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States lose challenge to rules governing ‘permissible’ interest rates

States failed to persuade a judge that federal agencies had issued rules that enable predatory lending.

OAKLAND, Calif. (CN) — Siding with the government, a federal judge OK'd rules exempting payday lenders that partner with federally regulated banks from having to comply with state caps on interest rates.

California, Illinois and New York sued the Office of the Comptroller of Currency, a bureau of the U.S. Treasury Department, in July 2020 over a new rule that makes it easier for lenders to evade interest rate caps imposed by states looking to protect unsophisticated borrowers from potentially usurious loans.

The Federal Deposit Insurance Corporation came out with a similar rule that California’s attorney general also challenged in court.

The rules were intended to fix a lending conundrum created by the Second Circuit in 2015, when it held that New York’s 25% interest rate cap applied to a debt collector trying to recover a New York man’s credit card debt at 27% interest, even though the debt originally came from a national bank.

Up until 2015, it was generally understood that under Section 85 of the National Bank Act, both national and state banks are not subject to state interest rate caps and could originate loans at the interest rate permissible in the bank’s home state, regardless of where the borrower lives.

Banks can later sell that loan to a third-party nonbank, like a payday lender, which could continue to collect interest at the original rate, skirting state caps on payday loan interest rates.

California tightened its payday lending law in 2019, setting a 36% interest rate cap for payday loans. Illinois passed laws in 2005 and 2010, capping interest for loans at $15.50 per $100 and 36% for certain loans. New York has prohibited high interest loan rates for centuries, capping rates for most loans at 25%.

The OCC’s finalized its rule in 2020, overruling the Second Circuit's holding in Madden v. Midland Funding LLC by clarifying that when banks sell or transfer a loan, the interest rate allowed before that sale or transfer is still permissible, effectively extending the National Bank Act’s preemption of state rate caps to any entity.

The states were outraged, arguing the rules unlawfully allow payday lenders to sidestep state consumer protection laws. They also claimed the rule will facilitate a “rent-a-bank scheme” in which payday lenders partner with banks to take advantage of National Bank Act preemption and charge whatever interest rates they want.

In a pair of rulings Tuesday, U.S. District Judge Jeffrey White found the agencies have the authority to issue the rules, and that they did not do so arbitrarily and capriciously. He was also not persuaded that the rules preempt any specific state or consumer law.

"Plaintiffs argue that the OCC’s interpretation is not reasonable because the privilege of preemption cannot be transferred or assigned. The court is not persuaded by this argument, because the final rule does not grant a nonbank party the same most favored status a national bank holds with respect to the power to set interest rates,” White wrote. “Instead, commensurate with a national bank’s power to transfer or assign loans, the final rule states the national bank has the power to do so without altering the interest rate upon which it and the borrower initially agreed.”

Without getting into whether Madden was right or wrong, White determined that both the OCC and FDIC reasonably interpreted Section 85 of the National Bank Act since they relied on a general principle of law that "an assignee steps into the shoes of an assignor.” He also said the OCC considered the states’ concerns about predatory lending.

He concluded that both agencies are entitled to deference under Chevron U.S.A. v. Natural Res. Def. Council, Inc., which says courts should defer to agencies if their interpretation of the law is not unreasonable. 

In an email to Courthouse News, the California Attorney General’s Office said of White’s decision, “We are disappointed with today’s ruling, but remain committed to doing all we can to protect vulnerable California borrowers from predatory lenders and others who would seek to take advantage of them.”

Ashley Simonsen, a partner with Covington & Burling who filed a brief in the case on behalf of Marketplace Lending Association, praised White's ruling in an email late Tuesday.

"Judge White's rationale for siding with the OCC's interpretation of Section 85 of the NBA over the plaintiffs' interpretation is grounded in a faithful application of Chevron deference," she said. "Importantly, the decision reflects a recognition that greater certainty regarding the transfer of interest rates following the Second Circuit's Madden decision, and a larger market for transfers, will serve to promote the safety and soundness of the national banking system"

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