Recently, two courts rendered decisions that have implications for the marketplace lending industry regarding the application of state usury and licensing laws to marketplace lenders. Concurrently, federal and state regulators announced they will be performing inquiries to determine whether more oversight is needed in the industry. This OnPoint analyzes these cases and regulatory investigations.
CashCall, Inc. and Marketplace Lending in Maryland
On October 27, 2015, the Court of Special Appeals of Maryland upheld the finding of the Maryland Commissioner of Financial Regulation (Maryland Commissioner of Financial Regulation v. CashCall, Inc.)1 that CashCall, Inc. (“CashCall”), a California based online consumer lender, engaged in the “credit services business” without a license in violation of the Maryland Credit Services Business Act (“MCSBA”). The violations were the result of CashCall assisting Maryland consumers in obtaining loans from federally insured out-of-state banks at interest rates that would otherwise be prohibited under Maryland usury law.
The decision raises the question as to whether marketplace lenders will be viewed as engaged in the “credit services business” and, therefore, subject to Maryland’s usury laws. A credit services business, under the MCSBA, may not assist a Maryland consumer in obtaining a loan at an interest rate prohibited by Maryland law, regardless of whether federal preemption would apply to a loan originated by an out-of-state bank.
The case is reminiscent of a 2014 case involving CashCall – CashCall v. Morrissey2 – in which the West Virginia Supreme Court found that CashCall payday loans violated West Virginia usury law, despite the fact that the loans were funded through an out-of-state bank. The court declined to recognize the federal preemption of state usury laws, finding that CashCall was the “true lender” and had the predominant economic interest in the loans. The 2015 Second Circuit case of Madden v. Midland Funding3 also called into question whether a non-bank assignee of a loan originated by a national bank was entitled to federal preemption of state usury laws. See Dechert OnPoint, Second Circuit Denies Request for Rehearing in Madden v. Midland Funding Case and Crunched Credit blog, Three Important Structured Finance Court Decisions of 2015. The Midland Funding case is on appeal to the U.S. Supreme Court.
In the Maryland case, CashCall marketed small loans at interest rates greater than what is permitted under Maryland usury laws. The advertisements directed Maryland consumers to its website where they could obtain a loan application. CashCall would then forward completed applications to a federally insured, out-of-state bank for approval. Upon approval, the bank would disburse the loan proceeds directly to the Maryland consumer, less an origination fee. Within three days, CashCall would purchase the loan from the issuing bank. The consumer would be responsible for paying to CashCall the entire principal of the loan plus interest and fees, including the origination fee.
The Court of Special Appeals of Maryland held that because CashCall’s sole business was to arrange loans for consumers with interest rates that otherwise would be prohibited by Maryland’s usury laws, CashCall was engaged in the “credit services business” without a license for purposes of the MCSBA. Accordingly, the Court of Special Appeals upheld the civil penalty of US$5.65 million (US$1,000 per loan made by CashCall in Maryland) imposed by the Commissioner of Financial Regulation and issued a cease and desist order.
In making its decision, the Court of Special Appeals of Maryland distinguished its facts from an earlier case decided by the Maryland Court of Appeals. The Court of Appeals in Gomez v. Jackson Hewitt, Inc.4 considered whether a tax preparer that assisted its clients in obtaining “refund anticipation loans” from a federally insured out-of-state bank at interest rates in excess of Maryland usury laws should be viewed as engaged in the “credit services business” in violation of the MCSBA. In that case, the bank made the loan to the consumer and paid fees to the tax preparer for promoting and facilitating the loans. Since there was no direct payment from the consumer to the tax preparer for services rendered, the Court of Appeals held that the tax preparer was not engaged in the credit services business without a license in violation of the MCSBA.
The Court of Special Appeals in CashCall held, however, that to require a direct payment from the consumer for services rendered would undermine the purposes of the MCSBA, which, according to the Gomez decision, was to prohibit third parties, particularly payday lenders, from partnering with non-Maryland banks to extend loans at usurious rates to Maryland consumers. As such, the Court of Special Appeals, limiting Gomez to the facts of that particular case, noted that the Court of Appeals did not intend to establish a universal “direct payment” requirement to determine whether a company was engaged in the credit services business for purposes of the MCSBA. What was important to the Court of Special Appeals was the fact that CashCall was exclusively engaged in arranging loans for consumers and was the type of entity intended to be subject to the MCSBA. On the other hand, the tax preparer in Gomez was only secondarily assisting the consumer with finding a loan and was primarily engaged in preparing the consumer’s tax return.
The reasoning of the CashCall court suggests that marketplace lenders, which are primarily engaged in facilitating loans to consumers through their internet platforms, could be viewed as “credit services businesses” subject to the MSCBA and, as a result, Maryland usury laws. While the CashCall decision may have been influenced by the fact that CashCall was engaged in payday lending, often charging rates far in excess of Maryland usury limits, the MCSBA does not distinguish between predatory payday lenders and non-predatory marketplace lenders. Accordingly, marketplace lenders wishing to do business in Maryland may need to obtain a license to engage in the “credit services business” or risk violating the MCSBA.
Marketplace Lending Industry Target of Federal and State Inquiry
In early December 2015, two gunmen opened fire inside a community center in San Bernardino, CA, killing 14 people. Shortly thereafter, it was reported that during the weeks leading up to the San Bernardino shooting, one of the alleged gunmen borrowed US$28,500 from Prosper Marketplace Inc. (“Prosper”), a marketplace lender based in San Francisco. Following these reports, California regulators began making inquiries of 14 different marketplace lending companies, which would require these companies to provide the California Department of Business Oversight with information regarding their loan volumes, the annual percentage rates they charge to borrowers and investor bases. Additionally, according to The Wall Street Journal, the federal House Financial Services Committee began investigating whether new regulation is needed with regards to the marketplace lending industry in light of the marketplace loan made to one of the alleged gunman.
These developments come on the heels of the US Treasury’s announcement last summer that it will be conducting a study of the online marketplace lending industry to determine its impact on the economy and how the financial regulatory framework should evolve to support the safe growth of the industry. Treasury solicited input from the public to inform its understanding and consideration of the issues. See Dechert OnPoint, U.S. Treasury Eyes Marketplace Lending. In response to its request, Treasury received more than 100 comment letters from marketplace lenders and other interested parties.
If the various inquiries by government authorities reveal, in their view, shortcomings in the regulatory scheme that applies to marketplace lenders, including with regard to the loan made by Prosper in the San Bernardino case, then a call for more regulation over the industry would be likely.
Beyond the federal and state inquiries, certain trustees are alleged to be temporarily not taking on business as trustees on securitizations of marketplace-originated personal loans. The banks cite both the ease with which the loan was made to the San Bernardino shooter as well as the uncertainty in the space over the ability to collect on marketplace loan-buyers’ accounts as a result of the decision in the Madden v. Midland Funding case currently on appeal to the Supreme Court.5
Pennsylvania District Court Latest to Decline to Recognize Federal Preemption of State Usury Laws in Commonwealth of Pennsylvania v. Think Finance, Inc.
In Commonwealth of Pennsylvania v. Think Finance, Inc.,6 the U.S. District Court for the Eastern District of Pennsylvania denied a motion by a group of non-bank servicing partners of a state chartered federally insured bank seeking to assert federal preemption as a basis to dismiss claims that loans originated by the bank and subsequently purchased by the non-bank partners violated Pennsylvania’s usury laws.
In Think Finance, five non-bank servicing partners (the “Think Defendants”) partnered with First Bank of Delaware (“FBD”), a state chartered federally insured bank in Delaware, to market and purchase loans made by FBD to Pennsylvania residents at rates that would otherwise be prohibited under Pennsylvania’s usury laws. The Office of the Attorney General of Pennsylvania alleged that FBD was merely a nominal lender fronting for the Think Defendants in a so-called “rent-a-bank” scheme and that the Think Defendants violated Pennsylvania usury laws by marketing, funding and collecting these loans.
The Think Defendants argued that the federal preemption rights enjoyed by FBD do not disappear when a loan is assigned or transferred from FBD. In rejecting this argument, the court noted that the Third Circuit distinguishes between claims against banks and claims against non-banks for purposes of preemption. In In re Community Bank,7 a case decided by the Third Circuit involving non-bank purchasers of mortgage loans, the court held that federal preemption did not apply when the complaint asserted no claims against a national or state chartered federally insured bank. Based on this precedent, the court in Think Finance held that the usury claims against the non-bank Think Defendants should not be dismissed on federal preemption grounds, notwithstanding that FBD retained an interest in the loans.
The Think Finance decision, like CashCall, is the latest example of a court declining to preempt state usury laws in circumstances where a non-bank is perceived to be the real party in interest in a lending transaction, notwithstanding that the loan may have been originated by a national or state bank.
Marketplace lenders are currently facing hurdles when doing business in both Maryland and Pennsylvania as a result of the courts applying state licensing and usury laws to bank issued loans that were assigned to non-banking entities. Further complicating the landscape is the increased scrutiny that the marketplace lending industry now faces from regulators after an alleged terrorist was able to take out a personal loan from a marketplace lender in California. As such, marketplace lenders should monitor the developments in these areas as they continue to consider doing business in Maryland and Pennsylvania.
1) Maryland Commissioner of Financial Regulation v. CashCall Inc. (Md. Ct. Spec. App. 2015).
2) CashCall Inc. v. Morrisey, No. 12-1274, 2013 W. Va. LEXIS 587 (W. Va. May 30, 2014).
3) Madden v. Midland Funding LLC, 786 F.3d 246 (2d Cir. 2015).
4) Gomez v. Jackson Hewitt, Inc., 427 Md. 128 (2012).
5) See Trustees Forgo Marketplace Deals, Asset-Backed Alert, January 29, 2016.
6) Commonwealth of Pennsylvania v. Think Finance, Inc., No.14-CV-7139, 2016 WL 183289 (E.D. Pa. Jan. 14, 2016).
7) In re Community Bank, 418 F.3d 277 (3d Cir. 2005).