California Court Weighs in on “True Lender” Issue as CFPB Expands its UDAAP Enforcement Authority
In a significant decision, on August 31, the US District Court for the Central District of California held that a tribal bank originating loans for a non-bank lender was not the “true lender”—making the loans subject to state usury limits.
In December 2013, the Consumer Financial Protection Bureau (CFPB) commenced litigation against CashCall (a payday lender in a partnership with a tribal bank) and other defendants, claiming that they had violated the federal law prohibition on unfair, deceptive, or abusive acts or practices (UDAAP) for financial services providers by servicing and collecting on loans that were wholly or partially void or uncollectible under state law.
The CFPB alleged that
CashCall (a non-bank payday lender) and not the tribal bank that partnered with CashCall was the “true lender” because only CashCall had money at risk;
there was no reasonable basis for the choice of tribal law as the governing law for the loan contract and, therefore, in the absence of an effective contractual choice-of-law provision, the law of the borrower’s state governed the contracts;
because the loan contracts charged interest rates in excess of the usury limits in the sixteen states identified by the CFPB, the contracts were wholly or partially void and/or uncollectible under applicable state law in those states;
therefore, by collecting on the loan contracts and attempting to collect on the same, CashCall’s actions were deceptive and violated the federal UDAAP statute.
The court granted the CFPB’s motion for partial summary judgment on all four elements of its liability theory.
This case is the latest in a number of cases brought against CashCall that have raised “true lender” questions and have caused uncertainty for marketplace lending and other non-bank lenders that use a bank partnership model for the origination of consumer loans. However, the court’s decision is particularly significant for a number of reasons, most notably the following:
The CFPB’s argument that a state law violation can be a predicate for a federal UDAAP violation represents a significant potential expansion of the agency’s authority. As the court noted, state law violations have been used, with some limitations, as predicates for finding deceptive practices violations of the Fair Debt Collection Practices Act’s prohibitions against misrepresenting the “legal status” (that is, the collectability) of a debt, which often depends on state law, but this appears to be the first significant application of that theory to the general Dodd-Frank Act UDAAP prohibition.
In deciding the “true lender” issue, the court essentially adopts the holding in CashCall, Inc. v. Morrisey, 2014 WL 2404300 (W.Va. May 30, 2014), a West Virginia state law case, holding that the proper test for determining the “true lender” is the “predominant economic interest” of the parties. Varying slightly from Morrisey, the court finds that the “key and most determinative factor” is whether the bank “placed its own money at risk at any time during the transactions, or whether the entire money burden and risk of the loan program was borne by CashCall.” Therefore, although the court uses the term predominant economic interest, the court’s holding could be read to establish that the bank does not have to have more economic interest in the transaction than the non-bank partner. Rather, the bank would be found to be a “true lender” if the bank has any of its own funds at risk for any period of time.
The court dismisses without comment the holdings in other federal cases that looked to the contractual relationships between the parties to determine the “true lender,” such as Sawyer v. Bill Me Later, Inc., 23 F. Supp. 3d 1359 (D. Utah 2014).
Typically, “true lender” issues are raised by private litigants or state regulatory authorities tasked with enforcing state law. In this case, the CFPB, a federal agency that has no apparent authority to enforce state law, has used state law as a predicate for a federal law violation.
According to the court, CashCall relied on the advice of counsel that the tribal bank partnership did not require CashCall to obtain state lending licenses or subject the loans to state laws. However, reliance on counsel did not absolve CashCall—or its CEO and owner—from liability for the UDAAP statute and other violations.
The combination of using state law as a predicate for a UDAAP violation and rejection of the advice of counsel defense makes this decision noteworthy. The legal theory implicit in the CFPB’s approach is that, in attempting to collect a debt, a creditor makes an implied representation that that debt is enforceable or, conversely, a material omission that the debt is unenforceable. In rejecting the advice of counsel defense, the CFPB successfully took the position that the objective falsity of this implied representation or omission is “deceptive” in violation of the UDAAP statute regardless of the creditor’s subjective belief that the debt was collectible. Under that combination of theories, a creditor’s failure to “disclose” any violation of state law that the CFPB concludes is “material”—even if the creditor reasonably believes that its practices comply with state law—may give rise to a federal “deception” charge.
One can expect the CFPB to use a similar “bootstrap” approach to relying on other state law violations as a predicate to its UDAAP enforcement authority in future litigation, and reliance on the advice of counsel regarding state law compliance will not afford a consumer financial services provider a safe harbor from accusations of wrongdoing by the CFPB. Given the CFPB’s active and aggressive approach to UDAAP enforcement, consumer financial services providers would be well-advised to evaluate their state law compliance programs and scrutinize very closely bank partnership models. We also believe that other federal agencies such as the Federal Trade Commission (FTC) and Federal Communications Commission (FCC), which have longstanding authority similar to the CFPB’s UDAAP authority, could view this decision as judicial encouragement to exercise their authority in this space as well.
The decision presumably will be appealed to the US Court of Appeals for the Ninth Circuit, where CashCall’s prospects for success are unknown at this time.