Partnerships between financial technology companies (fintechs) and banks have revolutionized the financial services landscape. The convergence of technology and banking has resulted in financial products and services being delivered faster and better than ever. Lending partnerships are the most prevalent type of fintech-bank partnership, and they can be structured many ways. Each unique program presents tremendous opportunities. For the close relationship between a fintech and a bank to succeed, the parties must strike the right balance in allocating a program’s risks and rewards.
This article discusses eight key issues along the risk-reward continuum that commonly arise in lending partnerships. The parties can improve the negotiation process and achieve better outcomes by considering these issues early.
Issue #1: Bank’s Retention of an Economic Interest
In lending partnerships, “true lender” risk is a critical regulatory risk that banks and fintechs face. Often, a fintech will acquire a program’s loan or an interest in a program’s loan after the bank has made the loan. A regulator or plaintiff might allege that the fintech is the true lender, not the bank, and that the fintech is therefore engaged in unlicensed lending or charging impermissible interest rates or fees. One of the best defenses to these allegations is that a bank has a continuing economic interest in the loans. Accordingly, fintechs and banks should cooperate to structure their programs to ensure that the bank retains an interest, such as through retention of a horizontal slice of receivables, trailing loan performance fees, or monthly account fees. There are many other structures, too. A true lender analysis can be complicated and should be tailored to the specific program.
Issue #2: Bank’s Control of Program
A bank’s control over a program is another important factor in establishing the bank as the “true lender.” And from the bank’s perspective, control is also an understandable and important risk mitigant more generally, particularly in the face of significant changes in law, regulator action, and significant safety and soundness concerns. From the fintech’s perspective, however, there must be some reasonable checks and balances on control so that the fintech can implement the program as anticipated and the program will have staying power. For example, where a bank has sole discretion to change any aspect of a program or to decline to fund any loan to a qualified applicant, the bank may act (or decline to act) in a way that effectively amounts to a termination right or might otherwise be adverse to the interests of the fintech or the program. In preparing the program agreement, the parties should consider appropriate standards of conduct for each party’s decision-making processes (e.g., reasonableness and good faith, collaboration, and acting in the best interests of the program). Timelines and efforts standards can also be effective. A fintech should also consider insisting that a bank fund a loan where the applicant satisfies the applicable underwriting guidelines (which are controlled by the bank). These types of measures can improve the predictability and reliability of a program for both parties.
Issue #3: Exclusivity
A bank will often seek exclusivity for a fintech’s lending products (and sometimes additional products), especially if it takes risk as an early adopter of a fintech’s program. While a fintech might begin with only a narrow product line, as the fintech grows and expands into new lines, broad bank exclusivity rights can become problematic. A fintech should consider whether to limit exclusivity to products that are substantially similar to the product offered in the lending program (e.g., for a credit card program, offering exclusivity for other credit card products but not mortgage loan products). Similarly, a bank should consider what products and services will complement its existing business lines and future plans. Where parties agree on some level of exclusivity, the parties should also discuss customary carve-outs. Common carve-outs in lending partnerships include those permitting a percentage of product volume sourced by the fintech to be made by another lender, backup arrangements where loans the bank does not make (e.g., those failing to meet the bank’s underwriting guidelines or during a suspension period) are made by another lender, situations where the fintech itself acts as a lender, and others. These types of carve-outs are particularly helpful ways for a fintech to mitigate counterparty risk. A bank might suspend or terminate a program not only when a fintech is at fault but also when the bank adopts a new business strategy or enters into conservatorship or receivership, among other scenarios. These carveouts can help the fintech pivot to another established, operational lender instead of being left without any business while searching for and negotiating a new fintech-bank partnership.
Issue #4: Expenses
A bank’s template program agreement will often make the fintech responsible for all of the bank’s out-of-pocket program expenses. From the bank’s perspective, the fintech is often best positioned to manage and mitigate program expenses. These broad, open-ended requirements, however, can be burdensome and unpredictable. The parties should consider specifying those expenses for which the fintech will be responsible and including caps where appropriate (e.g., the bank’s reasonable legal fees in connection with a program change requested by the fintech, up to a specified amount).
Issue #5: Customer Relationships
It is important for the parties to recognize that in many programs, a given customer will have a relationship with both the fintech and the bank. For example, the fintech sourcing a customer establishes such a relationship, and by making a loan to the customer the bank also establishes such a relationship. Where the fintech has sourced the customer or established the initial customer relationship, the fintech may intend to grow that relationship by offering the customer additional products and services beyond those available through the bank’s lending program. These additional products and services may compete with other products and services offered by the bank. Accordingly, a fintech may wish to limit the bank’s ability to solicit additional business from customers that the fintech has sourced and introduced to the bank. Naturally, a bank may have strong views on this issue.
Issue #6: Intellectual Property and Data
Typically, a fintech will contribute its own branding, platform, technology, or other intellectual property that is valuable for the lending program. Likewise, a bank might make similar contributions. Parties expect to continue to own the intellectual property they respectively developed and contributed to the program. Ownership and use of customer data or other data generated by a program are often more heavily negotiated points because customers can have customer relationships with both the fintech and the bank (as noted above). The fact that customer data may constitute data of one party does not preclude the same data from being data of the other party. The parties should focus on the use of customer data more than on its ownership. For example, in some cases it may be that a license to use the data is sufficient.
Issue #7: Suspension, Termination, and Transition Rights
A bank’s template program agreement often has light suspension or termination triggers, making it easy for the bank to suspend or terminate a program. From the fintech’s perspective, it is important to have a bank partner that can be relied upon to advance the program, except in truly extenuating circumstances, such as significant changes in law, regulator action, and significant safety and soundness concerns. A compromise on other matters might be reached through appropriate processes and procedures, such as notice and cure periods, cooperation between the parties, or limiting suspension or termination to only the particular jurisdiction in which an issue has arisen. These processes and procedures can help the bank ensure that it may extricate itself from serious situations, while also helping the fintech mitigate the likelihood of an abrupt cessation.
In case the parties cannot avoid suspension or termination of a program, then the program agreement should cover what happens to the applicant pipeline and existing customers. Often, the most important issue for a fintech is the ability to transfer customers to a successor bank following termination. The program agreement should have well-developed transfer provisions, calling for a mutually agreeable written transition plan to include each party’s responsibilities, transfer procedures, and milestones with target dates.
Issue #8: Indemnification Rights
A bank’s template program agreement may attempt to make the fintech responsible for all of the bank’s program losses, regardless of the cause or whether the fintech is at fault (e.g., even if the bank acted negligently). Positioning the fintech as a guarantor is not helpful in the true lender analysis, because the “true lender” should retain the level of risk that is expected of a lender. Parties should strive to limit their indemnification obligations to third-party claims that result from a breach of the party’s representations, warranties, or covenants within the four corners of the program agreement.
We find that fintechs and banks streamline negotiations and achieve better outcomes when they reach consensus on these eight issues before drafting and redlining their program agreement. It is important to either memorialize these issues along with key business terms in a term sheet or more informally reach a business agreement on them before advancing to the program agreement.
Alexander J. Callen is a partner in Goodwin’s Financial Industry group. As a member of the firm’s Banking, Consumer Financial Services, and Fintech practices, he focuses on the convergence of banking and financial technology through his representation of banks, fintechs, holding companies, and investors. He advises on fintech-bank partnerships and a wide variety of innovative regulatory, transactional, and corporate governance matters. For questions, contact him at email@example.com or 202-346-4161.
Goodwin’s Fintech group strategically leverages its regulatory, transactional, and litigation and enforcement practices to provide full-service support in every vertical of fintech and financial services, including: lending, payments, alternative finance, deposits, brokerage and wealth management, digital currency and blockchain, insurance and insurtech, and transactions, including bank partnerships and deal due diligence.
Goodwin’s accomplished Banking group regularly advises on M&A, corporate finance, securities offerings and regulation, corporate governance, banking regulation, commercial lending, complex bank products and services, consumer financial services, privacy and cybersecurity, risk and compliance management, investment management. And with the breakneck pace of technology disrupting industries around the world, we partner with clients to embrace the promise and potential of innovation to make a lasting impact.
Alexander J. CallenPartner