Madden and the Choice of Law
On February 27, 2017, Judge Seibel of the Southern District of New York issued an important ruling in the latest stage of the proceedings captioned Madden v. Midland Funding.1 The case involves usury claims against Midland Funding, which purchased defaulted debt from FIA Card Services, N.A., a national bank with its principal office in Delaware. When Midland attempted to collect on that debt, as interest continued to accrue, the debtor, Madden, sued, alleging that Midland's efforts violated the Fair Debt Collection Practices Act and New York law because Midland was attempting to collect amounts it was not owed, namely usurious interest.
In earlier stages of the case, Judge Seibel held that the National Bank Act preempted Madden's state-law usury claims, but the Second Circuit reversed that holding on appeal, and the US Supreme Court denied certiorari.
In her most recent ruling, adjudicating the questions raised regarding the law applicable in the absence of National Bank Act preemption, Judge Seibel held that New York law, and not the law of Delaware specified by the loan agreement, applies to the criminal usury issues raised by the plaintiff. However, since the applicability of the criminal usury provisions was at issue only for purposes of determining the choice of law, this holding pertains only to the plaintiff's claims under the Fair Debt Collection Practices Act and New York General Business Law § 349.2 After modifying the proposed definition of the class that the plaintiff would represent, Judge Seibel also certified a class under Federal Rule of Civil Procedure 23(b)(2) [injunctive relief] and 23(b)(3) [damages].
Applicability of New York's Usury Statutes to Defaulted Debt
In the course of reaching her holding regarding the applicability of New York's criminal usury statute, Judge Seibel also considered whether New York's usury statutes apply at all to defaulted debt. She concluded, on the basis of a substantial line of cases, that the civil usury statutes do not apply to such debt. However, on the basis of an analysis of cases that were not uniformly clear in their holdings, and acknowledging that the question was a close one that might ultimately need to be decided by the New York Court of Appeals, she concluded that New York's criminal usury statutes do apply.
Choice of Law
Although she discussed the reasonable relationship test that is part of New York's choice-of-law jurisprudence, Judge Seibel rested her decision as to the applicable law on the ground that applying Delaware law, which does not cap interest rates, would in this case violate a fundamental public policy of New York. This allowed her to avoid considering the details of any argument about the actual reasonableness of the relationship of the original creditor to Delaware, including the importance of the creditor's principal place of business and any allegation that the creditor was only nominally operating there.
Judge Seibel cited numerous cases holding New York's usury statutes to represent a fundamental public policy of the State. She also found the treatment of criminal usury as a felony to be further evidence of the importance of usury law to New York. In the course of her review of the usury statutes, she also found that the rule of validation, which calls for the choice of the law that is most permissive of the creditor's claims, is neither followed by the courts of New York nor needed in this case. As she opined, the rule of validation was intended to avoid the harsh penalties, including forfeiture, imposed by the usury statutes. But in this case, where a violation of the criminal usury statutes is only a predicate for the application of non-usury statutes, the rule of validation would serve no purpose.
In deciding to certify a plaintiff class, Judge Seibel reviewed the standards established by Federal Rule 23 regarding the definition of a class and the ability of the plaintiff to maintain the proposed class. Her decision to certify a class is essentially grounded on two fundamental conceptual moves:
- A revision of the definition of the class to include only "persons residing in New York who were sent a letter by [Midland Funding] attempting to collect interest in excess of 25% per annum regarding [consumer debt] whose cardholder agreements: (i) purport to be governed by the law of a state that, like Delaware's, provides for no usury cap; or (ii) select no law other than New York."3
- A bifurcation of the claims for damages and an injunction, since only the New York General Business Law claim permits the granting of an injunction.
Possible Next Steps and Thoughts
If it does not settle the litigation, Midland will have to continue litigating within the framework established by Judge Seibel and prepare to appeal if it loses. Its appeal would likely focus on challenging the holding that New York's criminal usury law applies to defaulted debt and, perhaps, on the reasoning behind the choice-of-law analysis. Midland would also likely revisit the preemption issue if it once again seeks certiorari in the US Supreme Court.
Judge Seibel's holding—that adjudicating criminal usury claims in New York by applying the more expansive law of another jurisdiction would violate a fundamental public policy of New York—will (if followed by other courts), significantly narrowing the ability of non-bank lenders and debt buyers to rely on a loan agreement's choice-of-law provision in states that have criminal usury statutes or other compelling indicators of a fundamental public policy. Institutions that acquire defaulted or undefaulted debt are accordingly confronted with the need to consider strategies in two different contexts.
First, to the extent that such parties continue to make or acquire loans to consumers residing in such states, they will need to ensure that their diligence regarding permissible interest rates takes into account not only the maximum rate but also the existence, or lack thereof, of special criminal provisions or other indications that a fundamental public policy is involved. They may also wish to devote additional consideration to the involvement of creditors that are clearly entitled to interest rate preemption, at least in Federal judicial circuits other than the Second Circuit.
Second, to the extent that such parties have the opportunity to support Midland or other similarly situated defendants in their lawsuits, or if they themselves get embroiled in similar litigation, they should consider developing arguments and positions that take into account the following:
- the question of whether the validity of an interest rate should be determined as of the time at which the debt is created;
- the soundness of the public policy determination regarding usury as balanced against the public policy of encouraging banks to provide credit to all consumers;
- public policy issues relating to the advantages of the free assignability of debt;
- the existence of other jurisdictions that may have an equal or greater public policy interest in having their laws enforced (an issue left open by the court's ruling); and
- the argument that the borrower's claims in this case were preempted by the National Bank Act.