By Ryan Weeks on 28th June 2016
Yesterday saw the U.S. Supreme Court reject calls to review a Second Circuit decision on the Madden vs. Midland case, in what’s been described as a serious blow to marketplace lenders.
The Madden vs. Midland case – a long-time thorn in the side of US marketplace lenders – may come to mean that the interest rates charged by marketplace lenders could in certain instances be deemed to be in breach of state interest rate caps. Banks are exempt from these caps under the National Bank Act. Marketplace lenders in the US rely on banks, most commonly the Utah-based WebBank, to originate loans on their behalf, in what is known as the “exportation model”. These loans are then purchased for the price of the principal, plus a fee, and sold on through the marketplace. In the past, the assumption was that marketplace lenders could piggy-back on the exemptions of the issuing bank, but the Madden case throws that assumption into doubt.
The Madden vs. Midland case revolves around a credit card account belonging to one Saliha Madden, which was opened with Bank of America in 2005, and sold to Midland Funding LLC in 2008 when Madden failed to pay off the debt. In 2010, Midland contacted Madden to inform her that interest was still accruing on the account at a rate of 27% per annum. Instead of repaying the debt, Madden's response was to file a class action lawsuit against Midland.
The District Court sided with Madden in May 2015. Midland then appealed to Second Circuit Court of Appeal. That appeal was rejected. Midland then appealed the case to the U.S. Supreme Court in November 2015. We learnt yesterday – in a Law360 report – that the Court has elected not to review the Second Circuit decision. The ramifications for marketplace lenders, and indeed for a large variety of non-bank lenders, could be far-reaching.
When we interviewed him in September 2015, former Lending Club CEO Renaud Laplanche said that roughly 12.5% of the platform’s outstanding loans would exceed state interest rate caps. Lending Club in fact rejigged its relationship with WebBank in February of this year, in direct response to concerns stemming from the Madden case. The big change was that WebBank would thenceforth retain an interest in all loans, even after having sold them off to the platform. In exchange, the net fee paid to the bank by Lending Club was to be enhanced, but it would be paid in instalments, and would be terminated if borrower repayments were to stop.
Joe Cioffi, Partner at Davis & Gilbert LLP, has been following the Madden case closely. Cioffi is also chair of the Insolvency & Financial Institutions practice group. He offered a gloomy outlook on yesterday’s news for marketplace lenders: “The decision by the Supreme Court not to review the Second Circuit’s holding in Madden means we’re probably just seeing the very beginning of lawsuits against marketplace lenders, such as LendingClub. Not only are marketplace lenders at risk, but so will be the sponsors and other participants in the securitization of marketplace loans to the extent loans are held unenforceable or interest rates are reduced. Experience shows that when cash flows to investors are reduced, litigation follows.”
Lending Club is still reeling from the shock dismissal of Laplanche in early May. The stock has fallen drastically since, and fell a further 8% to $4.30 yesterday. The company’s tanking share price has led to a large number of lawsuits in and of itself. AltFi has received close to ten notifications of such action. Lending Club also received a grand jury subpoena from the U.S. Department of Justice in mid-May, and the company then advised that it “may be subject to litigation related to the events surrounding the resignation of Mr. Laplanche”. The Supreme Court’s refusal to review the Midland case is just the latest blow to the industry. Lending Club holds its Annual Meeting of Stockholders at 11am Pacific Time today. The meeting was originally slated for Tuesday June 7th, but was postponed after Lending Club's second largest shareholder sold off its entire stake in the company, according to a report from the Wall Street Journal.