Delivering a significant win for the financial services industry, a California federal judge upheld "valid when made" rules promulgated by the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) in California v. OCC, No. 4:20-cv-05200 (N.D. Cal. Feb. 8, 2022) and California v. FDIC, No. 4:20-cv-05860 (N.D. Cal. Feb. 8, 2022). Those rules sought to undo the Second Circuit's 2015 decision in Madden v. Midland Funding—a decision that class-action plaintiffs' lawyers and state regulators have invoked to bring lawsuits challenging so-called "rent-a-bank" schemes between banks and third parties. The rules were finalized in June and July 2020, and established a bright-line rule that the interest rate charged on a bank-made loan may still be charged after the loan is sold to a third party.
The attorneys general of several states—including California, New York, and Illinois—had challenged the rules in separate lawsuits filed against the OCC and the FDIC, contending that the rules facilitate so-called "rent-a-bank" schemes. In the states' view, the rules violate the Administrative Procedure Act because, among other reasons, the agencies (i) lacked authority to promulgate the rules, and (ii) arbitrarily and capriciously created a regulatory vacuum that will permit nonbanks to ignore state interest-rate caps.
The court rejected the states' challenge, concluding that the banking regulators reasonably interpreted statutory gaps in federal banking laws—namely, section 85 of the National Bank Act and section 27 of the Federal Deposit Insurance Act. The rules do not regulate the conduct of nonbanks because the rules simply authorize a bank to sell a loan "without altering the interest rate upon which [the bank] and the borrower initially agreed." Nor did the court find the rules arbitrary and capricious. Far from creating a regulatory vacuum, the OCC reaffirmed its "strong" opposition to predatory lending—such as rent-a-bank schemes—reflected in existing guidance, which sets standards for bank partnerships with third parties. In addition, the FDIC "did not alter any state's ability to opt out of [section 27's and thus the rule's] coverage" with regard to loans made in that state.
Underlying the rulings is a recognition that banks rely on the ability to sell loans as a source of liquidity, especially in times of economic stress. As the court observed, "it was not unreasonable" for banking regulators "to determine greater certainty regarding the transfer of interest rates, and a large market for transfers, would serve to promote the safety and soundness of the national banking system." The uncertainty in the absence of the valid-when-made rules is not hypothetical. The rules responded to the Second Circuit's Madden decision, which declined to recognize the valid-when-made principle in the context of a national bank's sale of charged-off debt to a third-party debt collector. Several comments and amicus briefs filed in support of the rules cited empirical studies finding that Madden impaired the secondary market for loans, resulting in a considerable decline in credit availability for borrowers within the Second Circuit. The court reasoned that these and other comments "provide[] support for the" banking regulators' view "that Madden did create uncertainty for those within the industry."
The rulings are also significant for what they do not address: the "true lender" doctrine. This doctrine addresses which entity in a bank partnership with third parties is the supposed "true lender" for purposes of assessing the validity of the loan's interest rate. In October 2020, the OCC finalized a so-called true lender rule, which established a bright-line standard to determine which entity makes a loan. But Congress repealed that rule under the Congressional Review Act. The repeal marked a return to a world of uncertainty caused by fact-intensive, multifactor tests that some courts have applied to determine which entity makes a loan. Indeed, new lawsuits attacking bank partnerships have started to abandon Madden arguments in favor of arguments that the nonbank partner is the "true lender." See, e.g., Class Action Complaint, Carpenter v. Opportunity Fin., LLC, No. 2:21-cv-09875 (C.D. Cal. Dec. 22, 2021). Now that the valid-when-made rules have been upheld, this trend is likely to continue.
Immediately after the rulings, Acting Comptroller of the Currency Michael Hsu issued a press release. Hsu cautioned that the "legal certainty" provided by the rulings "should be used to the benefit of consumers and not abused." The states have until April 11 to appeal the rulings to the Ninth Circuit. For now—and because no appeal has yet been filed—the rulings should promote that very goal: by affirming the valid-when-made rules, the rulings will help bring greater stability to the market for bank loans, providing a more reliable source of capital that enables banks to make even more loans to underserved consumers.
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