More than six years after it was decided, the practical consequences of the US Court of Appeals for the Second Circuit’s Madden v. Midland Funding, LLC decision continue to diminish. The decision—which held that, under some circumstances, a loan originated by a bank became subject to state usury laws once transferred to a non-bank—implicitly rejected the long-standing doctrine of “valid when made” and once threatened to upend the lending industry. It has been repeatedly narrowed and rarely expanded.
One of the most significant steps in the post-Madden efforts to provide nationwide certainty to market participants was a pair of 2020 regulations issued by the Office of the Comptroller of the Currency (OCC), which regulates national banks, and the Federal Deposit Insurance Corporation (FDIC), which regulates state-chartered banks. The rules codified pre-Madden judicial precedent and “valid when made” principles to expressly state that a loan properly originated by a bank at an interest rate that the bank was permitted to charge under federal law (including when the bank relies on preemption of state usury limits) can lawfully be serviced and collected at the same interest rate even when transferred to non-banks.
Shortly after the rules became effective in 2020, several state attorneys general (AGs) sued to invalidate the rules on the grounds that they exceeded the banking agencies’ power to regulate and were enacted in a way that did not comply with the Administrative Procedure Act’s requirements for the rulemaking process.
On February 8, 2022, the US District Court for the Northern District of California entered two orders resolving the state AGs’ two lawsuits by granting the banking agencies’ motions for summary judgment and denying the state AGs’ motions for summary judgment. The court held that the OCC and FDIC had the power to issue the rules and that their interpretations of the federal banking laws were entitled to judicial deference under the Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc. doctrine.
- Nationwide certainty (for now): The ruling comes a step closer to removing a cloud over the two rules and advances the banking agencies’ objective of giving both originating banks and their purchasing counterparties nationwide certainty about what interest rates can be charged on their loans after they are sold. While the AGs can still appeal, the US Court of Appeals for the Ninth Circuit, which would hear the appeal, in September 2020 issued a published decision that strongly agreed with the policy rationale the OCC and FDIC advanced in support of the argument and implied that Madden was wrongly decided. That precedent should constrain the AGs’ ability to succeed on appeal on the merits of the argument, but, if the AGs choose to appeal, it may be years before there is a definitive ruling from the Ninth Circuit.
- Laying the groundwork for overruling Madden in the Second Circuit: US Supreme Court precedent holds that, under some circumstances, an administrative interpretation of a statute that is entitled to deference under Chevron overrides a contrary judicial interpretation of the same statute. Specifically, National Cable & Telecommunications Association v. Brand X Internet Services holds that the agency’s interpretation controls unless the prior judicial decision was based on the “unambiguous” language of the statute. One of the AGs’ arguments was that the OCC and FDIC had no authority under Chevron to issue the rules because Madden was based on the banking laws’ unambiguous text—therefore failing the Brand X test. The Court expressly disagreed with this contention and held that Madden was not based on the statutes’ text. This ruling is the first time that a court has squarely addressed this question. While not binding on other courts, the decision substantially strengthens lenders’ and assignees’ argument, under the Brand X doctrine, that Madden is no longer the law—even in the Second Circuit.
- The issue is not political at the federal level: While the AGs who pursued this case are all elected Democrats, the position the banking agencies took in this case has been consistent through three administrations. The OCC and US Department of Justice under the Obama administration argued to the Supreme Court that Madden was wrongly decided. While the OCC and FDIC issued the rules at issue under the Trump administration, the two agencies continued to aggressively defend the rules as necessary to federally regulated banking in litigation under the Biden-Harris administration.
- The litigation does not resolve the true lender question and may lead to greater scrutiny of bank/non-bank partnerships: In promulgating and defending these rules, the banking agencies have consistently disclaimed that the rules change in any respect the analysis of whether, in a bank partnership, the bank or the partner non-bank was the “true lender” of the extension of credit. The rules only provide that a loan that a bank originates at a lawful rate of interest may continue to carry that rate of interest when sold. If a consumer or regulator successfully argues that the bank did not originate the loan in the first place, then the rules are irrelevant. State and federal regulators have signaled that, precisely because these rules take away post-origination arguments about the correct interest rate, the spotlight shifts to the predicate question of who originated the loan. Indeed, immediately after the decision Acting Comptroller of the Currency Michael Hsu issued a press release recognizing the OCC’s successful defense of the rule but warning that “[t]his legal certainty should be used to the benefit of consumers and not be abused. I want to reiterate that predatory lending has no place in the federal banking system. The OCC is committed to strong supervision that expands financial inclusion and ensure banks are not used as a vehicle for ‘rent-a-charter’ arrangements.” After the invalidation of the OCC’s true lender rule, there is no uniform federal standard to answer the true lender question, nor what constitute “rent-a-charter arrangements.”
The ruling is a welcome development in the more than six-year history of the consequences of the Madden decision. Subject to the outcome of any appeal, for loans originated by banks without third-party involvement and sold to third parties—such as the bank credit card originations at issue in Madden itself—that certainty should dramatically simplify securitization and balance-sheet optimization transactions. For loans originated as part of bank/non-bank partnerships, the ruling sharply reduces one area of risk but reemphasizes the importance of closely assessing true lender issues in those arrangements.