In 2005, Saliha Madden, a New York occupant, opened a Visa account with Bank of America. The account cardholder agreement had a Delaware choice-of-law clause whereby the parties involved stipulated that Delaware law would oversee the agreement. Madden defaulted on the loan and her account was later sold to debt buyer Midland Funding, LLC. Midland’s member endeavored to collect the obligated amount with a default interest rate of 27%.
In 2011, Madden sued Midland and its subsidiary accusing the company of using oppressive and out of line debt collection practices under Federal law and charging high interest under New York law (which states that rates surpassing 25% every year are criminally usurious). Midland retaliated saying that, as a national bank assignee, it was entitled to preemption of state usury laws granted to national banks by the National Bank Act (the “NBA”). The district court agreed with Midland and entered judgment in its favor. Madden appealed to the Second Circuit. The Second Circuit reversed that holding on appeal, reasoning that preemption applies only where the use of state law would undermine a national bank’s exercise of its power under the NBA. While Bank of America is a national bank, Midland or its partners are not. The US Supreme Court refused to hear the case, and on February 27, 2017, Judge Cathy Seibel of the Southern District of New York gave the borrower a key victory by holding that New York law and not Delaware law would apply to the case.
This has led to bills being introduced to untangle the uncertainty created by the court’s decision. The “Madden-Fix” bills are now a source of heated discussion. Below, we will analyze how it will affect the marketplace lending industry.
Bone of Contention: Choice of Law
In spite of the fact that the cardholder agreement chose Delaware law to oversee the legally binding relation between the parties, the District Court determined that New York law should be applied. The Court found there was no reasonable connection between the parties or the transaction with the State of Delaware. In addition, the Court noticed that New York’s usury restriction “constitutes a fundamental public policy” against exorbitant interest rates. Therefore, use of Delaware law would contradict that policy.
Impact on Alternative Lending Market
The District Court’s decision will completely take out “choice-of-law” clause from the credit agreements with New York borrowers unless the lender is a national bank. This will adversely impact alternative lenders as they extensively deal in consumer and credit cards loans, and most of their loan agreements carry interest rates in excess of 25%.
Additionally, the verdict adds another layer of vulnerability among lenders and debt purchasers who work in the Second Circuit (New York, Vermont, and Connecticut). Before Madden, it was broadly comprehended that loans that are “valid when made” are not made invalid when assigned or sold to another party. The District Court’s verdict weakens this guideline, rendering a valid- when-made loan possibly unenforceable to the degree it negates the law of the borrower’s home state.
The logic used in this case can have significant bearing and could be used beyond the sale of delinquent loans to debt collectors including, maybe, to any secondary sale of loans to non-national bank purchasers. Specifically, this verdict could unfavorably affect the MPL industry. There still might be a possibility for the originating banks to authorize the terms of a high-interest loan agreement, but the debt collection agencies might not be able to collect in the future. This could make banks downsize their primary lending (especially at higher interest rate), which will, in turn, reduce the supply of loans available for refinance by MPL. With the uncertainty hovering over the enforceability of existing loans, it has had a ripple effect on their value in the secondary market as well. Vulnerability additionally increases the risk of loss, thus making investments through companies or platforms that extensively invest in loans made to New York borrowers less appealing.
Madden “Fix” Bill
Lending, especially by MPLs, has plummeted in Second Circuit states following the Madden decision. Intense lobbying has seen Congress propose the Protecting Consumers Access to Credit Act of 2017, which is awaiting approval in both the House and Senate. This will enforce the validity of a loan after it is bought by a non-bank, basically recognizing the “valid when made” doctrine once again, and will give impetus to MPL but will also help in normalizing the lending in Second Circuit states. These bills will also go a long way in removing the bias between primary and secondary loan markets, and will also assist the securitization market and other avenues where the loans are sold to non-bank entities.
Obviously, there are apprehensions with regards to these bills. Adam Levitin, professor of law at Georgetown University, has voiced his opinion in an article in American Banker in which he widely criticized the bills saying they are overly broad and will help in facilitating predatory lending. But a consumer seeking credit will get it any which way they can and MPLs are at least regulated in comparison to illegal lending sharks and payday lenders.
Though Madden has not been applied to MPLs, the industry will be closely monitoring the ongoing proceedings. The possibility of class action is particularly worrying as it could open the Pandora box of litigations and deliberate defaults. Meanwhile, it will be a good idea for industry players to assess their lending activities to see whether they come within Madden’s reach or not, particularly in the Second Circuit states of Connecticut, New York, and Vermont.
Written by Heena Dhir.