Who's the Lender? Two "True Lender" Cases with Implications for Marketplace Platforms

The US District Court for the Central District of California (the Central District) has recently rendered two decisions with "true lender" implications of potential significance to the marketplace lending industry, but with markedly contrasting results. First, on August 31, 2016, US District Judge John F. Walter of the Central District granted a motion by the Consumer Financial Protection Bureau (CFPB) for partial summary judgment in Consumer Financial Protection Bureau v. CashCall, Inc., et al.,¹ relying upon, inter alia, a recent West Virginia decision, CashCall, Inc. v. Morrissey,² and its "predominant economic interest" test to conclude that CashCall, Inc. (CashCall) and not the federally-recognized tribe that originated the loans at issue in the case, was the "true lender" for purposes of applying federal choice of law rules. Then, on September 20, 2016, in Beechum v. Navient Solutions, Inc.,³ US District Judge Jesus G. Bernal, also of the Central District, dismissed a putative class action alleging California state usury violations in relation to certain student loans originated by a national bank. The court declined to recharacterize the Student Loan Marketing Association (Sallie Mae) or its successors⁴ as the "true lender" for purposes of the exclusion afforded to banks under the California usury laws. The plaintiffs in the Navient Solutions case filed a notice of appeal to the Ninth Circuit on October 20, 2016. The CashCall and Navient Solutions cases are discussed in further detail below.

CashCall

The Central District's decision in Consumer Financial Protection Bureau v. CashCall, Inc., et al. is potentially of significant importance to participants in the marketplace lending sector for two reasons: first, following the "predominant economic interest" test applied in a recent West Virginia case,⁵ the Central District looks to the economic substance of a third-party lending arrangement, rather than its form, in identifying the "true lender" for purposes of state usury limits and licensing requirements. Second, in upholding the CFPB's position that the act of servicing and collecting loans which violate a fundamental state policy can, in and of itself, constitute a deceptive practice under the Consumer Financial Protection Act of 2010 (CFPA),⁶ the Central District, in effect, appears to acknowledge the power of the CFPB to enforce usury limits and other substantive state consumer lending laws at a federal level. The level of the penalties and other remedies the CFPB may impose for such violations, in comparison with those typically imposed by the various states, remains unclear, however.

Background

CashCall, a California-based consumer lender and servicer, entered into certain agreements with Western Sky Financial, LLC (Western Sky), an online lender offering high interest rate, small dollar consumer loan products. Under the agreements, each loan made by Western Sky on its website would be purchased by a subsidiary of CashCall three days after it was funded and prior to the borrower's making any payments on the loan. Following the purchase, all economic risks and benefits passed to CashCall. Western Sky was licensed to do business by, and wholly owned by a member of, the Cheyenne River Sioux Tribe (the Tribe), and its offices were located on the Tribe's reservation in South Dakota. As a "federally recognized tribe," the Tribe is afforded constitutional sovereignty by the Indian Commerce Clause,⁷ and the Western Sky loan agreements specified that they were governed exclusively by the laws of the Tribe and not by the laws of the US or any state. The CFPB sued CashCall in the Central District, alleging that CashCall had engaged in unfair, deceptive and abusive acts and practices (UDAAP) under the CFPA by servicing and collecting loans that the CFPB alleged were void or uncollectible under the state usury or licensing laws of 16 US states. The Central District granted the CFPB's motion for partial summary judgment on this issue, and also agreed with the contention of the CFPB that CashCall's president (who is also its founder and sole owner) was personally liable under the CFPA for these violations.

The court's decision rests upon several legal conclusions: first, that choice‑of‑law principles applicable under federal common law required the application of the law of the state in which the relevant borrower resided; second, that CashCall, and not the Tribe, was the "true lender" under the relevant loans, and, therefore, should be regarded as the real party to the relevant loan agreements; third, that the relevant loans were void or uncollectible under the laws of most of the relevant states; and, fourth, that CashCall's conduct violated the CFPA by misleading the borrowers about the status of the loans into which they entered. These conclusions are discussed in further detail below.

Choice of Law and True Lender Analysis

In the first instance, the Central District needed to determine the validity of the choice of the Tribe's law to govern the loan agreements. The court first states that "[b]ecause [its] jurisdiction is premised on federal question jurisdiction, federal common law supplies the choice-of-law rules," essentially represented by §§ 187 and 188 of the Restatement (Second) of Conflict of Laws (the Restatement). Applying those sections, a court should not recognize the laws of the jurisdiction chosen to govern a contract if (1) the chosen jurisdiction has no substantial relationship to the parties or the transaction and there is no other reasonable basis for the parties' choice (the substantial relationship test) or (2) the law of the chosen jurisdiction would be contrary to a fundamental policy of a jurisdiction with a materially greater interest than the chosen jurisdiction and that other jurisdiction's law would otherwise apply (the fundamental policy test).⁸.

The Central District implicitly reasoned that application of the substantial relationship test would require it to determine the identity of the parties, and in so doing, the identity of the "true" or "de facto" lender.⁹ In conducting that analysis, the court cites CashCall, Inc. v. Morrissey for the proposition that courts "generally consider the totality of the circumstances and apply a 'predominant economic interest test' which examines which party or entity has the predominant economic interest in the transaction." In applying this test to CashCall's arrangement with Western Sky, the court considers a number of factors, including that: (1) CashCall continuously funded a reserve account with an ongoing balance sufficient to fund two days of loans made by Western Sky; (2) CashCall purchased all of Western Sky's loans; (3) CashCall paid a 5.145 percent premium for each loan and guaranteed Western Sky a minimum payment of $100,000 per month and a monthly administrative fee of $10,000; (4) although Western Sky held the loans for a three day holding period, CashCall purchased the loans prior to any payments being made by the borrower; and (5) CashCall agreed to fully indemnify Western Sky for all costs arising from civil, criminal or administrative claims or actions. Based on these facts, the court concluded that the "entire monetary burden and risk of the loan was placed on CashCall" such that CashCall "had the predominant economic interest in the loans and was the 'true lender' and real party in interest."

Having established CashCall's status as the true lender, the court went on to conclude that (i) the governing law provision did not meet the substantial relationship test because the Tribe did not have any substantial relationship with the true lender,¹⁰ the borrowers or the transactions and (ii) application of the Tribe's laws would also not meet the fundamental policy test because, in the court's view, the 16 states had a materially greater interest in application of their state usury laws. Based on that analysis, the court found that the laws of the 16 states where the borrowers were located¹¹ applied to the loans entered into by the borrowers resident there. However, the court did not consider the specific remedies for usury in any state.

Impact on "True Lender" Case Law

Although CashCall addressed tribal sovereignty and related questions, the "true lender" analysis adopted by the court would appear to apply equally to a preemption defense raised in relation to a third-party lending arrangement involving a national or state-chartered bank, and, in fact, largely relies upon prior cases decided in that context. Unfortunately, however, the basis upon which both CashCall and the earlier cases were decided leaves market participants with little guidance as to the specific terms and structural features that would be necessary to assure that a marketplace platform's partner bank, and not the platform itself, would be regarded as the "true lender."¹² While the court is clear in emphasizing the sharing of economic risks over other features of the arrangement, stating that the "most determinative factor is whether Western Sky placed its own money at risk at any time during the transactions, or rather the entire monetary burden and risk of the loan program was borne by CashCall," the economic arrangements (as the court describes them) did not require a careful articulation of the degree of economic risk that would need to have been borne by Western Sky in order to change the outcome. Moreover, the court considers a variety of other factors as part of its holistic determination, with no indication made as to respective weights of these factors.

The court's decision may further bolster the Morrissey court's use of a "predominant economic interest" test in determining which entity functions as the true lender, but, in addition to its very broad formulation (discussed above), the decision is based on a number of circumstances that may not always be present:

• CashCall assumed all of the economic risks and rewards, took over the account and servicing relationship and assumed all legal liability. In other instances, the fact pattern may not be as simple, and, therefore, it may be difficult to determine how to apply the "predominant economic interest" in a more nuanced scenario.
• The case involved the choice of tribal law and the use of a tribal entity. Conceivably, courts might exercise greater deference in circumstances involving loans originated by federal and state banks that benefit from federal preemption of state interest rates under the National Bank Act and the Federal Deposit Insurance Act.
• After concluding there was no binding precedent, the court cited Ubaldi v. SLM Corp.,¹³ (a case in which a national bank was alleged to be a lender in name only), Eastern v. American West Financial,¹⁴ (a case involving the treatment of de facto lenders under the law of the State of Washington), Morrissey (a West Virginia decision which remains controversial) and Spitzer v. Cty Bank of Rehoboth (a case which was not decided on the facts) as precedent, and on appeal it is possible that defendants will raise the fact that other courts have used other methods for determining the true lender (including merely looking to the lender of record or a three pronged non-ministerial acts test).¹⁵

The CFPA's Relationship to State Law

Under the CFPA, it is unlawful for any "covered person" (i.e., a person engaged in offering or providing consumer financial services) to engage in any UDAAP. The CFPB alleged that CashCall and its affiliates were covered persons (lenders) or servicers with regard to loans that were void or uncollectible because they violated the 16 states' usury and licensure laws and thereby committed UDAAP violations.¹⁶ The court agreed that such conduct amounted to a deceptive practice under UDAAP on the grounds that (i) CashCall had created the net impression that the loans were enforceable, (ii) borrowers were obligated to repay them and (iii) the complexity of the Western Sky loan program "made it impossible for reasonable consumers to know that [tribal] law did not govern their agreements and thus that their loans were void and/or not payable under the laws of their home states."¹⁷

This holding is significant if upheld on appeal because it treats as an abusive practice the failure to disclose to borrowers that the obligations they are undertaking may be partially or completely unenforceable under laws other than those chosen by the lender and the other parties operating the lending platform. Note in this connection that this part of the court's holding might arguably apply even if Western Sky were the true lender and CashCall were just the servicer if the individual states' usury laws were found to apply for other reasons, such as the fundamental policy test or the failure of the lender to have the licenses necessary to make loans bearing a particular interest rate.

The CFPB’s views of its enforcement authority in this regard may be opposed by banking regulators (who might view the CFPB as usurping their enforcement authority). While the Dodd-Frank Act took the primary responsibility for enforcing consumer laws from the federal banking regulators as to insured depository institutions (IDIs) with total assets over $10 billion, the federal banking regulators retain such authority over smaller IDIs—which may include the partner banks for the major marketplace lending platforms. The CFPB does, however, retain the exclusive enforcement authority over the platforms themselves, although it is unclear how the federal banking regulators (such as the FDIC and others who are supportive of federal preemption of usury limits and the assignability of loans) would react to a claim by the CFPB that paralleled the claims against CashCall but related to a bank lender that was operating in a manner that the federal regulators believed was safe and sound.

The court must still render a decision on the extent of penalties and remedies. Thereafter, CashCall may file an appeal with the Ninth Circuit. The CFPB is, in general, entitled to "any appropriate legal or equitable relief with respect to a violation of a federal consumer financial law," including rescission of contracts, refund of payments, disgorgement, restitution, damages, injunctive relief and the authority to impose civil penalties ranging from $5,000 to $1,000,000 (for knowing violations) per day. Even if the court does not specifically enforce state usury laws, the remedies it can grant could approximate the results of such enforcement. While such remedies may only be granted in extreme cases, the heightened regulatory risk may reduce the viability of the unsecured consumer loan market. The CFPB has indicated in pretrial proceedings that it will only seek restitution for (or disgorgement of) interest and origination fees, and will not pursue penalties or other remedies.¹⁸

Navient Solutions

In Beechum v. Navient Solutions, Inc., the Central District dismissed a putative class action against, inter alios, Navient Solutions, Inc. (Navient) and a Sallie Mae loan securitization trust alleging that certain student loans originated through Sallie Mae by its national bank partner, the Stillwater National Bank and Trust Company (Stillwater), were usurious under California state law. As the plaintiffs alleged only state-law violations, the case involved no federal question, and was brought in federal court on the basis of diversity of citizenship.

At issue were certain private student loans that were marketed, underwritten and serviced by Navient, on behalf of Stillwater, and then subsequently sold by Stillwater to Navient, under an arrangement entered into by the parties in 2002. Under the arrangement, Navient agreed to market, underwrite and service student loans satisfying certain eligibility criteria as Stillwater's exclusive agent. Stillwater was generally entitled (and, at the option of Navient, obligated) to sell to Navient at least 80 percent of the eligible loans originated under the arrangement, at a purchase price equal to the outstanding principal amount (adjusted for accrued interest and Stillwater's related insurance costs), within a specified period after the loans were funded. Navient, in reality, purchased 100 percent of such loans within 90 days following their origination. Navient disbursed the loan proceeds, on behalf of Stillwater, using funds in a Stillwater account over which it is been granted rights under a power of attorney.

The plaintiffs alleged that the 13 percent per annum interest rate of the loans¹⁹ violated California's usury laws, which limit consumer loan rates to 10 percent per annum. Loans made by national banks, however, are expressly excluded from this limitation under California law, and Navient relied upon this exclusion in its defense,²⁰ noting that the loans were originated on behalf of Stillwater, a national bank. Citing the decision of the US District Court for the Northern District of California (the Northern District) in Ubaldi v. SLM Corp.,²¹ and urging the court to adopt a substance‑over‑form approach, the plaintiffs argued that Navient, and not Stillwater, was the "true lender" under the relevant loans—and, therefore, the national bank exclusion did not apply.

In rejecting this argument, Judge Bernal stated that, under California law, courts may consider the intention of the parties, or the substance of a transaction, in assessing whether the transaction itself is a disguised loan intended to evade the usury laws courts, but "must look only to the face of a transaction when assessing whether it falls under a statutory exemption from the usury prohibition,"²² citing two California appeals court decisions, WRI Opportunity Loans II LLC²³ and Jones v. Wells Fargo Bank.²⁴ The court also noted that this conclusion is consistent with the public policy considerations underlying the bank exclusion, which was designed to promote the assignability of loans by national banks. Accordingly, Judge Bernal concluded that Ubaldi, which addressed federal national bank preemption, was "irrelevant to whether Plaintiffs state a claim under the [California] usury prohibition."²⁵

Comparison

The CashCall decision is not referred to anywhere in Judge Bernal's opinion, nor is there any indication that it was brought to the court's attention or taken into account in its decision.²⁶ On their face, the facts before the Central District in CashCall and Navient Solutions were, in fact, quite different. CashCall involved a tribal arrangement between private companies and consumer loans with annual percentage rates (APRs) exceeding, in some instances, 300 percent,²⁷ while Navient Solutions considered student loans with APRs of approximately 13 percent which were originated on behalf of a bank by a successor to Sallie Mae, a government-sponsored entity.

Nevertheless, the arrangement between Navient and Stillwater included some of the same features that Judge Walter had taken into account, just three weeks earlier, in holding that CashCall, and not Western Sky, was the "true lender,"²⁸ and either court might have interpreted the relevant authority in a manner that would have allowed them to reach the opposite conclusion. The two judges might well have been influenced, to some extent, by the very different facts before them—including the nature of the parties, the interest rates charged, and, potentially, in the case of Navient Solutions, concern regarding the potential market disruption that would likely have resulted from an adverse holding—and may have had differing inclinations as to the appropriateness of a judicially-created "true lender" doctrine.

Ultimately, however, the two decisions considered the "true lender" question in different contexts—CashCall, in applying federal choice-of-law rules to a federal question (and in what Judge Walter determined to be the absence of binding authority);²⁹ Navient Solutions, in interpreting California's usury laws (a matter of state, not federal, law). When they are compared with one another, the ruling of the Central District in Navient Solutions is much narrower in its scope, as it considers the "true lender" question only in the context of the bank exclusion from the California usury laws. CashCall, on the other hand, adds to a line of cases that have adopted the "predominant economic interest" test and similar theories in a variety of contexts, and also provides precedent for empowering the CFPB to enforce substantive state-law violations.