Legal Briefs
Court Finds Usurious Late Fees Unenforceable
September 19, 2015
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)
Multiple State Regulators Challenging Lender’s Use of Choice of Law Clause in Usury Enforcement Actions
September 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)
3rd Circuit Affirms FTC’s Role as Cybersecurity Cop
September 10, 2015
Under the Federal Trade Commission Act, the FTC has broad powers to regulate unfair and deceptive business practices. The FTC has interpreted these powers to include the regulation of cybersecurity measures used by businesses to protect customer data. If the FTC believes that a company’s cybersecurity measures are unreasonably inadequate, it may bring a suit against the company for what it deems an ‘unfair’ act.
This is exactly what the Commission decided to do in its recent suit against Wyndham Worldwide Corporation. On three different occasions, Wyndham’s computer systems were hacked and consumers’ personal data was accessed and stolen. In its complaint, the FTC alleged that the security breaches were a result of Wyndham’s failure to use adequate measures to safeguard its customers’ data. The FTC argued that Wyndham’s security measures were so lax that it constituted an ‘unfair’ act under federal law. Wyndham moved to dismiss the complaint and argued that the FTC lacked the authority to regulate cybersecurity under the unfairness prong of the FTC Act.
The trial court denied Wyndham’s motion and the Third Circuit upheld the decision. In its opinion, the Third Circuit noted that the FTC Act purposely does not list specific unfair acts. Rather, the Act was intended to be flexible and capable of evolving along with changing business practices. Therefore, the Circuit Court held that the FTC had authority to regulate cybersecurity.
The decision is noteworthy for alternative small business funders and brokers that electronically receive and store volumes of personal customer data. Companies must be aware that the FTC expects them to maintain a certain standard of cybersecurity and those that fail to meet that standard may be subject to enforcement actions. It is also clear that the FTC is making cybersecurity a top priority as just yesterday it held the first of a series of conferences on data security strategies.
Companies in the small business finance space would be wise to compare the FTC’s recommendations with their current cybersecurity procedures.
FTC v. Wyndham Worldwide Corp., 2015 U.S. App. LEXIS 14839 (3d Cir. N.J. Aug. 24, 2015)
Regulator Disregards Choice of Law Provision in Usury Enforcement Action
September 1, 2015
Last Thursday, the Attorney General of North Carolina was granted an injunction against Western Sky Financial and CashCall prohibiting them from offering any loans to North Carolina consumers or collecting on any outstanding accounts in that state. The Attorney General argued that the payday loans offered by the defendants violated North Carolina’s usury laws.
The defendants countered that the loan agreements at issue included choice of law provisions that made the law of the Cheyenne River Sioux Tribe the governing law. The defendants argued that the rates charged were permissible under tribal law.
The Superior Court rejected the defendants’ arguments and granted the Attorney General’s request for the injunction. The court reasoned that the Attorney General “was not a party to the Loan Agreements, but instead [wa]s acting as an enforcement arm of the State of North Carolina.” Because the Attorney General was not a party to the agreements, the court found that the Attorney General was not bound by the agreements’ choice of law. Therefore it could enforce North Carolina’s usury laws against the defendants.
In support of its ruling, the court cited BankWest, Inc. v. Oxendine. In that case, the Georgia Court of Appeals held that “[t]he parties to a private contract who admittedly make loans to Georgia residents cannot, by virtue of a choice of law provision, exempt themselves from investigation for potential violations of Georgia’s usury laws.” 462 Mass. 164, 172 (2012).
These cases are concerning for lenders that engage in interstate lending activities because they undermine the use of choice of law provisions as a method of usury law compliance. Choice of law provisions serve dual purposes. By selecting the governing law beforehand, a lender can be more confident that the terms of its loan agreement will be enforceable against a debtor. Additionally, a choice of law provision narrows the number of states that could potentially have an interest in the transaction. This limits the number of laws the lender must comply with.
These decisions, however, cast doubt on a lender’s ability to rely on a choice of law clause when faced with a regulatory enforcement action. This could result in the paradoxical situation where a court permits a lender to enforce a choice of law clause to collect interest on a contract but at the same time allows a state regulator to bring a usury action against the lender based on the exact same contract.
What Does the Federal Reserve Think About When It Thinks About Alternative Small Business Financing?
August 27, 2015
The Federal Reserve Bank of Cleveland recently published results of a focus group it conducted on alternative small business financing. As part of the paper, the Fed included a brief discussion of some of the questions raised by the study. The considerations discussed offered an interesting glimpse of some the legal issues the Fed is thinking about in relation to alternative small business finance.
First, the Fed considered the increasing trend of bank referral partnerships and wondered if such referral arrangements raise disparate impact concerns under the Equal Credit Opportunity Act. It asked:
Do issues of disparate treatment arise if banks refer certain customers to their alternative lending partners, but offer traditional loan products to others?
The Fed’s question seems to suggest that a bank’s referral of some customers to alternative lenders over others could potentially be used against the bank in a disparate impact claim. The Fed’s comment is especially noteworthy given the recent Supreme Court decision in Texas Department of Housing and Community Affairs v. The Inclusive Communities Project, Inc. That decision approved the use of the disparate impact theory under the Fair Housing Act. Many observers had hoped the Court would find that such claims could not be brought under the FHA and thereby limit their use under other federal statutes, such as ECOA.
The Fed was also interested in the effect the use of automated underwriting systems is having on small business lending. It asked:
Does the use of automated underwriting raise or address fair lending concerns?
Unfortunately, the Fed did not specify in what ways it believes fair lending laws may be implicated by the use of automated systems. These concerns could include larger societal issues, such as the effect automated systems are having on credit availability. Or they may involve practical considerations, such as how lenders are meeting their disclosure requirements under ECOA given the increasing number of applications reviewed by automated processes.
While these questions are quite preliminary, they offer interesting insight about how regulators are thinking about the industry and the issues they’re focusing on.
Debtor Permitted to Pursue Injunction Against Creditor Even After Creditor Ceases Collection Efforts
August 26, 2015
Debt collection is tricky business. While a creditor would love to be able to recover on their outstanding accounts, they have no desire to incur additional losses. So its understandable that when a creditor encounters a potentially litigious debtor the creditor may, in certain circumstances, decide to cease attempts to collect on the debt rather than risk incurring additional costs in the form of attorney fees. A recent case out of a Louisiana federal court, however, shows that simply ceasing collection efforts may not be enough to avoid litigation.
The case involved allegedly usurious late fees a condominium association charged its member on association dues. Two association members filed a class action lawsuit arguing that the interest rates associated with the fees exceeded Louisiana’s usury cap. The members requested that the court issue an injunction against the association prohibiting it from charging or seeking to collect the allegedly usurious fees.
The association responded by submitting affidavits to the court stating that it was no longer charging its members the fees at issue and that it had ceased collection efforts on all outstanding fees. It argued that because no fees were being assessed or collected, injunctive relief was inappropriate.
The court rejected the association’s argument and permitted the members to pursue their request for the injunction. The court reasoned that because the association’s governing documents had not been revised and still permitted the assessment of the allegedly usurious fees, there still existed a possibility that the association could decide to resume charging and collecting the fees. Therefore, the members were entitled to seek protective relief.
The court’s decision shows that simply ceasing collection efforts on disputed debt may not be sufficient to prevent later litigation costs. Instead, a creditor that believes that it is likely to face a usury challenge may want to consider taking steps to affirmatively disclaim the potentially usurious interest charges or even the entire interest amount altogether. By disavowing its rights to such payments, the creditor may be able to preempt the debtor’s ability to obtain injunctive relief from hypothetical collection efforts.
Case cite: Reyes v. Julia Place Condos., 2015 U.S. Dist. LEXIS 110310 (E.D. La. Aug. 20, 2015)
New York Choice-of-Law Statute Helps Creditor Overcome Usury Defense
August 20, 2015
An alternative litigation financing company provided a California law firm with a $6 million dollar line of credit. When the law firm failed to pay, the finance company filed suit for breach of contract. The contract provided that the parties’ agreement would be governed by New York law.
In response to the complaint, the law firm filed a motion to dismiss. It argued that if the court conducted a choice of law analysis the court would find that New York’s choice of law rules required the application of California law. The law firm argued that once the agreement was examined under California law the agreement would be found unenforceable because it violated California usury law. The finance company countered that the court was prohibited from conducting a choice of law analysis because the parties had agreed that New York law would govern their transaction and that, pursuant to New York statute, the court was required to respect the parties’ choice.
The court agreed with the finance company. It cited New York General Obligations Law § 5-1401, which provides:
The parties to any contract … arising out of a transaction covering in the aggregate not less than two hundred fifty thousand dollars … may agree that the law of this state shall govern their rights and duties in whole or in part, whether or not such contract, agreement or undertaking bears a reasonable relation to this state.
As the contract at issue involved a transaction in excess of $250,000, the court held that sec. 5-1401 required that the parties’ choice of law provision be enforced. The court noted that the statute explicitly prohibited the court from conducting a choice of law analysis even if the contract would ultimately found to be usurious under California law.
After reviewing the parties’ agreement, the court found that the transaction was not usurious under New York law and denied the law firm’s motion to dismiss.
Hamilton Capital VII, LLC v Khorrami, LLP, 2015 N.Y. Misc. LEXIS 2954 (N.Y. Sup. Ct. Aug. 17, 2015)
Participate in Alternative Finance? You Might Want to Start Watching the Supreme Court
August 19, 2015
A trio of cases before the Supreme Court could have far reaching effects on alternative small business finance. Here’s a rundown of what to watch.
1. Texas Department of Housing and Community Affairs v. The Inclusive Communities Project, Inc. (Decided June 25, 2015)
In this case, the Court was asked to decide whether a disparate impact claim—a legal theory that allows regulators to bring discrimination claims against a defendant even where no intentional discrimination is alleged—could be brought under the Fair Housing Act. Many observers hoped the Court would find that such claims could not be brought under the FHA and nearby limit their use under other federal statutes such as the Equal Credit Opportunity Act. The Court, however, found that disparate impact claims could be brought under the FHA.
How does this affect alternative lenders?
The Dodd-Frank Act gave the CFPB authority to enforce ECOA, which is one of the few fair lending laws that apply to small business lenders. Some legal observers believe that the CFPB could potentially bring disparate impact claims under ECOA against alternative funders that the Bureau believes have engaged in policies that have resulted in discrimination. The Court’s decision may embolden the agency to bring future actions.
2. Hawkins v. Community Bank of Raymore (To be argued October 5, 2015)
ECOA prohibits lenders from discriminating against applicants on the basis of race, color, religion, national origin, sex, marital status, or age. It also requires lenders to provide applicants notice of any adverse actions taken by the lender in relation to the applicants’ request for credit. The Hawkins case asks the Court to decide whether guarantors should be included in the definition of applicant.
How does this affect alternative lenders?
If the Court determines that personal guarantors are included in the definition of applicant, guarantors would be entitled to the same protections and disclosures as business applicants. Lenders would be required to provide the primary business applicant as well as each guarantor with the appropriate adverse action notices in the event of a decline. Implementing procedures to comply with this requirement could require significant investment from alternative lender.
3. Madden v. Midland Funding, LLC (Appeal expected soon)
This case has been widely followed given its potential effects on marketplace lenders that use banks to originate their loans. The Madden court held that the usury preemption provision of the National Bank Act did not apply to non-bank assignees. Midland requested that the 2nd Circuit rehear the case en banc but that request was denied last week. Midland now has 90 days from the date of the denial to petition the Supreme Court to review the 2nd Circuit’s decision.
How does this affect alternative lenders?
As it stands now, Madden is binding in the 2nd Circuit. If the Supreme Court declines to hear the case, the denial will confirm that Madden is settled law. In that event, observers will be closely watching to see what effect Madden has on litigation involving marketplace lending as well as the purchase and sale of bank originated debt in the larger secondary markets. A recent case out of California may provide some early indications.
