Disruptive Potential of Madden v. Midland Funding Presented by Arthur J. Rotatori, Esq. McGlinchey Stafford

What is Rent-a-Charter? Non-bank enters into an arrangement with a “Bank” whereby: The non-bank markets and services the loans The “Bank” makes a loan payable to the “Bank” The “Bank” sells the loan to the non-bank The non-bank holds a portfolio with uniform loan pricing

Foundations of Rent-a-Charter The “Bank” is a federal-insured depository institution: National bank, federal savings bank, state-chartered bank, industrial loan company The Bank is located in a state with favorable lending laws  Either because it has a charter from that state or it is a federally-chartered bank relying on “most-favored lender” authority, the Bank relies on federal law to export the interest rate from its home state to other states Based on a combination of the True-Lender doctrine and the Valid-When-Made doctrine, the non-bank enforces the loan according to its original terms

Settled Law Federal statutes, regulations and regulator opinions say: A National Bank can charge interest at the rate allowed by the laws of the state where the Bank is located, relying on the rate permitted by state law for the “most-favored lender” A State-chartered bank relies on its own banking law Both National and State banks can export interest, and matters material to the interest rate, to borrowers in other states, notwithstanding the law of the borrower’s state Interest is broadly defined to include most fees as well as periodic interest

The Effect of Selling the Loan to a Third-Party If the Bank makes and holds the loan, all of the above should apply without controversy If the Bank contracts with a third-party who markets the loans, services the loans and buys the loans shortly after closing, does any of this change? If it does change, are the loans re-characterized as having been made by the third-party? True-lender analysis and the Valid-When-Made doctrine should apply here

True-Lender Doctrine The True-Lender Doctrine is found in case law and is a fact-specific determination of whether the bank was really the lender True-lender analysis looks at such facts as: Identification of the Bank as the lender in the loan documentation Loan program design and approval by the Bank Whether Bank assumes compliance responsibility for the loan program But other factors are more problematic: The Bank sells the loans to the buyer very shortly after closing, with little or no possibility of credit exposure The Bank uses funds placed on deposit by the buyer to make the loans The buyer controls all borrower interactions

Valid-When-Made Doctrine If the Bank is the true lender, is the loan re-characterized after sale? Sparse case law suggests that the interest rate remains enforceable after assignment if it was lawful at the time that the loan is made Some authority states that Section 85 may allow assignees to rely on the national bank’s authority to enforce a loan according to its terms Is the status (type of entity) of the buyer relevant to this issue? As the loan marketer As the loan originator/servicer As the loan holder Each of these roles raises licensing and compliance issues

The Current State of Rent-a-Charter The problematic issues discussed above remain unresolved Rent-a-Charter programs had become less numerous, although they are common for marketplace lenders, including private education loan lenders Large banks appear to have little or no appetite for rent-a-charter programs No regulatory action with respect to these programs Contradictory case law

Madden v. Midland Funding, LLC 786 F.3d 246, 2015 WL 2435657 (2nd Cir. May 22, 2015) Petition for Rehearing en banc denied No. 14-2131 (2nd Cir. August 12, 2015)

Midland Funding Facts: Putative class action filed by New York resident alleging that attempted collection of charged-off credit card violated New York law due to 27% interest rate Credit card was issued by Bank of America, assigned to FIA Card Services, NA, and sold to Midland Funding post charge-off

Midland Funding Argument: Midland Funding argued NBA federal preemption allowed it to enforce the terms of the credit card account Second Circuit concluded no Barnett Bank preemption because there was no interference with the national bank’s powers There was no interference with the national bank powers because Midland wasn’t acting on the bank’s behalf

Implications of Midland Funding Holding Relevance of preemption is unclear No discussion of Valid-When-Made Doctrine or other common law assignee rights A contract right can be assigned unless the assignment materially changes the obligor’s duty, risk, likelihood of obtaining return performance or value of the contract No recognition of significance to secondary market Federal preemption does not bear on common law of assignment

What Happens Now? Cert Petition filed 11/10/2015 currently pending Supreme Court review Conflicts with Krispin v. May Dept. Stores (8th Cir.) and FDIC v. Lattimore Land Corp. (5th Cir.) Common law of contract assignment Threat to functioning secondary; securitization markets Impinges on authority of national bank to sell loans by looking to state law applicable to loan purchases If no Supreme Court review, remand to trial court to determine whether Delaware law (where the bank is located) or New York law (where the borrower resides) applies OCC; FDIC reactions?

More Happening Now Uncertainty for any purchaser of any type of loan from any lender The effect of Midland Funding varies greatly by loan type and characteristics Marketplace lenders considering obtaining lender licenses Disclosures of risks in securities filings

If Cert Petition is Denied? Some question whether Midland really overturned the Valid-When-Made doctrine – no explicit holding to that effect Some question whether Midland really changed the common law applicable to contract assignment Can Midland be viewed as merely holding that there is no direct application of the National Bank Act (and federal preemption) to non-bank third-parties? If so, this is a side issue that doesn’t change Valid-When-Made

Questions?