The "Fintech Update and the Road Ahead" panel was moderated by partner and co-chair of the Structured Finance and Securitization department, Howard Schickler, joined by partner Jonathan Evans and Roxy Bargoz, general counsel of Avant, Inc. The discussion focused on challenges to the bank and financial technology company (fintech) partnership models in consumer lending, including the recent settlement reached among the Colorado Administrator of the Uniform Consumer Credit Code (the Colorado Administrator), Avant, Inc. (Avant), Avant's bank partner, WebBank, Marlette Funding, LLC (Marlette) and Marlette's bank partner, Cross River Bank. Here are the top five takeaways from the panel.
Basics of the Bank-Fintech Partnership Model
A fintech can lend to borrowers in two ways (1) directly; or (2) through a national bank partnership. When a fintech lends directly to borrowers, it must satisfy certain state licensing requirements and comply with the maximum interest rate rules in each state in which it lends. Under a bank-fintech partnership structure, however, a fintech is generally not required to abide by the licensing and interest rate rules of each state, relying instead on its bank partner's federal pre-emption of state laws. Under federal law, a national bank can charge interest at the maximum rate permitted in the state where such national bank is located, regardless of where the related borrower is located.
State Interest Rate and True Lender Challenges vs. Valid-When-Made
State regulators and private plaintiffs have challenged bank-fintech partnerships in two main ways: (1) alleging violations of state interest rate limits; and (2) bringing "true lender" challenges. Under the first theory, plaintiffs and regulators have challenged whether a loan's interest rate is permissible once the originating bank transfers the loan to the fintech if such loan's interest rate is above the legal limit in that state. The Valid-When-Made doctrine, however, provides that a loan that is valid at origination cannot become invalid or unenforceable according to its original terms upon a subsequent transfer. Under the second theory, "true lender" challenges assert that the fintech — not the national bank — is the "true lender" because the bank is not engaged in the lending program and does not take on the typical risks of a lender as it sells the loans to the fintech after origination.
Madden Ruling Complicates Matters
In Madden v. Midland Funding, LLC, No. 14-2131 (2d Cir. 2015), the plaintiff argued that the purchaser of loans originated by a national bank could not charge the same interest rate under New York state law as the national bank was able to otherwise charge, which constituted a major challenge to the underpinnings of the bank-fintech partnership model. Although the Second Circuit did not address the Valid-When-Made doctrine in its opinion, it reversed the district court's ruling and held that a non-bank purchaser of a loan could not inherit from the national bank its immunity from state usury caps; instead, the purchaser must adhere to the state interest rate limits. The Supreme Court denied certiorari in June of 2016 and since then, not only has the Court's decision in Madden made it much harder for national banks to sell loans to non-bank entities in the Second Circuit states of Connecticut, New York and Vermont, it has caused uncertainty for bank programs across the United States as well.
FDIC and OCC Attempt Fixes, Solicit Challenges
This year, the Office of the Comptroller of the Currency (OCC), the primary regulator of federally chartered banks and savings banks, and the Federal Deposit Insurance Corporation (FDIC), a regulator of state-chartered banks, have each attempted to address the uncertainty caused by the Madden decision. The OCC amended the relevant portion of the Code of Federal Regulations (CFR) so that "interest on a loan that is permissible [under the CFR] shall not be affected by the sale, assignment or transfer of the loan." Accordingly, the interest rate that a federally chartered bank or savings association can charge in the state where it is located, continues to be permissible following any sale, assignment or transfer, including a sale to a fintech. Similarly, the FDIC confirmed the Valid-When-Made doctrine by ruling a loan made by a state-chartered bank that is valid at origination may be enforced by any subsequent buyer of that loan, in accordance with the loan's stated terms. While neither rule overturns the Madden decision, both rules may be influential to regulators or other courts faced with similar disputes in the future. Several states have brought challenges against the OCC's and FDIC's new rules for allowing non-bank entities to charge interest rates above state limits.
Colorado Establishes a Safe Harbor, but Stormy Seas Elsewhere
Following an audit in 2016, the Colorado Administrator filed a complaint against Avant and Marlette alleging (1) under a Madden theory, even though Avant and Marlette purchased the loans in question from their respective national bank partners, holding such loans with interest rates above state usury cap was a violation of Colorado law; and (2) under a "true lender" theory, Avant and Marlette, not their national bank partners, were the "true lenders" of the loans in question, and thus neither Avant nor Marlette were able to claim federal preemption of Colorado's usury laws. Ultimately, the Colorado Administrator, Avant, Marlette and their bank partners reached a settlement finding utility in both the bank-fintech partnership model's ability to extend credit to borrowers that are often underbanked, and the state's interest in protecting consumers from potential bad actors and predatory lenders. The settlement allows for fintechs like Avant and Marlette to continue servicing loans in Colorado above the state's usury cap, so long as each company continues to meet certain criteria. While the Colorado settlement may certainly provide a framework for other states to draft similar rules, for now, no other state has adopted such a framework and regulatory uncertainty remains, despite the new rules issued by the OCC and the FDIC this year.