Consumer Finance Insights
January 19, 2017

Stage Set for Ninth Circuit to Weigh in on “True Lender” Test

On January 3, 2017, the Central District of California issued an order in CFPB v. CashCall, Inc., No. 2:15-cv-07522 (C.D. Cal.) allowing the defendants to request an interlocutory appeal of its August 31, 2016, decision granting partial summary judgment in favor of the Consumer Financial Protection Bureau (CFPB).  The court’s decision to certify the interlocutory appeal potentially sets the stage for the Ninth Circuit to weigh in on the “true lender” issue for the first time; if the Ninth Circuit grants review in the case, it would be the first time a circuit court has considered the issue since the Second Circuit’s 2015 decision in Madden v. Midland Funding, LLC, No. 14-2131 (2d Cir. May 22, 2015).

“True lender” issues arise where a bank that is exempt from state regulation—e.g., due to national bank preemption or where the bank is a tribal lender exempt from state regulation by treaty—transfers its interest in a loan to a non-bank entity that would otherwise be subject to state financial regulation.  In such cases, some courts will look beyond the loan documents to determine who the “true lender” is and consider whether the non-bank entity should be permitted to take advantage of the originating bank’s exemption from state regulation.  Decisions like the August 31, 2016 grant of partial summary judgment in CashCall have introduced uncertainty into agreements between banks and non-banks—called “bank partnership agreements”—because non-banks can no longer be sure that they can take advantage of banks’ exempt status in every jurisdiction.

The CashCall case provides a good illustration of the issue.  The case involves a bank partnership agreement between a tribal lender, Western Sky Financial, LLC (Western Sky), and non-bank entity CashCall, Inc. (CashCall).  Through their bank partnership agreement, CashCall paid Western Sky a fee to originate hundreds of short-term payday loans in more than a dozen states, and agreed to purchase all the loans that Western Sky originated.  The CFPB filed suit against these entities, alleging that this arrangement constituted unfair, deceptive, or abusive acts or practices because the defendants had used the arrangement to service and collect on loans that violated the states’ usury and licensing laws.  The CFPB alleged that the state usury and licensing laws applied because non-bank CashCall was the “true lender” in the loan transactions, and since it is subject to the state laws where the loans were made, the loans for which it was the “true lender” should also be subject to those state laws.  The district court agreed, and applied a “predominant interest” test to determine that CashCall was the “true lender.”  Under that test, the court considered which party (the originating bank vs. the non-bank purchaser of the loans) had the “predominant economic interest” in the revenues generated by the loan.  The court found that CashCall had the predominant economic interest because Western Sky risked nothing (it sold all the loans it originated to CashCall, and therefore bore no risk of default) and had no interest in the revenues generated by any of the loans (CashCall, as purchaser of the loans, was entitled to receive all of the revenue generated by the loans).  Accordingly, the court granted partial summary judgment in favor of the CFPB.

Notably, CashCall follows closely on the heels of another Central District of California decision which considered the “true lender” issue in a different context, and which reached a different conclusion.  In Beechum v. Navient Solutions, Inc., No. 2:15-cv-08239 (C.D. Cal. Sept. 20, 2016), a national bank originated and securitized a series of student loans, and transferred ownership of the loans to a non-bank trustee entity created during the securitization process.  The plaintiff filed a class action alleging that the non-bank trustee should be subject to the California usury law because it was the “true lender” in the transaction, and was not exempt from state law.  The court disagreed, finding that the loans in Beechum were exempt from California’s usury law because the California usury statute itself contained a clear exemption for loans originated by national banks.  The court found it unnecessary to apply a “true lender” analysis given the explicit statutory exemption written into California’s usury statute.  Beechum materially differs from CashCall because the Beechum court avoided a “true lender” analysis due to the express exemption in the California statute.  But Beechum is nevertheless noteworthy because it is also on appeal before the Ninth Circuit, and that court may disagree with the district court’s analysis.

Another approach to resolving this issue was articulated by the Second Circuit in Madden v. Midland Funding, a case in which the court reached the same result as the court did in CashCall using a different rationale.  In Madden, a debt collector entered into an agreement to purchase a defaulted loan—for which the interest rate exceeded New York’s usury law—from a national bank.  The Second Circuit ruled that the debt collector could not take advantage of the bank’s national bank preemption for two reasons:  (1) the debt collector itself was not a national bank; and (2) declining to apply national bank preemption to the debt collector would not “significantly interfere” with the national bank’s ability to exercise its powers under the National Bank Act.

If the Ninth Circuit accepts the CashCall appeal and adopts the “predominant interest” test set forth by the district court, it could introduce further uncertainty about the effect of bank partnership agreements because CashCall involves a tribal lender and not a national bank.  Therefore, if the appellate court reviews the CashCall case, it may try to limit its holding as much as possible in order to leave open the possibility for other approaches in future cases that do involve loans originated by national banks.  It also may avoid the question of whether the “predominant interest” test applies instead of, or in addition to, the Madden “significant interference” test.  LenderLaw Watch will monitor the “true lender” issue as well as the CashCall and Beechum appeals, and bring you updates as they arise.

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