The OCC’s True Lender Rule: Helping Markets or Harming Consumers?
Posted on Mar 26, 2021Luke Porcari
The OCC has moved to resolve a debate which has swirled for a number of years. Frequently, banks will enter into partnerships with third parties, often fintech firms, to make loans. These partnerships “play a critical role in our financial system” by expanding access to credit and allowing banks to remain competitive as new technologies develop.[1] The OCC’s recent action is aimed at dealing with the consequences of recent court decisions that have complicated this model, but has been criticized by some as harming consumers.
The majority of states have usury laws limiting interest rates that can be charged on loans.[2] The interest rate that national banks can charge on loans, however, is governed by federal law.[3] Under federal law, national banks can charge “on any loan . . . interest at the rate allowed by the laws of the State . . . where the bank is located.”[4] The Court in Marquette held that a bank is located in the state listed in its certificate of incorporation.[5] Thus, if the entity making the loan is a national bank, it will be subject to its home state’s usury laws, but if the entity making the loan is non-bank third party, it will be subject to the usury laws of the state in which the loan is made.
This pre-emption and the certainty it creates for national banks is very important. States vary significantly in how they regulate interest rates, what maximum interest rates are allowed, and what remedies are available for violations of usury laws.[6] Complying with such varied requirements will lead to transaction costs and make it more difficult to lend. Further, this pre-emption works in tandem with the so-called valid-when-made doctrine to allow banks to sell loans they originate without altering the legal treatment of those loans. “[A] contract, which, in its inception, is unaffected by usury, can never be invalidated by any subsequent usurious transaction.”[7]
Thus, federal law pre-emption and the valid-when-made doctrine work together to incentivize the origination and sale or securitization of loans. This helps “facilitate an active lending market for consumers” by allowing banks “to liquefy their debts and redeploy capital in the form of new loans.”[8]
In 2015, however, the Second Circuit took a significant step away from this framework. In a decision criticized as a “significant departure from established precedent,”[9] the Second Circuit held that a subsequent purchaser of a bank-originated loan had to comply with the interest rate requirements of the state in which the loan was originated, rather than the state listed in the bank’s certificate of incorporation.[10] The case represented a threat to the valid-when-made doctrine.[11]
The Madden decision “created urgency and panic throughout the market,”[12] raising the possibility that “[c]onsumer lending in [the Second Circuit] and the securitization thereof may soon deteriorate.”[13] Crucially, Madden threatened to “increase the cost of consumer credit and reduce the availability of credit for high-risk borrowers.”[14]
Relatedly, the true lender doctrine has worked in tandem with Madden to destabilize lending markets. When applying this doctrine, courts look to which party has the predominant economic interest in the loan to determine which party is the lender, rather than more formalistic tests.[15] The vagueness of the predominant interest test leaves lending partnerships vulnerable to litigation and uncertainty regarding which state’s usury laws will apply to their loans. Together with Madden, cases applying the true lender doctrine spurred a wave of suits against lending partnerships. [16]
To address the fallout from Madden, the OCC issued a rule on interest rate exportation that served to codify the valid-when-made-doctrine for national banks.[17] The FDIC issued a similar rule for state-chartered banks.[18] Left unaddressed, however, was the true lender developments.
On October 27, 2020, the OCC finalized a true lender rule, under which, “a [national] bank makes a loan if, as of the date of origination, it is named as the lender in the loan agreement of funds the loan.”[19] The OCC stated that it was seeking to provide the “legal certainty necessary for banks to partner confidently with other market participants and meet the credit needs of their customers.”[20] Specifically, the OCC was concerned that legal uncertainty about which entity is making a loan “may discourage banks from entering into lending partnerships, which, in turn, may limit competition, restrict access to affordable credit, and chill the innovation that can result from these relationships.”[21] Some have speculated that the FDIC may soon issue a similar rule for state-chartered banks.[22]
Many have criticized the OCC rule as harming consumer protection. The National Consumer Law Center stated the rule “allows predatory lenders to do an end-run around state interest rate caps” by adopting “rent-a-bank” schemes.[23]Senator Sherrod Brown (D-OH), the ranking member of the Senate Banking Committee, issued a statement stated that the rule “empowers and enables predatory lending.”[24] He continued that it will allow “payday and other non-bank lenders to funnel their high-interest, abusive loans through national banks.”[25] Balancing these concerns against the need for certainty is certainly difficult, and we can expect that there will be litigation related to this rule.
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[1] National Banks and Federal Savings Associations as Lenders, 85 Fed. Reg. 68742 (to be codified at 12 C.F.R. 7.1031)
[2] Richard Hynes, Payday Lending, Bankruptcy, and Insolvency, 69 Wash. & Lee L. Rev. 607, 624 (2012).
[3] Marquette Nat. Bank of Minneapolis v. First of Omaha Service Corp., 439 U.S. 299, 308 (1978).
[4] 12 U.S.C. § 85.
[5] Marquette, supra note 3 at 310.
[6] Michael Marvin, Interest Exportation and Preemption: Madden’s Impact on National Banks, The Secondary Credit Market, and P2P Lending, 116 Colum. L. Rev. 1807, 1814 (2016).
[7] Nichols v. Fearson, 32 U.S. 103, 109 (1833). See also Federal Deposit Ins. Corp. v. Lattimore Land Corp., 656 F.2d 139, 148-149 (5th Cir. 1981) (“The non-usurious character of a note should not change when the note changes hands.”)
[8] Andrew Silvia, Madden v. Midland Funding LLC: Uprooting the National Bank Act’s Power of Preemption, 92 Chi.-Kent L. Rev. 653 (2017).
[9] Marvin, supra note 6 at 1808.
[10] Madden v. Midland Funding, LLC, 786 F.3d 246, 240 (2d Cir. 2015).
[11] Davis Polk & Wardwell LLP, Federal Banking Regulators Can and Should Resolve Madden and True Lender Developments, August 14, 2018, https://www.davispolk.com/publications/federal-banking-regulators-can-and-should-resolve-madden-and-true-lender-developments.
[12] Silvia, supra note 8 at 654.
[13] Id. at 653.
[14] Marvin, supra note 6.
[15] See, e.g., CashCall, Inc. v. Morrissey, 2014 WIL 2404300 (W. Va. May 30, 2014).
[16] See Zane Gilmer, “True Lender” Litigation and Enforcement Actions Challenge Traditional Bank Partnership Model, 37 No. 8 Banking & Fin. Services Pol’y Rep. 1 (August 2018) (discussing recent litigation relying on Madden and CashCall and the challenge it poses to lending partnerships).
[17] See 12 C.F.R. § 7.4001(e) and 12 C.F.R. § 160.110(d).
[18] See 12 C.F.R. 331.1.
[19] 85 Fed. Reg. 68742, supra note 1.
[20] Id.
[21] Id.
[22] See Center for Responsible Lending, The OCC and FDIC Plan to Trample State Laws by Gutting the Longstanding “True Lender” Doctrine, August 10, 2020, https://www.responsiblelending.org/research-publication/occ-and-fdic-plan-trample-state-laws-gutting-longstanding-true-lender-doctrine.
[23] National Consumer Law Center, New OCC Rule Protecting Predatory Lenders Could Face Legal Challenge, Oct. 27, 2020, https://www.nclc.org/media-center/new-occ-rule-protecting-predatory-lenders-could-face-legal-challenge.html
[24] Senator Sherrod Brown, Brown Blasts OCC for Finalizing the “Rent-a-Bank Rule”, Oct. 27, 2020, https://www.brown.senate.gov/newsroom/press/release/brown-blasts-occ-rent-a-bank-rule.
[25] Id.