnership is structured as an arrangement in which the
non-bank partner acts on behalf of the Bank in carrying out the Bank’s business,
bank partnerships can certainly look to the language of the Edwards decision for
the idea that bank partnership arrangements should be treated differently than the
sale of defaulted debt to a non-bank debt buyer (which was the form of the
transaction in Madden).
By partnering with non-bank service providers, banks can market services,
generate loan volume, and reach customers that they may not otherwise be able
to reach, especially in an online environment, thus allowing banks to fully
exercise their federally-granted powers to act as a lender.
18. Recent Bank Partnership Decisions
Commonwealth of Pennsylvania v. Think Finance: Court declined to allow
the non-bank servicing partners of a federal bank to assert federal
preemption as a basis to avoid a claim that the loans originated by the
bank - and subsequently purchased by the non-bank partners - were
usurious.
19. Recent Bank Partnership Decisions
The Kane court noted that the U.S. Court of Appeals for the Third Circuit, which
includes Delaware, New Jersey and Pennsylvania, distinguished, for purposes of
preemption, between claims against banks and claims against non-banks. In In re
Community Bank, the court found state law claims against a non-bank were not
preempted by DIDMCA and the National Bank Act.
On that basis, the Kane court held that even though the complaint contained state
usury claims, those claims were not asserted against the bank, and thus,
preemption did not apply. The Kane court concluded that In re Community Bank
allowed state usury law claims to go forward against non-bank entities.
20. FDIC Developments
In July 2016, the Federal Deposit Insurance Corporation (“FDIC”) issued proposed
guidance for its member banks that work with outside partners to originate loans,
including vendors involved in bank partnerships, supplementing the many
financial institution letters the FDIC has issued on this topic. FDIC has also
directed its member banks to consider:
• What duties does the bank rely on the partner company to perform?
• What are the direct and indirect costs associated with the program?
• Is the bank exposed to possible loss, and are there any protections
provided to the bank by the partner company?
21. FDIC Developments cont’d
• What are the bank’s rights to deny credit or limit loan sales to the partner
company?
• How long will the bank hold the loan before sale?
• Who bears primary responsibility for compliance requirements and how are
efforts coordinated?
• Is all appropriate and required product-related information effectively and
accurately communicated to borrowers?
• What procedures are in place to prevent identity theft and satisfy other
customer identification requirements?
• What other risks is the bank exposed to through the arrangement?
22. “Predominant Economic Interest” Test
In Consumer Financial Protection Bureau v. CashCall, Inc., a tribal lending case,
the U.S. District Court for the Central District of California adopted the
“predominant economic interest” test for determining “the true lender” in a case
involving a tribal model of installment lending.
The relevant language from the opinion follows:
In identifying the true or de facto lender, courts generally consider the totality
of the circumstances and apply a "predominant economic interest," which
examines which party or entity has the predominant economic interest in the
transaction.
Emphasis added. Consumer Fin. Prot. Bureau v. CashCall, Inc., (C.D. Ca. 2016) 2016 U.S. Dist. LEXIS 130584, at 17-19.
THIS IS A FICTION
23. “Predominant Economic Interest” Test
To date, we have seen this “predominant economic interest” test pop up in one other lawsuit
that the court cites – Spitzer v. County Bank of Rehoboth Beach.
In Spitzer, the court noted that “(w)hile we have no quarrel with the federal regulatory
guidelines that define a lender, we disagree with respondents' contention that simply
because written documentation provides that County Bank is responsible for such functions
that such is dispositive of the question here. It strikes us that we must look to the reality of
the arrangement and not the written characterization that the parties seek to give it, much
like Frank Lloyd Wright’s aphorism that ‘form follows function.’ Thus, an examination of the
totality of the circumstances surrounding this type of business association must be used to
determine who is the ‘true lender,’ with the key factor being ‘who had the predominant
economic interest’ in the transactions.”
IT IS A CONSUMER INSTALLMENT LOAN STATUTE CONCEPT
24. “Predominant Economic Interest” Test
Two important findings in the California CashCall case.
Court concluded that “absent an effective choice-of-law provision, the law
of the borrowers’ home states applies to the loan agreements.” “Absent
an effective choice-of-law provision” is an important qualifier to the
holding, as the existence of an effective choice-of-law provision would
mean the governing law designated in the loan agreement should apply.
25. “Predominant Economic Interest” Test
Second, another interesting item in the CashCall case appears in
Footnote 8:
The CFPB apparently contends that the Court should find that
Western Sky loans made to borrowers in New Mexico and Colorado
are void under those state’s licensing laws, even though CashCall
held a license to make loans in those states. The CFPB appears to
rely on the fact that Western Sky was not licensed in those states. The
Court finds that the CFPB’s position is disingenuous in light of its
argument that CashCall, not Western Sky, is the true lender.
26. “Predominant Economic Interest” Test
In connection with any review of a bank partnership, note what licenses
the non-bank partners hold to engage in brokering or marketing,
purchasing, or servicing and collections. In the event that a court set
aside a governing law clause and determined that a party other than the
state or national bank was the true lender, a non-bank partner that
adopted a “belt and suspenders” approach to compliance may, in fact,
have been able to originate the challenged loan directly under licenses it
holds.
27. Contact Information
Katherine C. Fisher
Hudson Cook, LLP
7037 Ridge Road
Suite 300
Hanover, MD 21076
410-782-2356
kfisher@hudco.com
Catherine M. Brennan
Hudson Cook, LLP
7037 Ridge Road
Suite 300
Hanover, MD 21076
410-865-5405
cbrennan@hudco.com
Robert F. Gage
Hudson Cook, LLP
3025 Boardwalk Street
Suite 120
Ann Arbor, MI 48108
734-369-4456
rgage@hudco.com
