Courts and regulators have carefully scrutinized Internet lending, beginning with the 2008 decision of the United States 10th Circuit Court of Appeals in Quik Payday Inc. v. Stork. The court found that Quik Payday was required to obtain a license to offer payday loans to Kansas residents despite offering the transactions under Utah law. Following the Quik Payday ruling, the Consumer Financial Protection Bureau and various state agencies took significant action regarding Internet lending, particularly with respect to loans of relatively short duration or with annual rates in relatively high percentages, such as payday loans. Often, these actions hinge on whether the Internet lender’s choice of law was appropriate or whether the parties chose a certain state law that circumvents consumer financial protections. Internet lenders in the small-dollar space operate under one of the following models: single-state choice of law, banking partnerships, and tribal partnerships. Internet lenders as well as consumers should be aware of the risks that come with each of these models.
SINGLE-STATE CHOICE OF LAW MODEL
As seen in the Quik Payday case, many online lenders choose to operate under the laws of their home state and apply them to all loan agreements through a choice clause. of the law, whether the transaction involves in-state or out-of-state transactions. consumers. In this model, the lender generally does not associate itself with an entity such as a bank or a tribe.
Instead, the lender establishes a place of business in a certain state and offers loan agreements that provide that the law of that state governs the terms of the loan, even though consumers often reside in other states.
In several actions, private plaintiffs and regulators have challenged the enforceability of clauses that choose the law of the lender’s home state as the law governing the terms of the contract.
In Swanson v. Integrity Advance, a case strikingly similar to the Quik Payday case, the Minnesota Supreme Court ruled that Minnesota payday loan laws, rather than Delaware law, applied to payday loans made by a lender online from Delaware.
The court based its decision on federal constitutional grounds. Even though the transactions were completed in Delaware, the court found that lender Integrity injected itself into Minnesota’s trade flow by establishing contact with Minnesota residents and disbursing funds to bank accounts that found there.
The Integrity case is evidence that lenders may fail to argue that online transactions do not reach the consumer’s doorstep. Instead, courts will consider a variety of factors in determining whether to apply a choice of law clause in a consumer loan agreement, including whether the lender targeted out-of-state consumers with advertising and communications. Courts also often refuse to uphold choice of law clauses on the grounds that the application of foreign law would violate public order.
Community and regional banks and other regulated financial institutions applaud this effort by regulators to ensure that regulatees and their regulators have a clear understanding of the appropriate role of guidance in supervision.
As the cases above show, internet lenders can face compelling arguments that they have injected themselves into the trade flows of other states. They will find it difficult to overcome these arguments.
BANKING PARTNERSHIP MODEL
Banking partnerships are also the subject of ongoing regulatory interest. In the banking partnership model, banks offer loans in conjunction with a non-lender acting as a marketing and servicing agent. The bank generally sets the underwriting criteria and finances the loans.
The partner entity performs marketing and service functions and, in some partnerships, purchases the right to collect loan revenue after origination.
Opponents of the partnership banking model argue that non-bank entities are the true lender and are simply using the bank’s charter to evade state interest rate limitations. These opponents have successfully challenged the validity of the banking partnership model in a few cases.
In Meade v. Avant of Colorado LLC, the administrator of the Colorado Uniform Consumer Credit Code filed a lawsuit alleging that Avant, a non-bank loan assignee subsidiary of a federally insured bank, violated limits Colorado finance charges.
Guidance may provide examples of practices that agencies generally consider to comply with safety and soundness standards or other applicable laws and regulations, including those designed to protect consumers.
The U.S. District Court for the District of Colorado found Avant to be the true lender, finding that Avant was the assignee of the loans and had “only a contractual relationship with WebBank”, and that WebBank was “only playing an ephemeral role in the granting of loans”. » before « sell immediately[ing] them, and he [was] Before who generally lead[ed] charges and activities that allegedly violate[d] State Law.”
Similarly, in Pennsylvania v. Think Finance Inc., the U.S. District Court for the Eastern District of Pennsylvania ruled that Pennsylvania law, rather than federal banking law, applied to a transaction when the Pennsylvania Attorney General sued Think Finance Inc., which had partnered with an out-of-state bank under a “rent a bank” program.
The Avant and Think Finance cases illustrate the importance of significant banking activity in a partnership banking transaction. It is important that the programs and their related documents make it very clear to consumers, regulators and the courts that they see significant bank involvement in the transaction. It should be clear that relationships are more than fleeting.
Of course, it should be clear that the bank is doing more than just providing the financing. Courts and regulators will not authorize transactions if it appears that non-bank service providers are directing the actions and decisions of the bank. A critical question is whether the bank retains more than a nominal equity interest in transactions after origination.
Another internet lending model is called the tribal model, in which an entity partners with a tribe to offer loans. The tribe is the lender, and the partner entity typically helps market and service the transactions.
Those who use this model claim that the law of the tribe applies to the transaction rather than the law of the consumer’s state of residence. Federal and state regulators and attorneys general have been particularly skeptical of this model.
For example, in 2015, North Carolina sued an online consumer lender and its assignees who offered transactions under the laws of the Cheyenne River Sioux Tribe. The state alleged that the agreements violated North Carolina usury law.7 The North Carolina Superior Court held that North Carolina law could apply because the law of State usury provides that loans to North Carolina residents are governed by North Carolina law, regardless of where the law specifies. Contract.
In 2016, the Georgia Supreme Court also rejected Western Sky Financial LLC’s argument that Georgia law did not apply to their small-value loans because the contracts were entered into on a reservation. The court ruled in favor of the Attorney General of Georgia, finding that Georgian law applied.
In November 2017, the CFPB sued Think Finance LLC for its alleged involvement in originating, managing and collecting online credit transactions. The CFPB asserted that the transactions violated state law and were void, even though they included a contractual choice of law clause intended to establish tribal law as governing law.10 As of the date of publication, the lawsuit is pending. Classes.
Of the three models described, the tribal model seems to be the most likely to be examined. Although state regulators and courts may not have the power to regulate tribal sovereign governments in many cases, this does not mean that consumer lending by tribes, often with the assistance non-tribal partners, will be deemed enforceable (or even lawful) by state authorities.
In some situations, examiners may refer to supervisory guidelines to provide examples of safe and healthy driving.
Likewise, while tribal governments may enjoy immunities, those who serve the tribe would have a much harder time winning the argument that they are also immune. Moreover, the federal authority over the tribes, in particular for the CFPB, is an omnipresent reality.
Many people are watching closely to see how the CFPB under Mick Mulvaney (and possibly agency head candidate Kathy Kraninger) will approach internet lending and the various models described above, especially tribal lending. .
If the CFPB takes a less active approach to internet lending regulation, we could see more activity among state regulators and attorneys general seeking to protect their consumers from out-of-state lenders. However, given the late 2017 action against Think Finance, it appears the CFPB is not backing down from its position against the tribal model.
Since federal and state control is unlikely to diminish, internet lenders should carefully consider the risks associated with the three models discussed above when structuring their business. The best way for them to avoid complaints from consumers and regulators is to follow federal laws as well as state-specific lending, licensing, and consumer protection requirements.