By Jim Bullock
Debate over the rule issued in June by the Office of the Comptroller of the Currency—that the valid interest rate on a national bank loan remains permissible after being sold to a state or local entity notwithstanding state usury law—has moved to the courtroom. Attorneys General for California, Illinois and New York filed suit against OCC in the Northern District of California to nullify the “valid when made” rule.
Under the National Bank Act and the Federal Reserve Act, national banks may charge the highest interest rates allowed in their home states even when making loans in other states. Thus, they are exempt from state and local usury laws that apply lower permissible rates. Conflicts arise when national banks sell the loans to third parties like debt collectors. That was the issue in Madden v. Midland Funding, LLC, 786 F.3d 246 (2nd Cir. 2015), where Bank of America—a national bank headquartered in Delaware—issued a credit card account with a 27% interest rate to a New York resident. Delaware had a 27% usury cap—two points higher than New York’s cap. After the borrower defaulted, a debt collector (not a national bank) bought the debt and tried to collect the unpaid balance plus 27% interest. The borrower sued, arguing that the lower New York cap applied. Reasoning that application of state usury law would not significantly interfere with a national bank’s ability to exercise its powers under the NBA, the federal Second Circuit Court of Appeals agreed—casting doubt on whether the loan, in the form of a credit card, was truly valid when made.
OCC’s “valid when made” rule, sometimes called the “Madden Fix,” is one prong of the Treasury Department’s two-pronged approach to resolve this doubt. The rule clarifies that loans issued by national banks remain exempt from the usury laws of states even after being transferred. (The other prong is OCC’s new “true lender” rule which was recently finalized—see our discussion here—which provides that the “true lender” on a loan is either the lender executing the loan documents or the institution funding the loan.)
OCC says that the objective of the new rule is to protect the sanctity of contracts, support the orderly function of markets and availability of credit, and discourage litigation against financial institutions over usury issues. According to OCC, the rule simply reaffirms the “longstanding understanding” that a national bank may assign a loan without impacting its interest term—that doing so is national bank’s “essential right” under the NBA which banks use to replenish liquidity. Hence, the rule seeks to encourage the trend of partnerships between national banks and state or local non-bank entities.
The lawsuit filed by California, Illinois, and New York AGs reasserts consumer advocates’ and some state financial regulators’ arguments that, when a loan is transferred to a non-bank third party, that third party becomes bound by the laws, including usury laws, of its home staate. The lawsuit’s legal claims largely focus on (i) OCC’s authority under the NBA (arguing that the new rule exceeds OCC’s authority under the statute) and (ii) OCC’s compliance with the Administrative Procedures Act in issuing the rule (asserting that OCC did not follow proper procedures under the APA but rather acted arbitrarily and capriciously in issuing the rule).
Both the “valid when made” rule and the “true lender” rule provided much needed certainty for the banking industry which is good for the credit markets and, in turn, good for all consumers. But while this new lawsuit winds its way through the federal court system, the uncertainty created by Madden remains. Check back for updates as this case moves forward.