Courts Prepare to Take On the True Lender Question

Rhemé Sloan1Rhemé Sloan is a J.D. Candidate at the University of Chicago Law School, Class of 2023. They thank Annie Kors, Matthew Makowski, Renic Sloan, and the University of Chicago Law Review Online team.

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Financial technology (“fintech”) firms and banking institutions have thoroughly cemented lending in the digital realm. Storefront lending has not tracked with the ubiquity of online lending given growing access to the internet and the scope of smartphone usage, especially in lower socioeconomic communities. While the remnants of the brick-and-mortar lending era still exist in many neighborhoods across the country—often awash in flashing LED lights and signage reminding passersby of their opportunity to “Get Cash Today!”—there has been a shift in practice. Small dollar loans servicing numerous financial service categories—including auto title loans, payday loans, and rent-to-own agreements—are advertised through sleek pop-ups and website banners that capitalize on the precision with which web advertisements can be targeted to potential customers.

While these products provide much needed access to loans for consumers, fintech companies and their bank partners have structured many of these loan products—often called rent-a-bank loans—to bypass state usury laws that place caps on the interest rates that they can charge. The linchpin in the partnership is the proposition that the nationally chartered bank partner is recognized as the “true lender” of the loan and can use federal statutory authority to set higher interest rates—sometimes well into the triple digits. After the loans have been originated, the fintech-bank partnership transforms, and the fintech company takes on the loan through a combination of purchase, securitization, or servicing, all the while maintaining the high interest rates that it could not offer but for the partnership with the national bank. Whether a nonbank transferee can reap this interest rate benefit depends on which partner qualifies as the “true lender” of the loan.

In order to establish a bright line rule on what entity within the partnership qualifies as the true lender, the Office of the Comptroller of the Currency (“OCC”) established what is known as the true lender rule (the “OCC Rule”) in 2020. The rule stated that when a federally chartered institution (a bank) “[i]s named as the lender in the loan agreement” or “[f]unds the loan,” it is the true lender of the loan. In 2021, Congress rescinded the rule through a joint resolution. The recission of the OCC Rule will place courts in the thick of complex economic analysis as they attempt to define the substantive standards of what constitutes a true lender. Normative questions regarding consumer protection from rent-a-bank partnerships will likely play a distinct role in future court outcomes. Ultimately, this Essay argues that from a pro-consumer protection standpoint, the recission of the OCC Rule is likely only a short-term win against an industry with ample resources to pursue the legal outcome most favorable to their operations in a fragmented judicial landscape.

In Part I, this Essay discusses the statutory and legal background that led to the OCC Rule and some of the political elements operating in the background. Part II discusses doctrinal approaches that shape the application of federal interest rate preemption. Part III walks through two pertinent analyses in case law that may suggest how courts will tackle a true lender inquiry moving forward. Part IV offers some high-level themes to consider in the ongoing discussion.

I.  Statutory and Legal Background

When these loan products are the subject of litigation, the factor that determines what interest rate can be charged stems from whether the associated national bank was the “true lender” of the loan. Under the Supreme Court’s interpretation of Section 85 of the National Bank Act (“NBA”) in Marquette National Bank v. First Omaha Corp. (1978), federally chartered banks are permitted to export the interest rates of the state in which they are incorporated (their “home state”). This gives national banks the option to charge borrowers the highest maximum interest rate in any state in which they operate, thereby exceeding the interest rates capped by usury laws in stricter states. For example, a nationally chartered, Utah-incorporated bank that is recognized as the true lender of a loan can set a loan’s interest rate at 160% for a consumer in Ohio, despite Ohio’s legal maximum interest rate of 8%, because Utah has no legal maximum interest rate. A similar legal structure exists for state-chartered banks under Section 27 of the Federal Deposit Insurance Act (“FDIA”), which allows state-chartered banks to charge the maximum interest rates allowed in their home states or a prescribed federal interest rate, even to borrowers in states that set lower interest rate caps. Federal savings associations have the same power under Section 4(g) of the Home Owners’ Loan Act (“HOLA”).

In January 2021, a group of state attorneys general filed a lawsuit to invalidate the OCC Rule, claiming that the rule unlawfully preempted state law thereby allowing rent-a-bank partnerships and fintech firms to bypass state usury laws. Consumer protection advocates pushed for the repeal of the OCC Rule, often citing research on the harm that high-interest loans have on communities of color. Additionally, the Conference of State Bank Supervisors (CSBS), which represents Republican and Democratic officials, urged Congress to repeal the OCC Rule because “the OCC should not erode state consumer rights and protections.”

As a part of the campaign against the OCC Rule, California, Illinois, and New York sued the OCC in California v. OCC (N.D. Cal. 2022) alleging violations of the Administrative Procedure Act (“APA”) in promulgating the rule. The ruling came after Congress rescinded the OCC Rule in July 2021 through a joint resolution, which passed in a divided Senate with three Republican senators voting in favor of repeal. In California v. OCC, the United States District Court for the Northern District of California granted summary judgement to the OCC. On the question of whether Madden v. Midland Funding, LLC (2d Cir. 2015) rendered the OCC Rule invalid, the court carved out space for non-national bank entities acting as the equivalent to a national bank based on Supreme Court precedent in Watters v. Wachovia Bank, N.A. (2007). The district court reasoned that the Supreme Court distinguished between instances where national banks did not completely divest their interests in the financial products and instances where the national bank retained no interest.

Before the OCC Rule, courts had adopted varying multi-factor tests and standards to decide the factual question of the true lender of a loan, as in CashCall, Inc. v. Morrisey (W. Va. 2014). In the wake of the repeal, courts will now have to conduct fact-based inquiries to determine whether the national banks that fund these loan products are the true lender in order to justify rates exceeding state usury laws. While this repeal effectively reinstates the pre-OCC Rule status quo for the rent-a-bank legal framework, the state of true lender law was remarkably unsettled. Unfortunately, there are only a few cases that deal directly with the issue. Some may argue that the courts can simply adopt the OCC Rule moving forward, but the politicized nature of consumer protection coupled with legal realism (i.e., Karl Llewellyn’s notion that “our government is not a government of laws, but one of laws through men”) casts doubt on the effectiveness of this move. If circuit courts of varying political predilections develop different tests regarding what substantive facts denote a true lender and, by extension, the qualification for federal interest rate preemption, we will likely see the creation of numerous standards that place consumers in the crosshairs.

II.  Federal Interest Rate Preemption and the Need for Clarity

As stated above, the Supreme Court’s interpretation of the NBA provides that the interest rate of a loan made by a national bank or a federal savings association is determined by the law of the state where the lending institution is located without regard to the state in which the borrower resides. Claims asserted against banks under the usury laws of states other than the bank’s home state are preempted by the NBA and HOLA. The fractured judicial approach to these transactions is made of three doctrinal propositions: the valid-when-made doctrine, the Madden rule, and the true lender doctrine.

Under the valid-when-made doctrine, assignment of a bank loan, even to a nonbank entity, does not destroy federal preemption: “[S]tate laws that would be preempted in a lawsuit against a bank are also preempted in a suit against the bank’s assignee.” Proponents of the valid-when-made doctrine (often the fintech-bank partnerships that rely on clear regulatory pathways) argue that the valid-when-made doctrine is firmly supported within the common law and caution that contrasting doctrines pose harm to the credit markets. These proponents also argue that the doctrine was incorporated into Section 85 of the NBA, which governs interest rate exportation for nationally chartered banks. In contrast, some commentators argue that the doctrine has tenuous connections to the common law and is a modern invention based on problematic interpretations of nineteenth century cases.

Challengers to the valid-when-made doctrine also often invoke the Second Circuit’s controversial holding in Madden v. Midland Funding, LLC (2015). A Madden challenge to the valid-when made doctrine argues that, when a bank assigns a loan to a nonbank entity, “though the loan may have been valid when made by the bank, the subsequent sale, transfer, or assignment of the loan to a third party means that the loan no longer enjoys federal preemption because the nonbank could not have made the loan on the same terms.” In Madden, the court answered whether a non-national bank entity could collect on a credit card debt sold to it in full by a national bank at the same interest rate afforded to the national bank under the NBA. The court declined to extend federal preemption to the non-national bank entity, noting that “extension of NBA preemption to third-party debt collectors . . . would create an end-run around usury laws for non-national bank entities that are not acting on behalf of a national bank.” For NBA preemption to apply to a non-national bank entity, application of state law must “significantly interfere with national bank’s ability to exercise its power under the NBA” (e.g., a state law impacting a subsidiary of a national bank).

The true lender doctrine suggests that preemption should not apply to the loan if, after conducting a fact-intensive analysis, it is determined that the bank is not the “true lender” of the loan (i.e., the loan’s terms violated state law when the loan was first made). Tracing its history back to the nineteenth century anti-evasion principles in usury law, this doctrine attempts to assess the true economic interest in a loan. Nonbank entities generally need licenses to conduct financial services activities, so partnerships with nationally chartered banks are the typical work-around that allows for federal preemption with respect to usury laws. When loans from these partnerships are subject to judicial review, the court will typically apply a totality-of-the-circumstances inquiry to determine which party is serving as the lender. The court may, for instance, consider: (1) which entity provides the analytics to approve customers, (2) which entity retains a significant economic interest in the loans after origination and assignment, (3) which entity services the loans, and (4) which entity bears the risk of loss in the event of default. Notably, no court has articulated an exclusive list of factors and corresponding weights.

III.  Trudging through Corporate Structures Led by the True Lender Doctrine

    The repeal of the OCC Rule marks a return to a world in which true lender issues will be determined on a case-by-case basis, informed by differing state laws and the facts in each particular instance. In his Article Rent-a-Bank: Bank Partnerships and the Evasion of Usury Laws, Professor Adam Levitin outlines the true lender rule’s historical roots related to anti-evasion principles in usury law, which informs courts’ penchant to consider a transaction’s substance over its form. His discussion of the disjointed regulatory and economic realities regarding disaggregated lending situations and current doctrinal arguments almost foreshadows the issues courts will have as new regulatory regimes attempt to grapple with modern business. The complexity with which corporations operate and structure their dealings will likely create extended and precarious discussions across many levels of the judiciary as it attempts to assess control and economic exposure as proxies for culpability.

The disaggregation of the lending mechanism (i.e., the splitting of lending functions into discrete functions played by separate entities) is well articulated in Meade v. Avant of Colorado, LLC (D. Colo. 2018). Avant, a lender making loans capped at 36%, partnered with WebBank, a Utah-chartered bank, to make loans in Colorado. Colorado’s state administrator sued Avant, alleging that the company’s 36% interest rate violated Colorado’s 21% usury cap. Colorado alleged that WebBank was not the true lender because it was not the entity that bore the predominant economic interest of the loans.

Although the case eventually settled, the court’s factual findings demonstrate the protracted inquiry that courts generally face when determining whether a party qualifies as a true lender. The court noted that Avant “service[d] and administere[d] the loans, [bore] all the risk on the loans in the event of default, pa[id] all the legal fees and expenses related to the lending program, retain[ed] 99% of the profits on the loans, and indemnifie[d] WebBank against all claims arising from [the bank’s] involvement in the loan program.” Avant securitized much of the receivables from its lending program, thus spreading economic exposure to the secondary market; WebBank owned the loan accounts, but allegedly received only 1% of the total profits; and Avant and its subsidiaries operationalized the lending.

A more recent example of a true lender analysis is found in the District Court for the District of Columbia’s opinion in District of Columbia v. Elevate Credit, Inc. (2021). Elevate is a Delaware corporation and nonbank entity that, according to its 2019 Form 10-K filed with the Securities and Exchange Commission, “provide[s] online credit solutions” to nonprime consumers, a group “typically defined as those with credit scores of less than 700.” Elevate uses its technology to serve more than 2.5 million customers with $8.8 billion in credit according to its 2021 Form 10-K. It primarily operates in partnership with two state-charted banks in Kentucky and Utah—two states that do not have interest rate limits.

In Elevate, the District Court for the District of Columbia addressed its subject matter jurisdiction over the case and found that the District of Columbia’s complaint adequately alleged that Elevate was the true lender in its rent-a-bank partnership. The Elevate court’s analysis relied heavily on Avant and similar case law to draw parallels between WebBank and Elevate’s administrative structures regarding loan marketing, origination, and sale. The Elevate court went further, however, by addressing loan elements outside of the interest rate provisions, including “deceptive marketing, misrepresentations, and [Elevate’s] failure to obtain a money lending license.” It also acknowledged other courts’ inquiries considering whether the nonbank entities “carried out all interactions” with loan customers or “owned and controlled the branding of the loans.” Thus, the Elevate court’s analysis and affirmative stance toward consumer protection suggests an expanded true lender inquiry compared to Avant. The district court remanded the case to the Superior Court of the District of Columbia, but the District of Columbia and Elevate Credit, Inc. settled shortly thereafter. It remains unclear whether Madden will play a defining role in future courts’ calculus.

IV.  Resurgent Themes We Will Likely See Regarding Fintech, Lending, and the Law

The repeal of the OCC Rule, while successful in its efforts to protect states’ short-term interests in maintaining usury standards, has likely compromised how the government puts guardrails on small dollar lending across the country by handing the reigns of this unwieldy industry to the judiciary. As corporations continue to structure their businesses in increasingly more complex ways, courts will be proportionally slower to administer the justice that is demanded in true lender cases. In the few instances we see courts addressing the core doctrinal question of whether interest rate exportation afforded to banks can attach to the loan products after the loans are sold, securitized, or transferred, we have seen significant progressions in the analyses (compare Avant with Elevate).

The OCC Rule would have established that lending banks must maintain prudent credit underwriting practices, follow loan documentation practices that allow the bank to, among other things, assess risk on an ongoing basis, and have appropriate internal controls and information systems to assess and manage the risks associated with the lending activities. With the advent of courts’ trudging through true lender inquiries, the political background animating the repeal of the OCC Rule may create negative incentives for fintech-bank partnerships to mitigate operational risks. In an effort to maintain business competitiveness while remaining nimble in the marketplace, corporations will likely operate with more risk across multiple levels of the business. Without a robust enforcement mechanism in a sector already disinclined toward disclosure, we will likely see increasingly less consumer friendly financial products.

Of course, in this digital age, information intermediaries abound. Consumers conducting the most rudimentary searches on credit card or small-dollar loan options online can have a marketplace-worth of material at their fingertips containing consumer reviews or information on cards with the most favorable terms. Centrists that espouse the value of freedom of contract may see this as the ideal antidote to the oscillating political undercurrent with respect to financial regulation.

The OCC acknowledged that the “uncertainty [regarding applicable laws] may discourage banks from entering into lending partnerships, which, in turn, may limit competition, restrict access to affordable credit, and chill the innovation that can result from these relationships.” In this moment of rising interest rates, downward pressure on demand for financial products may fill the gaps left in the wake of the repeal of the OCC Rule. Regulators will undoubtedly keep their ears pressed against the wall amidst the din of transactional lawyers feverishly restructuring rent-a-bank partnerships to spread the administrative and economic burden of their clients and avoid the scant legal implications we can glean from Elevate.

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Rhemé Sloan is a J.D. Candidate at the University of Chicago Law School, Class of 2023. They thank Annie Kors, Matthew Makowski, Renic Sloan, and the University of Chicago Law Review Online team.

One thought on “Courts Prepare to Take On the True Lender Question

  1. These “rent a bank” companies and the banks that finance their loans are examples of our “gotcha” capitalism that plagues poorer and financially undereducated communities. There should be a federal law limiting the “state hopping” that these companies and banks use.
    This type of usury hurts our whole social order. Of course in America, the individual’ s right to make money trumps over the welfare of society. Great enlightening article!

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