Without Scalia, Media Outlets Reporting Marketplace Lenders Supposedly Doomed With Supreme Court Case (They’re Wrong)

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US Supreme CourtWithout Antonin Scalia, marketplace lending is apparently doomed, according to news outlets reporting on the matter. A high profile case (in the banking world anyway) known as Madden v Midland, is pending before the U.S. Supreme Court. Midland Funding seeks to reverse an appellate court ruling that said that interest rate preemption under the National Bank Act did not apply to them and thus they were subject to New York State’s usury laws.

According to BankRate.com’s reporting on the Scalia angle, “The U.S. Supreme Court has been asked to review a lower court decision that prevents marketplace lenders from getting around state usury laws by hooking up with banks headquartered in states that don’t have those rules.” But that’s not true at all. The case isn’t about marketplace lenders and the appellate court’s ruling isn’t currently preventing marketplace lenders from doing anything.

Midland Funding is a debt collector. Saliha Madden, a New York resident, obtained a bank issued credit card with an interest rate of 27% APR, racked up charges and didn’t pay them. The debt got written off and the bank sold the debt to Midland Funding. Midland continued to assess interest on the credit card debt while it attempted to collect. Saliha Madden sued on the basis that Midland was violating New York State usury laws. Midland Funding won and Madden appealed. Then a weird thing happened. The United States Court of Appeals for the Second Circuit held that in order “[t]o apply NBA preemption to an action taken by a non-national bank entity, application of state law to that action must significantly interfere with a national bank’s ability to exercise its power under the NBA.”

And from there began the somewhat justifiable panic in the marketplace lending industry. If a collector buying a charged-off debt from a bank can’t continue to enforce the terms as originally contracted, then could you make the same argument for loan platforms that buy newly issued loans? The answer is simply that you could make the argument. It’s not definitive. It’s one of those things that would likely have to be challenged in court by a borrower confident that a case involving a debt collector and a bank issued credit card somehow related to the matter between a marketplace lender and a borrower.

But there’s another problem in trying to make that link.

The Madden v Midland case involved a national bank and preemption under the National Bank Act. Many marketplace lenders such as Lending Club are not even conducting their business with national banks but with state-chartered banks. Their preemption ability falls under the Federal Deposit Insurance Act.

Lending Club did not shut their business down after the appellate court ruling and they didn’t stop lending in the states in which the Second Circuit has jurisdiction (New York, Connecticut and Vermont). Lending Club’s CEO Renaud Laplanche even expressed little worry about how it would impact their business when asked about it during their 2015 Q2 earnings call.

American Banker reported that “Scalia’s Death Is a Setback for Online Lenders in Key Court Fight.” But it’s really only a setback in the sense that a loss would peel away just one layer of the onion. Marketplace lenders weren’t going to suspend their operations regardless of whether or not the Supreme Court heard the case and regardless of whether or not Scalia was there to dissent.

Consider also that exporting home state interest rates using national and state chartered banks is only one system available to marketplace lenders. Square’s working capital program for example, is actually structured as a purchase of future receivables. There is no bank, no loan, and no preemption. An unfavorable Madden v Midland ruling would have no impact on that model or the dozens of merchant cash advance companies that offer similar products.

There’s also state by state licensing, which while costly and time consuming to set up, would at least allow marketplace lenders to lend in many states without relying on a bank or preemption. “I think the stronger business model is the state licensing model, as opposed to partnering up with a bank,” said Richard Eckman, a lawyer at Pepper Hamilton, to American Banker.

Even further distanced from this case are commercial marketplace lenders since state lending laws are generally less burdensome for business-to-business transactions.

And even if all else failed, a choice-of-law provision in a loan agreement can potentially decide which state’s law applies. Lending Club’s Laplanche said as much last year. “We continue to operate in the Second Circuit district where that decision was rendered, exactly as we did before and are relying on our choice of law provisions,” he said during an earnings call.

Scalia’s absence is at most a bummer for marketplace lenders. A win would only serve to tie up loose ends and finally put an end to bank charter model naysayers. Madden v Midland became so famous because the ruling was just so shocking. It practically begged the industry to take a look and wonder, what if? If this, then why not that? And if that, then who’s to say not this then? Even on deBanked, we’ve explored the nightmare scenario in which a well established system totally unravels and the world ends. The real world holds much more promise.

The real losers in an unfavorable Supreme Court ruling would be national banks and credit card companies. And that’s because if debt collectors can’t enforce their loan agreements, then they’re not going to buy that debt to begin with. And if debt collectors won’t buy that debt, then banks are going to have to figure out a better way to collect on their own, else they make even less risky lending decisions.

Something tells me though that banks would find a creative work-around for that anyway. Because if they didn’t, Madden v Midland would end up being a massive boon for marketplace lenders.

Imagine that.

Last modified: February 19, 2016
Sean Murray

Category: Marketplace Lending

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