Articles by Patrick Siegfried
Court Refuses to Apply Federal Preemption to Loan Servicer Despite Bank’s Continued Interest in LoanJanuary 20, 2016
In November 2014, the Pennsylvania Office of Attorney General (“OAG”) filed a complaint against a number of companies that did business with a group of payday lenders. The payday lenders were a Delaware bank and three tribal entities. The defendants provided marketing services and operational support to the lenders and in some instances purchased portions of the loans. In its complaint, the OAG alleged that the defendants, and not the bank or tribes, were the de facto lenders and that their partnership with the bank and tribes were constructed to circumvent Pennsylvania usury laws.
In their motions to dismiss, the defendants argued that, in regards to the loans issued by the Delaware bank, federal law preempted the OAG’s state usury claims. They explained that the Depository Institution Deregulation and Monetary Control Act (“DIDA”) allows state-charted federally insured banks to charge the same interest rate in any state as they are legally permitted to charge in the state in which they are located. The DIDA mirrors the language of section 85 of the NBA.
The defendants argued that because the Delaware bank was a state-charted federally insured bank, the DIDA preempted the causes of action in the OAG’s complaint as they pertained to the defendants’ partnership with the bank. As additional support for their preemption argument, the defendants highlighted the fact that the bank not only originated the loans but also retained them wholly, or at least in part.
Despite the bank’s origination and retention of the loans, the District court rejected the defendants’ arguments. It held that federal preemption only applied to the bank. In support of its holding, the court cited to the Third Circuit’s decision in In re Community Bank of Northern Virginia, 418 F.3d 277, 295 (3d Cir. 2005). In that case, the Circuit court held that state law claims against a non-bank were not preempted by the DIDA or the NBA.
The District court refused to apply federal preemption to the defendants even though the bank retained ownership of all or part of the loans. The court noted that the complaint alleged that the defendants, and not the bank, were the real parties in interest and therefore reasoned that preemption should not apply.
Pennsylvania v. Think Fin., Inc., 2016 U.S. Dist. LEXIS 4649 (D. Pa. 2016)
In a previous post, Creditor Fails to Navigate Usury Law “Minefield”, Ordered to Refund $1.3 Million to Debtor, I discussed a recent bankruptcy case in California. In the case, a lender had filed a claim in the borrower-debtor’s bankruptcy case. The debtor objected to the claim and brought a usury claim against the lender for allegedly usurious interest that it claimed it had paid.
After a two day trial on the debtor’s objection to the lender’s bankruptcy claim, the court found in favor of the debtor and ordered the lender to refund the usurious interest it had charged the debtor. The court also ordered post-trial briefing on a number of issues, including:
Are the debtors barred by the two year statue of limitations on usury actions from recovering usurious interest paid prior to the 2 years before the date of the bankruptcy petition?
In its post-trial brief, the lender argued that the California statute of limitations provides that a borrower that commences an usury action against a lender may only recover the amount of usurious interest paid to the lender in the preceding two years prior to filing the complaint. Therefore, the lender argued, the amount that the debtor could recover should be limited to those payments that the debtor had made within the two years preceding the filing of the bankruptcy petition. The court disagreed.
The court first noted that California usury claims generally must be filed within two years of the payment at issue. However, if the lender brings an action on the debt, the borrower may cross complain for recovery of all usurious interest paid, regardless of the two year statute of limitations. The court found that this was also true where a lender files a claim for usurious interest in a bankruptcy proceeding. As support the court cited a recent ninth circuit which explained:
The filing of a proof of claim is analogous to filing a complaint in the bankruptcy case… And a claim objection by the debtor is analogous to an answer… In re Cruisephone, Inc., 278 B.R. 325, 330 (Bankr. E.D.N.Y. 2002) (“In the bankruptcy context, a proof of claim filed by a creditor is conceptually analogous to a civil complaint, an objection to the claim is akin to an answer or defense and an adversary proceeding initiated against the creditor that filed the proof of claim is like a counterclaim.”).
Based on the Ninth’s Circuit holding, the court found that the lender had “‘brought an action’ by filing its proof of claim and actively and aggressively pursuing its remedies in the course of the bankruptcy case, and the usury defenses and claims of the Debtors are in the nature of counterclaims, thus rendering the two-year statute of limitations inapplicable here.” As a result, the debtor was permitted to recover all of the usurious interest that the court had awarded it at trial.
In re Arce Riverside, LLC, 2015 Bankr. LEXIS 4380 (Bankr. D. Cal. 2015)
California Finance Lenders Push Legislative Agenda in Response to Growth of Alternative Small Business Finance IndustryDecember 8, 2015
On October 10, 2015, California Governor Jerry Brown signed into law SB 197, a bill that allows licensed California finance lenders to pay commissions to unlicensed persons that refer prospective commercial loan borrowers to licensees that offer certain types of lower cost loans. The bill was co-sponsored by Opportunity Fund and the California Association for Micro Enterprise Opportunity. The stated purpose of the bill was to “remove a competitive disadvantage that applies to C[alifornia Finance Lender Law (“CFLL”)] licensees making commercial loans.” As the bill’s legislative background explains,
Existing CFLL regulations prohibit CFLL licensees from paying any compensation to any person or company that is unlicensed, in exchange for the referral of business. This places CFLL licensees who make commercial loans at a competitive disadvantage relative to their direct competitors, who are not required to hold CFLL licenses and are thus not subject to this restriction. Two types of direct competitors that are not required to hold CFLL licenses include merchant advance companies (not required to be licensed under the CFLL, because they are advancing, rather than lending money) and companies that partner with banks (not required to be licensed under the CFLL, because the loans are made under the banks’ charters).
Prior to the passage of SB 197, a CFLL licensee was prohibited from paying a commission to an unlicensed person that referred a potential commercial loan borrower to the licensee. The California Code of Regulation states that “no finance company shall pay any compensation to an unlicensed person or company for soliciting or accepting applications for loans…” 10 CCR § 1451.
The new legislation overrides the regulatory restriction and permits licensees to pay compensation to unlicensed persons if certain conditions are met. A CFLL licensee may pay a commission to an unlicensed person if:
- The loan made to the borrower does not charge an annual interest rate in excess of 36%.
- The lender conducts an underwriting and obtains sufficient documentation to ensure that the borrower has the ability to repay the loan.
- The lender maintains records of all compensation paid to unlicensed persons for at least 4 years.
- The lender submits annual reports to the California Commissioner of Business Oversight.
While the bill permits an unlicensed person to refer potential borrowers to commercial lenders in exchange for compensation, it limits the activities in which the unlicensed person can engage. Under the new legislation, unlicensed persons that refer borrowers for compensation may not:
- Participate in any loan negotiation.
- Counsel a borrower about a loan.
- Prepare any loan documents, including credit applications.
- Contact the lender on the borrower’s behalf, other than to refer the borrower.
- Gather documentation of the borrower or obtain the borrower’s signature.
- Participate in the development of any sales or marketing materials.
To be clear, the purpose of SB 197 was not to prohibit licensees from paying compensation to unlicensed persons in exchange for borrower referrals (licensees have been prohibited from paying commissions to unlicensed persons since the CFLL was enacted). Instead, the bill allows certain lenders that charge annual rates under 36% to do something that they were previously prohibited from doing, i.e. pay commissions to unlicensed persons for commercial loan referrals.
On Friday, the CFPB issued its semiannual update to its rulemaking agenda. The agenda lists the Bureau’s major current and long-term initiatives. Long listed as a long-term item, the Small Business Data Collection rule required by section 1071 of Dodd-Frank is listed on the update as a current initiative.
The move is unsurprising given the number of lawmakers that have publicly called for implementation of the rule. CFPB director Richard Cordray also recently mentioned that the Bureau would begin its initial work on the rule early next year.
In the update, the Bureau states that it plans to build off of its recent revision to the home mortgage data reporting regulations as it develops the new Small Business Data Collection rule. The first stage of the CFPB’s work will focus on outreach and research. This will be followed by the development of proposed rules concerning the type of data to be collected as well the procedures, information safeguards, and privacy protections that will be required of the small business lenders that will report information to the Bureau.
On November 6, the Federal Deposit Insurance Corporation (FDIC) issued Financial Institution Letter FIL-49-2015, titled “Advisory on Effective Risk Management Practices for Purchased Loans and Purchased Loan Participations.” Though billed as an update to an advisory letter issued in 2012, the new guidance requires all FDIC-supervised banks and savings associations to implement a number of new procedures before purchasing loans or loan participations that are originated by third-party nonbank entities. These restrictions would include the purchase of or participation in small business loans originated by marketplace lenders. In fact, the letter cautions supervised entities from relying on marketplace platforms that the FDIC believes do not provide sufficient information to potential investors:
[A]n increasing number of financial institutions are purchasing loans from nonbank third parties and are relying on third-party arrangements to facilitate the purchase of loans, including unsecured loans or loans underwritten using proprietary models that limit the purchasing institution’s ability to assess underwriting quality, credit quality, and adequacy of loan pricing. In some situations, it is evident that financial institutions have not thoroughly analyzed the potential risks arising from third-party arrangements.
The three pages of new guidance require a variety of procedures be implemented, including:
1. The new guidance significantly expands the policies a bank must establish before purchasing, such as:
- Establishing detailed procedures for purchased loans and participations
- Defining loan types that are acceptable for purchase
- Requiring board of directors approval of arrangements with third-parties to purchase loans and participations
Additionally, financial institutions are required to establish ongoing risk management processes for purchases made through third-party relationships.
2. The new guidance requires enhanced independent analysis of purchased loans and participations. A purchasing institution must ensure that it has “the requisite knowledge and expertise specific to the type of loans or participations purchased and that it obtains all appropriate information from the seller to make an independent determination.” The loans and participations must also be determined to be consistent with the bank’s appetite for risk. The letter states that this analysis must be done in-house and may not be contracted out to a third-party.
3. A supervised bank must also perform due diligence on the validity of a third party’s credit models if the bank relies on the model for credit decisions. A bank is permitted to subcontract this due diligence to third-parties but is still required to review the model validation to ensure it is sufficient.
The new guidance will undoubtedly increase the costs FDIC insured banks incur to purchase loans and loan participations originated by small business marketplace lenders. What effect these costs will have on current and future bank involvement in marketplace lending remains to be seen.
In the past two weeks, four ranking members of Congress have sent letters to the Treasury Department, SBA, SEC and CFPB requesting information about alternative small business lending. On November 3, Senators Jeff Merkley (D-OR), Sherrod Brown (D-OH) and Jeanne Shaheen (D-NH) sent a letter to the Treasury Department and the SBA requesting information about the impact of marketplace lending on small businesses. The Senators serve, respectively, as the ranking member of the Senate Subcommittee on Financial Institutions and Consumer Protection, the ranking member of the Senate Banking Committee, and the ranking member of the Senate Small Business Committee.
In their letter, the Senators cited concerns of some observers about the regulatory framework governing the space:
Observers have questioned what the appropriate role of federal regulators should be in supervising non-bank companies providing small business capital. Government agencies such as the federal financial regulators, Small Business Administration (SBA), or the Federal Trade Commission may have a role to play, as well as state regulators. However, it is possible that ‘the current online marketplace for small business loans falls between the cracks for Federal regulators.’ As we saw during the crisis, financial markets that fall between the cracks may result in predatory lending, consumer abuse, or systemic issues.
And last Thursday, Nydia Velazquez (D-NY), ranking member on the House Committee on Small Business, sent a letter to the SEC and CFPB inquiring about small business lending marketplaces. Rep. Velazquez cited a 2011 GAO report discussing early developments in P2P lending. Rep. Velazquez noted that in the report the GAO had proposed two approaches for federal regulation of online lending: one SEC-centered and the other CFPB-centered. Rep. Velazquez requested the agencies to provide her with more information concerning their regulation of online lending marketplaces for small business borrowers.
The lawmakers also posed a number of specific questions to the agencies, such as:
- What are the most significant risks in the market?
- What authority exists for federal agencies to supervise and examine companies offering online small business loans?
- What impact is the market having on community banks?
- How do online business lenders fit in the broader financial regulatory framework?
- What disclosures are required in small business lending?
- What resources have your agencies devoted to the regulation of the online lending marketplaces?
- Do you believe that your agencies possess the necessary legal authorities to protect small business borrowers and retail investors as it relates to the online lending marketplace?
And most interesting:
8. What statutory changes, additional legal authorities, and resources are necessary to support your agencies’ role in the regulation of online lending as it relates to small business loans and extensions of credit?
The recent congressional interest is likely a result of the RFI issued by the Treasury Department regarding marketplace lending. It seems Capitol Hill is also interested in learning more about the topic and, specifically, how alternative small business finance products are currently being regulated.
Treasury Official Discusses Responses to RFI, Offers Mixed Review of Alternative Small Business LendingNovember 3, 2015
Antonio Weiss, Counselor to the Secretary of the US Treasury, recently spoke at the Information Management Network Conference on Marketplace Lenders. In his prepared remarks, Mr. Weiss discussed the comments Treasury had received in response to its Request for Information about marketplace lenders. Mr. Weiss highlighted a number of themes about alternative small business finance that he believed had emerged from the responses.
First, Mr. Weiss stated that alternative small business lenders have the potential to increase lending to a historically underserved market.
Structural challenges in the small business lending market often make it difficult for business owners to obtain affordable credit. While larger businesses typically rely on banks for 30 percent of their financing, small businesses receive fully 90 percent of financing from banks. However, small business lending has high fixed costs for banks– it costs about the same to underwrite a $5 million dollar loan as a $200,000 loan. And we know that many small business owners are unable to access the credit they need to grow their businesses. Marketplace lending has the potential to unlock access to the capital markets for these borrowers.
Second, he stated that many responses to the RFI had cautioned that the new underwriting models used by market entrants were still untested. Mr. Weiss stated that many commenters had “noted that new underwriting models have yet to be tested through a full credit cycle” and therefore it was too soon to tell if these alternatives were better than traditional models at predicting future performance.
Third, Mr. Weiss noted that many commenters had argued that protections provided to consumers should be extended to small business borrowers. “[M]any commenters highlighted the need to establish a level playing field. All borrowers—businesses as well as consumers—should have the same protections. Small businesses are run by people. Those people receive protection as individual consumers, but when they are called ‘small businesses’ they get no protection,” he stated.
Mr. Weiss also highlighted calls for increased disclosure requirements. “…[C]ommenters almost universally agreed on the need for, and benefits of, greater transparency. To my mind, this means clear, simple terms that borrowers and investors can understand. For small businesses, transparency requires standardized all-in pricing metrics, so that a business understands a loan’s true cost and can make like-to-like comparisons across different loan products,” he stated.
In closing, Mr. Weiss noted that while Treasury will continue to monitor developments in the marketplace it is not a regulator in the space. Instead, Mr. Weiss stated that Treasury would work to inform those state and federal agencies that do have regulatory authority about developments in the market so that they could take any necessary actions.
Some interesting legislation was introduced last Tuesday by Senator Marco Rubio. The bill entitled “Investing in Student Success Act of 2015” would allow individuals to enter into Income Share Agreements that bear some of the characteristics of merchant cash advances. The bill defines an Income Share Agreement as,
[A]n agreement between an individual and any other person under which the individual commits to pay a specified percentage of the individual’s future income…in exchange for payments to or on behalf of such individual for postsecondary education, workforce development, or other purposes.
The bill goes on to state other aspects of a Income Share Agreement: “the agreement is not a debt instrument, and…the amount the individual will be required to pay under the agreement…may be more or less than the amount provided to the individual; and…will vary in proportion to the individual’s future income…” That last part differs from merchant cash advances in that there is no cap on the total amount an individual could be required to pay pursuant to an Income Share Agreement.
There are, however, a number of restrictions contained in the bill. The total percentage of income a person may be required to pay under an agreement—the split—may not exceed 15%. If a person’s income dips below $15,000 in any year, that person would not be required to pay any portion of their income. Also, the agreement may not exceed a term of 30 years, though the agreement may be extended for a term equal to the number of years the person was not required to pay because their income did not exceed $15,000.
Many states have enacted bans on income assignment agreements that would seem to prohibit the type of agreement proposed by the legislation. To address these laws, the bill contains a preemption provision: “Any income share agreement that complies with the requirements of [the bill] shall be a valid, binding, and enforceable contract notwithstanding any State law limiting or otherwise regulating assignments of future wages or other income.”
Additionally, because there is potential that a funder could receive an amount from an individual in a time period that would translate to a rate that exceeds state usury laws (as some merchant cash advances do, depending on the business’ performance) the bill also provides for preemption of state usury laws: “Income share agreements shall not be subject to State usury laws.”
So will Student Cash Advances be the next big thing in educational finance? Maybe, maybe not. For now, the bill has been referred to the Senate Finance Committee for further review.
You can read the full text of the bill here.
Lenders Subject to Section 1071 of Dodd-Frank May Find Silver Lining in CFPB’s Roll Out of New HMDA RulesOctober 23, 2015
Last week, the CFPB finalized its update to the reporting requirements of the Home Mortgage Disclosure Act (HMDA) regulations. Under the new rules, the CFPB expects that the number of non-depository institutions that will be required to report may increase by as much as 40 percent. This will lead to a sizable increase in the total number of records reported.
Given the breadth of the new rules and the additional compliance efforts they will require, the CFPB has set January 1, 2018 as the effective date of the new regulations. Given that the Bureau could have chosen January 1, 2017 as the effective date, the longer lead time is welcome news for many in the mortgage industry.
The longer lead time may also be positive news for small business lenders that will be subject to the new Small Business Data Collection rule required by the Dodd-Frank act. Section 1071 of the act requires the CFPB to issue implementing regulations. The Bureau has yet to begin its work on the new rule but some small business lenders have already voiced concerns about the costs of other regulations implemented pursuant to Dodd-Frank. They argue that these costs have already begun to restrict access to small business credit.
A well-timed roll out of the new data collection rule could reduce some of these costs. Having adequate time to develop and implement regulatory compliance procedures in a cost-effective manner will lessen the financial impact to small business lenders. This in turn will allow lenders to minimize the new rule’s impact on credit availability to small businesses.
Once the Small Business Data Collection rule is finalized, small business lenders should be given a sufficient period to adjust to the new requirements, just as the CPFB has done for mortgage lenders with the new HMDA rules. HMDA was enacted in 1975 and lenders have been subject its reporting rules for decades. Yet the increased reporting requirements of the revised rules more than justify a two year lead period.
A similar lead period is just as, if not more important for the small business lenders that will be subject to the new data collection rule. The Dodd-Frank act was enacted just five years ago and requires reporting about small business lending that has never been required before. Lenders will need adequate time to develop the new systems required to meet their reporting obligations.
The CFPB’s conscientious roll out of the HMDA revisions is a rare regulatory silver lining. Let’s hope small business lenders get one too.
Former SBA Administrator Applauds Growth of Alternative Small Business Lending, Says Loan Brokers are Under Watch by RegulatorsOctober 21, 2015
Former SBA Administrator Karen Mills spoke at the LendIt Europe Conference yesterday. The title of her speech was “The State of Small Business Financing in the U.S.” In her talk, Ms. Mills summarized the negative effects that the last economic recession had on small business lending in the U.S. and how alternative small business lenders have played a large role in countering these effects and expanding access to credit.
Ms. Mills urged alternative lenders to continue product innovation to meet the varying needs of small business customers. She stated that she believes that product innovation will be a key differentiating factor among industry participants and a critical component of market success. To that end, she echoed the views of many industry commentators that regulators should allow the marketplace to mature and develop before implementing a new regulatory framework.
“I believe this is a nascent market that is serving a need that small businesses have. These entrepreneurs have found a gap in the market and they are filling it in a cost effective way… The industry should get together and the industry should self-regulate.” Ms. Mills stated.
Ms. Mills did note, however, that some regulators are concerned about certain aspects of the small business finance marketplace.
“In the U.S., we’ve seen the rise of the loan broker. This may or may not be good news.” Ms. Mills stated.
She went on to note that loan brokers were a group that were “under some watch” by policymakers. Ms. Mills’ comments are similar to those she made at the LendIt U.S. conference earlier this year but appear to be the first time she has specifically referenced the monitoring of loan broker activity.
Chairman of House Financial Services Committee Requests Information from CFPB on Fair Lending Enforcement Actions, Requests Interview with Director of Fair Lending OfficeOctober 18, 2015
Earlier this month, the Chairman of the House Financial Services Committee, Rep. Jeb Hensarling (R., Texas), sent a letter to the CFPB requesting information related to the Bureau’s recent investigations in to alleged fair lending law violations by auto lenders. This information may be helpful in understanding how the Bureau conducts fair lending focused exams and investigations. The Bureau recently announced plans to conduct its first small business lending focused exams within the next year.
Chairman Hensarling’s letter was co-signed by Rep. Sean Duffy (R., Wis.) and requests emails and other records that document how the Bureau built its recent cases against Ally Financial, American Honda Finance Corp and Fifth Third Bancorp. In each of these cases the CFPB alleged that the companies pricing policies resulted in minorities being charged more than white borrowers. In the three actions, the lenders did not admit or deny wrongdoing.
Chairman Hensarling’s letter also asks if the Bureau will make the director of the CFPB’s Office of Fair Lending and Equal Opportunity, Patrice Ficklin, available for a transcribed interview. An interview may provide lawmakers additional insight in to the Bureau’s efforts to address allegedly discriminatory pricing policies.
Ms. Ficklin recently spoke at the ABA’s Consumer Financial Services Institute where she explained that she expects the Bureau’s upcoming small business lending focused exams to provide the CFPB with useful information about small business loan underwriting criteria. Ms. Ficklin said that this information will assist the Bureau as it begins its work on the small business lending data collection regulations required by Section 1071 of Dodd-Frank.
Chairman Hensarling’s letter requested a response on Ms. Ficklin’s availability by Oct. 13 and the other requested documents by Oct. 20.
A recent case out of Illinois serves as a reminder that when it comes to usury law compliance, its always best to double, or even triple check your contracts.
Preferred Capital Lending, a Nevada company that provides cash advances to attorneys working on personal injury cases, agreed to make a loan to the defendant. The defendant signed the promissory note in Preferred Capital’s Las Vegas office and the note expressly provided that it was executed in the State of Nevada. When the defendant later defaulted on the loan, Preferred Capital filed a breach of contract action in Nevada. The case, however, was transferred to Illinois pursuant to the loan contract’s choice of law clause which provided that that state’s law would govern.
In response to the complaint, the defendant filed a motion for summary judgment arguing that the loan carried an interest rate that exceeded Illinois’ usury cap. Preferred Capital countered that it had made a mistake when drafting the choice of law clause and that the clause should have stated that Nevada’s law applied. The court was unpersuaded by Preferred’s argument:
Preferred Capital contends that the Illinois choice-of-law provision was a mistake and the loan documents should have indicated that the law of Nevada, which has repealed its usury laws, applies to the loan documents. This assertion rings hollow in light of the fact that Preferred Capital analyzed its breach of contract claim under Illinois law in its opening motion for summary judgment, and expressly stated in a footnote that it was doing so pursuant to the Illinois choice-of-law provision in the promissory note at issue.
As a result, the court applied Illinois law and found that the amount of interest provided in the agreement violated the Illinois Interest Act.
Now to be fair, Preferred Capital operates offices in both Nevada and Illinois. So its understandable how a Illinois choice of law clause appeared in the loan documents. What’s less clear, though, is why Preferred Capital initially argued that the agreement should be governed by Illinois law given that it had originally filed the matter in Nevada. In any event, the oversight proved costly as Preferred Capital now finds itself defending a usury claim rather than collecting on the outstanding loan.
Preferred Capital Lending v. Chakwin, 2015 U.S. Dist. LEXIS 137383 (N.D. Ill. Oct. 7, 2015)
A recent court decision demonstrates the complexity and dangers faced by creditors attempting to navigate California’s usury laws. In the case, a lender agreed to purchase a debtor’s promissory note from a bank and refinance it for a lower amount. The entity that the lender used to purchase the note from the bank was a licensed California real estate broker. Simultaneously with the purchase of the note by the first entity, the lender assigned the note to a second entity under its control. Later the debtor defaulted on the note and filed bankruptcy.
In the bankruptcy proceeding, the lender filed a claim against the bankruptcy estate for the remaining amount due on the note. The debtor objected to the claim and argued that the interest rate that had been charged by the lender was usurious. As such, the debtor asked that the court order the lender to refund the usurious interest that had been paid.
While the lender agreed that the rate charged on the note exceeded the maximum rate set by California’s usury law, the lender argued that the purchase of the note had been arranged by a licensed real estate broker and therefore the transaction was exempt from the usury restrictions. After a two day trial, the court found in favor of the debtor and order the lender to refund over $1.3 million to the debtor.
In its decision, the court noted that the California legislature had provided an exemption from the applicability of California’s usury laws by exempting “any loan or forbearance made or arranged” by a licensed real estate broker and secured by real estate. The court went on to explain, however, that the exemption only applies where the broker was acting on behalf of another. Where a broker is acting as a principal, the exemption does not apply.
After examining the relevant loan documents, the court found that the purchase of the note by the first entity had been done on its own behalf and not on behalf of the entity to which the note was later assigned. The court rejected the lender’s argument that the lender had done little to formally structure the transaction as a broker-principal arrangement simply because it controlled both entities and knew it would be transferring the note following the purchase from the bank. For that reason, there was no “need to report anything to [itself]”. The court was unpersuaded by this argument and stated that “[t]he usury laws present a minefield that people in the [lender’s] position, with their… status as licensed brokers, can readily navigate. This time they did not navigate carefully.”
In light of this case, lenders doing business in California should be careful to “navigate carefully” the complex usury laws of that state, lest they too become a victim of its “minefield” of statutory dangers.
In re Arce Riverside, LLC, 2015 Bankr. LEXIS 3275 (Bankr. N.D. Cal. Sept. 28, 2015)
CFPB to Begin Work on Small Business Loan Data Collection Rule After Completion of HMDA Revisions; Plans ECOA Examinations Within the Next YearSeptember 30, 2015
CFPB Director Richard Cordray testified yesterday before the House Financial Services Committee. During the session, Director Cordray was asked when the Bureau plans to begin work on its implementation of the Small Business Loan Data Collection Rule of section 1071 of the Dodd-Frank Act. Noting the recent calls for implementation of the rule by members of Congress and a number of community groups, Mr. Cordray stated that the Bureau plans to begin work on the rule following the completion of its overhaul of the Home Mortgage Disclosure Act rules. He stated he expected the Bureau to finish the revisions to the HMDA regulations by the end of the year.
Mr. Cordray also noted that the CFPB plans to begin examinations of financial institutions regarding their compliance with the Equal Credit Opportunity Act as it relates to small business lending. “We have a little window of authority [over small business lending] under the Equal Credit Opportunity Act and we have indicated that we will begin examinations of institutions on their small business lending within the next year,” he said. ECOA is one of the few statutes applicable to small business lenders that is enforced by the CFPB.
The Director’s statement follows the Bureau’s recent ECOA enforcement action against Hudson City Savings Bank for alleged redlining in its consumer lending operations in New Jersey, New York, Connecticut, and Pennsylvania. Given the Bureau’s recent and controversial use of the disparate impact theory, it will be interesting to see if the Bureau expands the use of the theory when it begins its examination of institutions regarding their small business lending operations.
On September 22, 2015 the Attorney General of New Hampshire announced that it had entered in to an agreement with two credit card processors to settle allegations that both companies had engaged in unfair or deceptive business practices in violation of New Hampshire law. The allegations stemmed from the processors’ solicitations of New Hampshire businesses for credit card processing and other ancillary services. The AG cited the companies’ telephone solicitations as the primary focus of its investigation:
These solicitations were conducted through a pre-approved script that failed to identify the legal name of the company and failed to inform consumers that the company making the calls is located in the state of Florida. In addition, the script failed to provide a phone number for consumers to call back with any follow-up questions or concerns. Further, the script characterized the offer being made as an “upgrade” of the existing payment processing equipment, when, in fact, the solicitations were an attempt to identify new customers to enroll in new services. Finally, the script made several references to a “free” replacement of card payment processing equipment without clearly communicating to the consumers that the new equipment was conditioned on purchasing and remaining enrolled in their services.
Under the terms of the agreement, both processors have agreed to cease soliciting in New Hampshire until they are registered with the Secretary of State. They will also have to receive approval from the AG’s office on a revised script before resuming telephone solicitations. In addition, they are required to pay $5,000 to the state in lieu of a civil penalty and must reimburse the state’s investigation costs.
Unfortunately, the AG’s announcement provides little guidance to other businesses soliciting New Hampshire customers as it fails to specify which of the cited acts it believes are unfair or deceptive. While some of the allegations in the announcement suggest that the AG believed that portions of the solicitations were misleading and potentially deceptive, others are fairly innocuous omissions of information, e.g. failing to identify the legal name of the calling company and its location. It’s unclear whether the AG considers these omissions to be unfair or deceptive on their own or when considered in conjunction with the processors allegedly misleading characterizations of “upgrade” and “free”.
In light of the AG’s announcement, companies soliciting potential New Hampshire customers may want to consider modifying their sales scripts to include the legal name of their business, the state in which they are located and a call-back number.
CashCall and its affiliates haven’t fared particularly well in their recent efforts to dismiss complaints filed against them by state regulators. They found some success, however, in their recent efforts to dismiss a private usury action filed against them in Kentucky Federal Court.
The plaintiff in the case received a payday loan from the defendants that she argued was usurious and, therefore, void. CashCall countered that the agreement contained a clause that required all disputes between the parties to be submitted to an arbitration conducted by the Cheyenne River Sioux Tribe. As such, CashCall argued that the lawsuit should be dismissed or stayed pending arbitration.
The plaintiff countered that the arbitration clause was a sham and illusory. She alleged that the tribal forum laid out in the agreement didn’t exist and, therefore, the arbitration clause was unenforceable. She also cited to a number of cases that had found arbitration clauses contained in other CashCall agreements void.
After reviewing the parties’ positions, the court sided with CashCall. The court noted that in the cases cited by the plaintiff, the agreements had required that the arbitration proceedings be conducted by a member or members of the CRST tribe. In the agreement at issue, however, the arbitration clause provided that the plaintiff could also choose other organizations to conduct the arbitration, including AAA and JAMS. Because the plaintiff was permitted to choose an established organization to conduct the arbitration rather than members of the CRST, the court found that the agreement was not illusory and should be enforced. Therefore, the court granted CashCall’s motion to compel arbitration and dismissed the case.
Yaroma v. CashCall, Inc., 2015 U.S. Dist. LEXIS 123457 (E.D. Ky. Sept. 16, 2015)
The FCC recently issued telemarketing citations against First National Bank and Lyft, Inc., a ride-sharing service. The Commission cited the companies for requiring their customers to consent to receiving auto-dialed calls and texts as a condition of using the companies’ services. The FCC alleged that the companies’ requirements violated regulations issued pursuant to the Telephone Consumer Protection Act that forbid companies from requiring their customers to agree to receive marketing robocalls and auto-dialed calls/texts as a condition of purchasing any goods, services, or property. The citations demonstrate the Commissions’ intent to actively enforcing the TCPA and its regulations.
In light of the FCC citations, small business lenders that engage in telemarketing sales –especially to cellphones – should review their TCPA disclosures. In particular, companies need to ensure they obtain “prior express written consent” before engaging in auto-dialed calls/texts to mobile numbers. And as the FCC noted, the requirements are exacting:
The agreement must be in writing;
The agreement must bear the signature of the person who will receive the advertisement/telemarketing calls or texts;
The language of the agreement must clearly authorize the caller to deliver or cause to be delivered advertisements or telemarketing messages via auto-dialed calls, texts, or robocalls;
The written agreement must include the telephone number to which the person signing authorizes advertisements or telemarketing messages to be delivered; and
The written agreement must include a clear and conspicuous disclosure informing the person signing that:
- By executing the agreement, the person signing authorizes the caller to deliver or cause to be delivered ads or telemarketing messages via auto-dialed calls, texts, or robocalls; and
- The person signing the agreement is not required to sign the agreement (directly or indirectly), or agree to enter into such an agreement as a condition of purchasing any property, goods, or services.
In the event that consent is disputed, it is the caller that bears the burden of “demonstrating that a clear and conspicuous disclosure was provided and that unambiguous consent was obtained.”
While the citations do not carry monetary penalties, the FCC may impose sanctions against First National and Lyft if the violations continue. The citations also invite the filing of private TCPA actions against the companies. All the more reason for small business lenders to conduct a proactive review of their TCPA compliance procedures.
Though usury caps are only applicable to loan transactions, courts often reference usury rates when determining the reasonableness of fees charged on amounts due. A fee that significantly exceeds the applicable usury rate may be found to be an unenforceable penalty and uncollectible. Companies that impose late fees or other types of charges on their customers must be careful to ensure their fees will be found enforceable by a court.
For example, a NY court recently found a late fee charged by a condominium association unreasonably excessive and refused to enforce it. The charge at issue was related to unpaid common charges. The defendant’s charges were $1,175.85 per month. The defendant failed to pay her monthly charges so the association assessed late fees ranging from $200 to $800 per month. When the association later filed a foreclosure action for multiple unpaid common charges, the defendant argued that the late fees were excessive and confiscatory and should not be allowed.
The court noted that while a usury defense was inapplicable, the 25% rate set by NY’s criminal usury statute provided a guide to what constituted excessive fees. The court found that because the fees significantly exceeded the usury rate they were unreasonable penalties and could not be enforced. As a result, the court reduced the late fees to $0.04 per dollar owed.
As this case shows, courts will often look to applicable usury rates when determining the reasonableness of contractual fees and other types of charges. Fees that significantly exceed these rates are likely void and uncollectible. For this reason, a company that wishes to charge contractual fees would be wise to stay below the statutory usury rate. While the rate may result in a lower fee, the amount charged is more likely to be enforced by a reviewing court.
Board of Mgrs. of the Park Ave. v Sandler, 2015 N.Y. Misc. LEXIS 3284 (N.Y. Sup. Ct. Sept. 11, 2015)
In response to the Treasury’s RFI, I expect many industry commentators to encourage potential government regulators to engage in a careful review of the small business finance market before deciding on a course of action. As an example of the type of review necessary, these commentators could highlight the recent issue brief published by the SBA Office of Advocacy entitled “Peer-to-Peer Lending: A Financing Alternative for Small Businesses“.
While the scope of the paper is limited to P2P loans used for business purposes, it explains how alternative small business lenders are expanding access to capital:
Compared to traditional loan products, marketplace loans feature decreased search costs; this is a result of the proprietary credit scoring algorithms that the lending platforms use. This decrease in costs makes it economical for lenders to provide smaller and/or shorter-term loans to firms on which less information is available. Such firms may include those that are younger, less established, have a shorter credit history, lack collateral, or may be in acute financial distress (e.g., imagine that you own a bakery and your only oven stops working).
The paper recognizes that alternative lenders are able to offer financing to small businesses that previously had no way of obtaining working capital, a fact that is often misunderstood or disregarded by industry critics. The paper also explains some of the reasons why alternative small business loans charge higher rates when compared with other types of loans:
[E]ven controlling for observable borrower characteristics, loans for small businesses were more than 250 times more likely to perform poorly than loans for other purposes, which may give some insights into why such loans are charged a higher rate. Put simply, investors require a higher payoff in order to fund these riskier loans, and for some small businesses, an expensive loan may be better than no loan.
Overall, the paper is a evenhanded assessment of a complex topic. It highlights how alternative lenders have increased credit availability for small business owners while explaining the economics behind the rates charged. And as the policy discussion regarding marketplace lenders begins, explaining these facts will become increasingly important.
Multiple State Regulators Challenging Lender’s Use of Choice of Law Clause in Usury Enforcement ActionsSeptember 11, 2015
A growing number of state regulators are challenging the use of choice of law provisions as a method of usury law compliance. On August 27, 2015, the Attorney General of North Carolina was granted an injunction against Western Sky Financial and CashCall¹. The injunction prohibits them from offering any loans to North Carolina consumers or collecting on any outstanding accounts in that state.
Prior to the issuance of the North Carolina injunction, the Massachusetts Division of Banks sent a cease and desist letter to Western and CashCall stating that each had violated Massachusetts’ law by engaging in the small loan business without a license and that each had violated the state’s criminal usury statute (the letters were initially sent in 2013 but the Division’s findings were recently challenged by Western and CashCall in Massachusetts Superior Court. The court issued its ruling on the challenge on August 31, 2015²). The cease and desist orders specifically directed Western and CashCall to cease collecting on loans made to Massachusetts borrowers, refrain from transferring the loans, refund all interest charges and fees received from borrowers during the last four years, and submit a list of borrowers to whom reimbursement is owed.
And just yesterday the Attorney General of the District of Columbia filed a lawsuit against Western, CashCall and their owner, J. Paul Reddam. The complaint alleges that the defendants charged their customers interest rates in excess of the District’s usury cap. The District is seeking a permanent injunction, restitution, statutory penalties and attorney fees.
In response to both the North Carolina and Massachusetts actions, Western and CashCall asserted that they were not subject to the regulators’ jurisdiction because the choice of law clause in their loan contracts provided the laws of the Cheyenne River Sioux Tribe governed the transactions. The defendants argued that the rates charged were permissible under tribal law (a similar argument is expected to be made by the defendants in response to the DC complaint).
Their argument was rejected in both cases. The reviewing courts found that a contractual choice of law provision did not govern a state regulator and that North Carolina and Massachusetts could pursue the defendants for their alleged violations of local usury laws. These decisions, along with the complaint filed by DC’s Attorney General, cast further doubt on a lender’s ability to rely on a choice of law clause when faced with regulatory enforcement actions.
¹State ex rel. Cooper v. Western Sky Fin., LLC, 2015 NCBC 84 (N.C. Super. Ct. 2015)
²Cashcall, Inc. v. Mass. Div. of Banks, 2015 Mass. Super. LEXIS 87 (Mass. Super. Ct. Aug. 31, 2015)