The Second Circuit Court of Appeal has rejected Midland Funding's appeal from the Madden v Midland case. The ruling could have a huge impact on P2P lenders across America.
To start with, some useful background. In 2005 Saliha Madden opened a credit card account with Bank of America. In 2008, after not repaying her debt, BoA sold the account to Midland Funding LLC - a debt purchaser. Fast forward to 2010 and Midland contacted Madden to tell her that interest was still accruing on the account at a rate of 27% per annum. Instead of repaying the debt, Madden's reply was to file a class action lawsuit against Midland, arguing that the company had violated state and federal laws by charging interest rates in excess of New York State's usury laws.
Many states have laws that put caps on how high interest rates can go. However, the National Bank Act exempts national banks from these state restrictions. As a result, these laws did not apply when the account was with BoA. Midland argued that since the account was passed to them from BoA the interest rate still applied.
On the 22nd of May 2015, the District Court sided with Madden and declared:
“If a bank assignee is not performing a task on a national bank’s behalf, the NBA does not protect the assignee from otherwise applicable state usury laws”
Midlands then launched an appeal to the Second Circuit Court of Appeal, but that was rejected on Wednesday.
The ruling undermines the "exportation model". Under this model, the national bank originates loans that the lender has underwritten and approved. Once funded, the bank sells the loan back to the lender for the value of the principal plus a fee. In this way, the third party lender gains national coverage, and must only conform to the state laws of the state that their partner bank is based in.
This ruling is of real importance for P2P lenders. Lenders, such as Lending Club and Prosper, have – up until now – used this exportation model and partnered with a national bank. Enforcement of this ruling will mean that platforms will have to conform to the nuances of each state’s law that they issue loans in. For example, Lending Club is partnered with WebBank which is based in Utah. Since Utah has no cap on interest rates, Lending Club doesn’t have to worry about caps on its loans. If the ruling is applied to them then they would need to conform to state caps. Alternative financiers are designed to work with a cheaper and more streamlined cost base and the extra work on compliance would push up costs, not to mention that some interest rates may be above state caps.
Reported in the American Banker, in an August 4th earnings call, Renaud Laplanche - Lending Club CEO - disclosed that 12.5% of his company's loans exceed state caps. If this ruling was applied across the US, it would have a dramatic effect on Lending Club's loan volume and rates. Platforms such as Prosper - which is also partnered with WebBank - would no doubt find itself in a very similar position. Mr Laplanche does argue, however, that there is still sufficient legal room for Lending Club to operate nationally whilst regulated through Utah state law.
It is important to note, as – according to American Banker - analysts from Compass Point have, that:
"The Second Circuit decision is only binding in New York, Connecticut, and Vermont but it could have broader implications as market participants begin to question marketplace lending issuance frameworks"
Midland can still appeal to the US Supreme Court. However, Compass Point analysts have noted that only 1% of these petitions are granted. A truly ground breaking ruling for the people of New York, Connecticut and Vermont. It is possible that in the future this will spread throughout the US.