Madden 2016: U.S. Supreme Court Calls for the Views of the Solicitor General in Case with Significant Implications for the Consumer Debt Market

On March 21, 2016, the U.S. Supreme Court announced that it has called for the views of the Solicitor General in connection with the certiorari petition in Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015), a decision restricting non-bank loan purchasers from benefitting from the National Bank Act's (the "NBA") state usury law preemption. The Court's invitation for a submission by the Solicitor General keeps alive the possibility for further review of the controversial Madden decision.

Background

In 2008, the issuer of Ms. Madden's credit card, a national bank located in Delaware, charged off and sold her defaulted debt to a non-bank purchaser. Madden, 786 F.3d at 248. Madden, a New York resident, later filed a putative class action lawsuit alleging that application by the non-bank and an affiliated servicer of a 27 percent annual interest rate, while permissible under Delaware law, violated New York's usury law. Id. The defendants argued that they, the assignees of a national bank located in Delaware, were permitted by the NBA to charge the maximum interest rate permitted under Delaware law. Id. at 250.

The NBA permits national banks to "charge on any loan . . . interest at the rate allowed by the laws of the State, Territory, or District where the bank is located." 12 U.S.C. § 85.[1] The U.S. Supreme Court has held that the NBA preempts state-law usury claims against national banks. See Marquette Nat'l Bank of Minneapolis v. First of Omaha Service Corp., 439 U.S. 299, 314-18 (1978). Accordingly, it is well established that a national bank located in Delaware can lawfully charge interest rates permissible in Delaware, regardless of usury limitations in the borrower's home state. See id.

Second Circuit's Reasoning

The district court granted summary judgment for the defendants on the grounds that the NBA preempted Madden's usury claim. Madden, 786 F.3d at 249. The Second Circuit reversed, holding that, although NBA preemption "may extend to entities beyond a national bank itself," the defendants could not benefit from the NBA's preemptive effect. Id. at 249, 251-52.

In applying the "significant interference" preemption analysis, the Second Circuit determined that precluding a non-bank debt purchaser from charging an interest rate available to the assignor national bank would not "significantly interfere with [the] national bank's ability to exercise its power under the NBA." Id. at 251. The panel emphasized the absence of any ongoing relationship between the national bank and the transferred debt in this instance, and concluded that a reduction in the price at which banks may be able to sell some consumer debt in the secondary market did not constitute "significant interference." Id. at 250-52. In this regard, the court also expressed concern about creating an "end-run" around state usury laws. Id. at 251-52.[2] According to the Second Circuit, in other cases involving transactions where NBA preemption was extended to non-bank entities, the national bank had maintained a relationship to the debt post-transfer and remained the "real party in interest." Id. at 252-53. In some instances, the third party acted on the bank's behalf, or the borrower's challenge was directed to actions taken by the bank before the debt transferred. Id. In Madden, the court concluded, the defendants acted solely on their own behalf and not for the bank, which had no post-transfer relationship to the debt. Id. at 251.

The Second Circuit nonetheless remanded the case for determination of whether a Delaware choice-of-law provision in Ms. Madden's cardholder agreement with the national bank card issuer would permit the defendants to charge interest as permitted under Delaware law. Id. at 253-54.

Implications for Secondary Market

The Madden decision, and the analogous state court decisions from Maryland and West Virginia involving FDIC-insured state-chartered banks, may inhibit banks' ability to transfer consumer debt off their books through securitization or to dispose of nonperforming loans through sale to non-bank entities. Marketplace lenders, for example, that have partnered with banks may need to adjust these arrangements. At least one large online lending platform has already modified its arrangement with its bank partner in an effort to create an ongoing connection between the loan and the bank potentially distinct from the debt transfer at issue in Madden. Now, the bank will maintain a relationship with each borrower through a "Borrower Account," pursuant to which the borrower can apply for additional loans. Additionally, the platform will pay its bank partner a "loan trailing fee" as the underlying loan is repaid. The platform, however, remains the sole owner of the loans.

It remains to be determined what type of arrangement would be sufficient to overcome the rule articulated in Madden, because the Second Circuit did not delineate the requisite interest the bank must maintain with the transferred debt. The court acknowledged that a national bank's subsidiaries "may benefit from NBA preemption"[3] and distinguished an Eighth Circuit decision[4] allowing a national bank, before selling the loan, to charge a borrower a fee that the bank paid to a non-bank third party acting as its agent. Madden, 786 F.3d at 250, 253. If Madden requires that the non-bank must effectively act for the bank as its agent, the determinative question would focus on whether the arrangement between the bank and the non-bank demonstrate that the latter is acting on behalf of the former, notwithstanding that the non-bank is the sole owner of the debt. A nexus between loan repayment and trailing fees due to the bank may bolster the argument that the platform or other purchaser is acting on behalf of the bank for NBA preemption purposes.

Even if the Supreme Court ultimately declines to grant certiorari, the Second Circuit's decision leaves open the possibility that the Delaware choice-of-law provision in Ms. Madden's cardholder agreement with the bank that issued her credit card may permit the defendants to continue to apply the interest rate permitted under Delaware law. The parties have filed motions in the district court addressing this subject. If a choice of law provision permits a non-bank to charge interest in accordance with the chosen state's law, non-banks may have an alternative mechanism for availing themselves of interest rates permitted in the originating bank's home state.

In addition, the Second Circuit's decision did not reference the longstanding common law "valid-when-made" principle that a loan cannot become usurious by virtue of subsequent transfer. See Nichols v. Fearson, 32 U.S. 103, 109 (1833). In Nichols, the Supreme Court stated it is a "cardinal rule[ ] in the doctrine of usury . . . that a contract, which, in its inception, is unaffected by usury, can never be invalidated by any subsequent transaction." Id. To the extent Madden remains intact, non-banks may increasingly seek to advance the "valid-when-made" principle as an alternate basis for applying the original terms of acquired loans.

There is no filing deadline applicable to the Supreme Court's request for submission of the views of the Solicitor General. It is possible that the Solicitor General could submit a brief in time for the Court to determine whether to grant certiorari before the summer recess begins at the end of June. A later filing may be more likely, in which case the Court will determine whether to hear the appeal when it returns in October.

Lawyer Contacts

For further information, please contact your principal Firm representative or one of the lawyers listed below. General email messages may be sent using our "Contact Us" form, which can be found at www.jonesday.com/contactus/.

Traci L. Lovitt
Boston
+1.617.449.6900
tlovitt@jonesday.com  

Matthew A. Martel
Boston
+1.617.449.6923
mmartel@jonesday.com  

Joseph B. Sconyers
Boston
+1.617.449.6901
jsconyers@jonesday.com

Anthony M. Masero, an associate in the Boston Office, assisted in the preparation of this Alert.

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[1] A similar provision of the Federal Deposit Insurance Act applies to FDIC-insured state-chartered banks. 12 U.S.C. § 1831d. 
[2] This concern has been cited by state courts that recently invalidated debt made through similar arrangements between non-bank loan purchasers and FDIC-insured state-chartered banks. See, e.g., CashCall, Inc. v. Morrisey, No. 12-1274, 2014 WL 2404300 (W. Va. 2014), cert. denied, 135 S. Ct. 2050 (2015); Maryland Comm'r of Fin. Regulation v. CashCall, Inc. 124 A.3d 670 (Md. Ct. Spec. App. 2015) cert. granted, 128 A.3d 51 (Md. 2015). 
[3] The court applied and cited case law predating the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which potentially limits the availability of NBA preemption to national banks and excludes their subsidiaries and affiliates. 12 U.S.C. § 25b(e) (". . . a State consumer financial law shall apply to a subsidiary or affiliate of a national bank . . . to the same extent that the State consumer financial law applies to any person, corporation, or other entity subject to such State law."). 
[4] Phipps v. FDIC, 417 F.3d 1006 (8th Cir. 2005).