Legal Briefs
Analysis: New York’s Lender/Broker Licensing Proposal
February 7, 2017
New York Governor Andrew Cuomo’s proposed budget includes a legislative proposal to “allow the Department of Financial Services (“DFS”) to better regulate the business practices of online lenders.”1 This legislation, which would amend Section 340 of the Banking Law, could have a dramatic impact on lending and brokering loans to New York businesses, as such lenders would have to obtain licenses to engage in business-purpose lending and could only charge rates and fees expressly permitted under New York law.2 It may impact the secondary market for merchant cash advances. If passed, the licensing requirements will take effect January 1, 2018.
The proposed law would amend NY Banking Law § 340 to require anyone “engaging in the business of making loans” of $50,000 or less for business or commercial purposes to obtain a license. The term “engaging in the business of making loans” means a person who solicits loans and, in connection with the solicitation, makes loans; purchases or otherwise acquires from others loans or other forms of financing; or arranges or facilitates the funding of loans to businesses located or doing business in New York.
Although the proposed law would require a license only for a person who “solicits” loans and makes, purchases or arranges loans, the DFS takes the position that the licensing law (as currently enacted) applies broadly and that “out-of-State entities making loans to New York consumers . . . are required to obtain a license from the Banking Department.”3 As a result, there is probably no exemption from licensing for a person who does not “solicit” loans in New York.
The potential impact of the legislation is significant.
Potential Impact on Lenders:
Licensing Required and Most Fees Prohibited. New York law already requires a lender to obtain a license to make a business or commercial loan to individuals (sole proprietors) of $50,000 or less if the interest rate on the loan exceeds 16% per year, inclusive of fees. The proposed law would require any person who makes a loan of $50,000 or less to any type of business entity and at any interest rate to obtain a license. And a licensed lender is governed by New York lending law that regulates refunds of interest upon prepayment;4 and significantly limits most fees that a lender can charge to a borrower, including prohibiting charging a borrower for broker fees or commissions and origination fees.5
Essentially, the DFS will regulate lenders who originate loans to businesses of $50,000 or less in the same manner as consumer loans of less than $25,000. The proposed law would exempt a lender that makes isolated or occasional loans to businesses located or doing business in New York.
Potential Effect on Choice-of-Law. The proposed law could lead courts to reject contractual choice-of-law provisions that select the law of another state when lending to New York businesses. With new licensing requirements and limits on loans to businesses, a court could reasonably find that New York has a fundamental public policy of protecting businesses from certain loans, and decline to enforce a choice-of-law clause designating the law of the other state as the law that governs a business-purpose loan agreement.
For example, the holding of Klein v. On Deck6 might have come out differently if New York licensed and regulated business loans at the time the court decided it. In the Klein case, a business borrower sued On Deck claiming that its loan was usurious under New York law. The loan contract included the following choice-of-law provision:
“[O]ur relationship including this Agreement and any claim, dispute or controversy (whether in contract, tort, or otherwise) at any time arising from or relating to this Agreement is governed by, and this Agreement will be construed in accordance with, applicable federal law and (to the extent not preempted by federal law) Virginia law without regard to internal principles of conflict of laws. The legality, enforceability and interpretation of this Agreement and the amounts contracted for, charged and reserved under this Agreement will be governed by such laws. Borrower understands and agrees that (i) Lender is located in Virginia, (ii) Lender makes all credit decisions from Lender's office in Virginia, (iii) the Loan is made in Virginia (that is, no binding contract will be formed until Lender receives and accepts Borrower's signed Agreement in Virginia) and (iv) Borrower's payments are not accepted until received by Lender in Virginia.”
The court concluded that this contract language showed that the parties intended Virginia law to apply. However, the court also considered whether the application of Virginia law offended New York public policy. The court compared Virginia law governing business loans against New York law governing business loans, and decided that the two states had relatively similar approaches. As a result, the court found that upholding the Virginia choice-of-law contract provision did not offend New York public policy.
The loan amount in the Klein case was above the $50,000 threshold for regulated loans in the proposed New York law, so this exact case would not have been affected. However, the court’s analysis in the Klein case would have been the same for loans of $50,000 or less. Accordingly, the new law could cause a New York court to reject a contractual choice-of-law provision.
Effect on Bank-Originated Loans. This proposed law apparently would not directly affect loans made by banks that are not subject to licensing under the statute.7 But, the law would require non-banks that offer business-purpose lending platforms that partner with FDIC-insured banks to obtain a license to “solicit” loans. And, it is possible, that the DFS could later, by regulation or examination, prohibit such licensees from soliciting loans at rates higher than permitted under New York law.
Potential Impact on Merchant Cash Advance Companies:
The proposed law imposes a license requirement if a person “purchases or otherwise acquires from others loans or other forms of financing.” New York law does not define the term “other forms of financing.” However, the DFS may consider merchant cash advance transactions to be a regulated transaction for which licensing is required.
As written, only purchasing or acquiring other forms of financing, such as a merchant cash advance, might require a license. As a result, the proposed law only has the potential for affecting the sale and syndication of merchant cash advances. It is unclear whether buying only a portion of a merchant cash advance, or “participation” could require a license, or if only purchasing the entire obligation could require a license.
Potential Impact on Brokers:
Because the new law would require a license to “arrange or facilitate” a business loan of $50,000 or less, ISOs and loan brokers would need a license. As mentioned above, a licensed lender is prohibited from charging broker fees or commissions. It is not clear at the moment whether an ISO or loan broker could contract directly with the borrower for a commission.8
1 See https://www.budget.ny.gov/pubs/executive/eBudget1718/fy18artVIIbills/TEDArticleVII.pdf, page 243. Although not discussed in this article, the proposal would also impose new licensing requirements on certain consumer lenders.
2 A licensed lender may impose a rate in excess of the 16% civil usury limit in New York, but is still subject to the 25% criminal usury limit. See, New York Banking Law § 351(1) and New York Penal Law § 190.40.
3 See http://www.dfs.ny.gov/legal/interpret/lo991206.htm The term “solicitation” of a loan includes any solicitation, request or inducement to enter into a loan made by means of or through a direct mailing, television or radio announcement or advertisement, advertisement in a newspaper, magazine, leaflet or pamphlet distributed within this state, or visual display within New York, whether or not such solicitation, request or inducement constitutes an offer to enter into a contract. NY Banking Law § 355.
4 NY Banking Law § 351(5).
5 NY Banking Law § 351(6).
6 Klein v. On Deck Capital, Inc., 2015 N.Y. Misc. LEXIS 2231 (June 24, 2015).
7 See NY Banking Law § 14-a; 3 NY ADC 4; NY Gen. Oblig. Law § 5-501.
8 See NY Gen. Oblig. Law § 5-531 that limits fees that brokers can charge on non-mortgage loans to not more than 50 cents per $100 loaned.
Katherine C. Fisher is a partner in the Hanover, MD office of Hudson Cook, LLP. Kate can be reached at 410-782-2356 or by email at kfisher@hudco.com.
If a Bank Made the Loan in California, It Doesn’t Matter What Happened Next, Federal Court Holds
January 27, 2017There’s no reason to examine whether a party intended to enter into a usurious loan if there is a constitutional exemption that permitted the lender to make the loan in the first place, a federal court in California’s central district ruled. In Jamie Beechum et al. v. Navient Solutions, Inc. et al, a student loan borrower argued that loans made by Stillwater National Bank and Trust Company, are a sham because the defendants who bought the loans from Stillwater (who were not a bank) originated, underwrote, funded, and bore the risk of loss on the loans.
Beechum asked the court to examine the substance and intent of the agreements between the bank and the defendants, which they claim were designed specifically to evade state usury laws. The court did not believe it was necessary to look beyond California’s constitutional exemption since both plaintiff and defendant agreed that Stillwater Bank was the lender. The complaint was therefore dismissed.
As a secondary defense, defendants had also contended that as a national bank, Stillwater was also exempt from state usury laws under the National Bank Act, but the court did not even have to consider that to arrive at their conclusion.
A good analysis of the case (including why buying a loan from a bank differs from buying a loan from a tribe) was written in Leasing News by Tom McCurnin, a partner at Barton, Klugman & Oetting in Los Angeles, California.
The Leads Are Weak, Court Rules
January 21, 2017
One disagreement that has come out of the Argon Credit bankruptcy case is the value of the consumer loan leads that the company has in its possession. Argon argued that it has 300,000 leads worth $5.5 million based on its alleged cost to acquire them.
In a court filing, Fund Recovery Services, LLC (FRS), a creditor, called that valuation “absurd on its face,” explaining that these were prospects that Argon had already declined for a loan and that they had not been able to sell these leads previously. A representative for FRS testified that the leads might be worth somewhere between a 1/2¢ and 1¢ each, giving them a value of only $1,500 on the lower end.
Presented with two completely different valuations for the leads, one for $1,500 and one for $5.5 million, the court ruled that it did not find Argon’s valuation credible and could not attribute any significant value to the leads.
Argon had hoped to use the leads’ value as collateral to keep the creditor at bay so that it could continue to spend its cash while the proceedings play out. The bankruptcy has been changed from Chapter 11 to Chapter 7.
The court has yet to rule on the motion to preclude non-closers from drinking the coffee.
If You Don’t Make Loans, You’re Not a Lender (And definitely not a ‘direct lender’)
January 19, 2017
Small business owners in multiple states are arguing that the contracts they engaged in were loans despite the agreements specifying otherwise. In one case with multiple defendants that was filed two weeks ago in federal court, the plaintiff attached emails from the ISOs and funders they allegedly communicated with as evidence, several of which purportedly used the words “loans” or “lender.” That on its own might not be so bad except that the plaintiff entered into contracts for the purchase of future sales, in which case the words would not make sense.
While that matter and others will be litigated and decided on the merits, this should be a wake-up call for any ISO or funder that thinks the use of proper terminology is best left for lawyers and fine print in contracts. A court ordered recharacterization of a contract could have very negative consequences (if you want to know what kind, speak with an industry attorney).
Imagine working for a small ISO and one day being subpoenaed to do a deposition and potentially facing liability because of something you said on the phone or in an email. The easiest way to avoid this is to use the proper terminology at all times. If the product you sell or underwrite is a standard merchant cash advance (purchase of future sales), then it will never make sense to say loan, lender or any words related such as repay in any communication regardless of whether or not it’s with a customer or internally. Calling yourself a “direct lender” for example, is especially illogical.
If you’re at all confused, seek out your company’s manager or compliance officer for additional training. Another helpful resource is Merchant Cash Advance Basics, A certification course offered by CounselorLibrary and deBanked to help explain the differences between loans and MCAs. Given the challenges taking place in courts around the country, it’s never been more important to be knowledgeable on the products you offer.
MCA Company Files Suit Against Debt Settlement Company
January 16, 2017Plaintiffs Pearl Gamma Funding, LLC and Pearl Beta Funding, LLC (Pearl) aren’t happy with what a debt settlement firm is allegedly telling their customers, according to a complaint filed in the New York County Supreme Court in November.
“Creditors Relief LLC researches customers who have entered into Merchant Agreements with Pearl, solicits them throughout the country, and advises them to breach their contracts with Pearl,” plaintiffs allege. They also cite an example in which an employee of defendant allegedly told a customer “that Pearl was engaging in illegal activity and its Merchant Agreements were unenforceable.”
Pearl’s causes of action against the defendant include tortious interference with contract, defamation and permanent injunction.
Creditors Relief, based in Englewood Cliffs, NJ, denied the allegations in their response but has asked the court to declare Pearl’s contracts with its customers unenforceable nonetheless.
Due to the nature of pending litigation, neither party was asked to comment.
Brief: The CFPB’s Unconstitutionality
December 28, 2016The Director of the consumer agency wields so much power that his authority actually violates Article II of the United States Constitution, according to the United States Court of Appeals for the District of Columbia Circuit which presided over PHH Corp v. CFPB. “In short, when measured in terms of unilateral power, the Director of the CFPB is the single most powerful official in the entire U.S. Government, other than the President,” the Court wrote. “Indeed, within his jurisdiction, the Director of the CFPB can be considered even more powerful than the President.”
Article II of the Constitution grants the President alone the authority to take care that the laws be faithfully executed. That means that Congress can’t even legally legislate another single individual to possess that amount of power even if they wanted to. But rather than order the dismantling of the CFPB, the Court suggested two remedies, either the director be overseen by the President of the United States or the single-directorship model be reconfigured to become a multi-member commission, a workaround that other executive agencies operate under.
Even though the agency is tasked to protect consumers, the Court recognized the potential for corruption when overseen by a single unaccountable person. “The CFPB’s concentration of enormous executive power in a single, unaccountable, unchecked Director not only departs from settled historical practice, but also poses a far greater risk of arbitrary decision-making and abuse of power, and a far greater threat to individual liberty, than does a multi-member independent agency,” the Court asserted.
Meanwhile, the CFPB has cast the decision aside as nonsense and has refused to comply, even going as far as to directly rebut it in another case shortly thereafter. In CFPB v. Intercept Corporation, the CFPB argued that the D.C. Circuit’s decision was “wrongly decided” and “not likely to withstand further review.” They’ve also asked the D.C. Circuit to rehear the case in part because they believe the decision “purports to override Congress’s explicit determination to create ‘an independent bureau’ to exercise regulatory and law enforcement authority in a particular segment of the economy.” The Court can simply deny to rehear the case.
One wild card to consider in this debate is that President-Elect Trump has pledged to repeal the Dodd-Frank Act, the law that created the CFPB to begin with. At the very least, Trump may feel it necessary to flex the power granted to him under Article II and subvert the directorship of the agency.
Online Loan Middleman Just As Culpable As the Lenders, Federal Court Rules
November 21, 2016A CFPB lawsuit against a payday loan lead generator survived dismissal last week, despite the US Court in the Central District of California acknowledging the company’s role as a “middle man” in the lending process. T3Leads and several people connected to the company are alleged to have deceived consumers, in part such that “they allowed consumers to be exposed to lenders that could cause them substantial harm.”
The court ruled that T3Leads was a service provider as contemplated by the Consumer Financial Protection Act and is therefore bound to the laws therein. The case will now proceed to discovery.
Notably, the court also agreed with the recent opinion of the D.C. Circuit in finding the CFPB’s structure unconstitutional. Nonetheless they did not believe the remedy was to toss this case or prevent the CFPB from carrying out its operations. Instead, they ruled that the CFPB’s director must report to the President of the United States to come into compliance with Article II of the US Constitution. The CFPB has refused to comply and is already appealing the D.C. Circuit’s decision.
The CFPB’s quest for power however, may come at a cost. That’s because President-elect Trump has pledged to repeal and replace the Dodd-Frank Act, the law through which the CFPB’s power is vested.
Despite the Consumer Financial Protection Act’s exemption on vendors that simply provide advertising space, a decision Google made earlier this year to ban all payday lenders could have something to do with their fear of being labeled a middle man and covered service provider.
CFPB Rebuts its Unconstitutionality
October 21, 2016
The CFPB does not agree with the D.C. Circuit’s ruling that its leadership structure is unconstitutional, according to a reply filed in a separate case in the District of North Dakota. Believing itself constitutionally exempt from oversight by the President of the United States and any checks on its power whatsoever, the CFPB argued that the D.C. Circuit “based its decision on (a) the lack of sufficient historical precedent for the Bureau’s structure, and (b) a policy judgment that multi-member commissions are superior to single agency heads.”
It also suggested that it will be appealing the decision to the U.S. Supreme Court.
Remarkably, the D.C. Circuit Court’s ruling did not even call for the CFPB to be dismantled or have its funding reassigned to Congress, but instead ordered that it fall into line with the structure of other executive agencies where a reasonable system of checks and balances be implemented at the top. As originally created, CFPB Director Cordray was granted unilateral power that neither his agency colleagues or the President of the United States could check. Now, the CFPB appears unwilling to cede such authority.
“The CFPB’s concentration of enormous executive power in a single, unaccountable, unchecked Director not only departs from settled historical practice, but also poses a far greater risk of arbitrary decision-making and abuse of power, and a far greater threat to individual liberty, than does a multi-member independent agency,” the D.C. Circuit Court asserted.
Despite that, in CFPB v. Intercept Corporation, et al., the CFPB argued that “decision was wrongly decided and is not likely to withstand further review.”
