On August 31, 2016, the Consumer Financial Protection Bureau (CFPB) obtained summary judgment against a California-based online payday lender, its individual owner, its subsidiary, and a servicer of its loans, which allegedly used a “rent-a-tribe” scheme to avoid state usury and licensing laws in violation of the Consumer Financial Protection Act.
According to the CFPB’s federal lawsuit, the company entered into a lending agreement with a tribal entity owned by a member of a Native American Reservation. Under the terms of the agreement, the tribal entity originated consumer installment loans (typically, payday loans) and then immediately sold the loans to an entity controlled by the company. The loans ranged from $850 to $10,000 and included large upfront fees, annual percentage rates that in some cases were higher than 340%, and extended repayment terms. The company claimed it was not subject to various states’ usury and licensing laws because the tribal entity originated the loans, and Native American tribes and tribal entities are exempt from those laws under federal tribal sovereign immunity protections.
The CFPB alleged the company was the “true lender” on the loans because the company and its affiliates allegedly funded all the loans given that the tribal entity sold all the loans back to the company within approximately three days of origination; indemnified the tribal entity for any liability related to the loans; underwrote the loans; and provided customer service, collection and marketing services. The CFPB alleged the company used the tribal entity as a front to avoid state usury restrictions and licensing requirements.
On August 31, 2016, the District Court for the Central District of California granted partial summary judgment to the CFPB, finding the company liable on all counts. The Court made the following rulings regarding the “rent-a-tribe” scheme:
- The usury laws of the sixteen states where the borrowers resided applied, despite the choice of law provision in the loan contracts stating the agreement was subject to the “exclusive laws and jurisdiction of the Cheyenne River Sioux Tribe, Cheyenne River Indian Reservation.” The Court determined that because the company was the “true lender” of the loans, the choice of law provision in the contracts was unenforceable.
- The loans were void or uncollectable under the usury and state licensing laws of most of the sixteen states.
- The company and its affiliated entities violated the Consumer Financial Protection Act by servicing and collecting on void or uncollectable loans, because such practices are inherently deceptive under the Act.
The most significant ruling was that the company was the “true” or “de facto” lender on the loans. Without that finding, the Court could not have determined that the choice of law provision in the loan contracts was unenforceable. Typically, courts will apply the parties’ contractual choice of law provision, unless the chosen state has no “substantial relationship” to the transaction, there is no other reasonable basis for the parties’ choice, or the choice is contrary to another’s state’s fundamental public policy and such state has a “materially greater interest” in the transaction.
To determine whether the Cheyenne River Sioux Tribe had a “substantial relationship” to the transaction, the Court stated it must first identify the parties to the transaction. Although the tribal entity was identified as the lender on the loan contracts, the Court determined that it must “consider the substance and not the form” of the transaction and therefore the name on the loan contract may not be the “true lender” in the transaction. The Court employed the “predominant economic interest test” to identify the true lender in the transaction, which it borrowed from other cases in which the same company attempted “rent-a-bank” schemes to avoid state usury laws.
The “most determinative factor” under the predominant economic interest test is identifying which party placed its own money at risk during the transactions. The Court concluded the company placed its own money at risk because it funded all the loans, purchased each loan the tribal entity originated within three days of origination, and indemnified the tribal entity. Thus, the Court determined the company was the “true” or “de facto” lender in the transactions and the tribal entity and the Cheyenne River Sioux Tribe did not have a substantial relationship to the transaction. Because the choice of law provision was unenforceable, the Court concluded the laws of the borrowers’ states had the most substantial relationship to the transaction, and applied their usury laws and licensing requirements.
This ruling has important implications for “bank partnership” model participants, including online marketplace lenders and other Fintech companies, which face potential “true lender” liability.
The Court also rejected defendants’ other arguments that the CFPB is not authorized to set federal interest rate caps or convert a violation of state usury and licensing law into a violation of federal law; that the CFPB is seeking penalties without fair notice in violation of due process; and that the CFPB itself is unconstitutional.
The summary judgment ruling establishes liability only, and the company may pursue appellate review of the California district court’s decision. Damages are to be determined in a subsequent proceeding. Enforcement Watch covered similar enforcement actions against the company by state attorney generals, which are available here, here, here, and here. And Mike Whalen, co-leader of Goodwin’s Fintech Practice, has covered “true lender” issues as part of Goodwin’s Fintech Flash series.