Dropping Anchor in the (Safe) Harbor: Colorado “True Lender” Litigation Settles

Ending years of litigation, the Colorado Attorney General and the Administrator of the Colorado Uniform Consumer Credit Code (“Administrator”) announced a settlement with marketplace lenders Avant of Colorado, LLC and Marlette Funding, LLC (together, the “Non-Bank Partners”), and their bank partners WebBank and Cross River Bank (together, the “Banks”). Under the terms of the settlement, the marketplace lending programs will be permissible under Colorado law, provided that the programs satisfy certain safe harbor conditions laid out in the settlement and the Non-Bank Partners obtain or maintain a Colorado license to make supervised loans.

Background

In January 2017, on behalf of the Administrator, the Colorado Attorney General filed actions against the Non-Bank Partners, alleging that these non-banks were making usurious loans to Colorado residents because the interest rates on the loans exceeded the allowable rates under Colorado law. The Administrator claimed that the Non-Bank Partners, rather than the Banks, were the true lenders because the Non-Bank Partners held the predominate economic interest in the loans. The loans therefore should be subject to Colorado’s usury cap applicable to the Non-Bank Partners, which were lenders licensed under Colorado law.

The Administrator contended in the alternative that even assuming the Banks were the true lenders, the Non-Bank Partners and securitization trusts that had acquired the loans could not collect interest at the rate specified when the loan was made and instead were bound by Colorado usury caps. The Administrator relied on the Second Circuit’s decision in Madden v. Midland Funding, LLC rejecting the valid-when-made doctrine.

These cases were litigated against the backdrop of regulatory rulemaking on both the “valid-when-made” and “true lender” doctrines:

Valid When Made. Since the filing of these cases, both the OCC and the FDIC finalized rules reaffirming the “valid-when-made” doctrine, under which loans assigned or otherwise transferred by a bank or savings association could retain the interest permissible prior to the transfer after the transfer is made. A few weeks before the FDIC issued its final rule, the court presiding over the Administrator’s cases issued an order following the Second Circuit’s Madden ruling and refusing to apply the valid-when-made doctrine to the Non-Bank Partners and related securitized trust assignees of the loans originated by the Banks.[1]

True Lender. The OCC also has proposed a rule that would establish a bright-line test for determining when a national bank or a federal savings association is the true lender of a loan. Specifically, if the bank is named in the loan agreement or funds the loan, the bank is the true lender. The Banks are state-chartered banks not national banks, however, and the settlement does not mention the proposed OCC true lender rule.

Instead, the settlement focuses on the true lender issue. By confirming the circumstances under which the Administrator will view the Banks as the true lender and specifying the types of assignments that qualify for safe harbor, the Administrator avoided the need to address the valid-when-made issue and the FDIC’s final rule on the issue.

Colorado Safe Harbor for the Banks and Non-Banks

In the face of this regulatory uncertainty and after prolonged litigation, the parties announced a settlement of all claims. The settlement provides a safe harbor for the marketplace lending programs at issue in the suits, as well as certain of the Banks’ other marketplace lending programs. If these marketplace lending programs meet certain criteria related to oversight, disclosure, funding, licensing, consumer terms, and structure, the programs will be deemed in compliance with Colorado’s usury caps.

Oversight Criteria

• The loans must be subject to the oversight of the Bank’s prudential regulators.
• Each Bank and its respective Non-Bank Partner must provide applicable regulators with access to examine, review, and audit the Non-Bank Partner.

Disclosure and Funding Criteria

• The Bank must be identified as the lender of the loan in the loan agreement.
• The Bank must fund the loans from its own account.
• Website content, pre-origination consumer disclosures, and marketing materials must reflect the fact that the Bank is the lender.

Licensing Criteria

• The Non-Bank Partners must obtain and maintain a license to make supervised loans.
• The Non-Bank Partners must, in connection with the initial licensing application, and before participation in any new programs, inform the Administrator and describe the proposed products and how the products comply with the settlement agreement’s safe harbor.
• The Non-Bank Partners must file annual licensed lender reports.

Consumer Terms Criteria

• Consistent with the Colorado usury limitations, the APR on loans made in Colorado cannot exceed 36%.
• The loan agreements must provide that Colorado laws applies, except where otherwise preempted or authorized by federal law.

Structural Criteria

• The program must comply with one of four possible structural options: (1) Uncommitted Forward Flow Option; (2) Maximum Committed Forward Flow Option; (3) Maximum Overall Transfer Option; or (4) Alternative Structure Option—each carrying prescriptive terms and limitations.
• Under the Uncommitted Forward Flow Option, for example, the Non-Bank Partners may not enter into a committed obligation in advance to purchase loans from the Banks.
• The Maximum Committed Forward Flow Option and the Maximum Overall Transfer Option both place percentage restrictions on the transfer of economic interest (e.g., whole loans, participation interests, economic risk of loss, or securities) in the loans.
• The Alternative Structure Option permits alternative structures with the approval of the Administrator in writing.

Additional Settlement Terms

The Banks and Non-Bank Partners, collectively, will pay a civil money penalty of $1,050,000, and contribute $500,000 to a Colorado-state financial literacy program. The Banks agreed to modify their marketplace lending programs to comply with the settlement agreement safe harbor, and ensure compliance with the safe harbor for a five-year period. This obligation is subject to a shorter compliance period if there is a change in law, such as a final FDIC rule that adopts a true lender test that is different from the safe harbor established under the settlement. The FDIC’s final valid-when-made rule does not qualify as a change in law under this provision.  This is consistent with the focus of the settlement on true lender arrangements, not the valid-when-made doctrine.

Takeaways

Only the Banks and Non-Bank Partners are bound by the terms of the settlement, but the settlement terms provide a possible framework for other banks and non-banks to use in structuring their own marketplace lending programs. By its terms, though, the settlement concerns only closed-end loans offered by the Banks in conjunction with the Non-Bank Partners or other fintechs partnering with the Banks that involve origination of loans through an online platform. It is unclear how the Colorado Administrator would view marketplace lending programs involving other types of loans or origination methods. It also is unclear whether banking regulators or AGs in other states would agree with or adopt the program structure approved by the Colorado Administrator in the settlement.

The settlement should be viewed in the context of increasing tension between the states and the federal government over the valid-when-made doctrine and true lender issues. AGs in California, New York, and other states have filed suits against the OCC and the FDIC to enjoin enforcement of the final rules affirming the valid-when-made rule. In these suits, the AGs blur the distinction between the two issues, arguing the valid-when-made rule allows non-banks to evade state consumer protection laws through illegal rent-a-charter schemes.

These AGs had objected strenuously to those rules when proposed, and we expect they will do the same in commenting on the OCC’s true lender proposal. Since the OCC has not yet issued a final rule and the FDIC has not yet proposed a true lender rule, we may see state officials focusing more on true lender issues in the near term.

[1] Fulford v. Marlette Funding, LLC, No. 17CV30376, 2020 WL 3979929 (Colo. Dist. Ct. June 9, 2020). More recently, a federal court in Colorado followed and relied on the OCC’s valid-when-made rule in affirming a bankruptcy court’s ruling that an interest rate on a loan that was valid when made remains valid after the loan is assigned to a non-bank. The district court reversed and remanded the ruling, though, directing the bankruptcy court to consider whether the state-chartered bank or the non-bank was the true lender on the loan at issue. Rent-Rite Superkegs West Ltd. v. World Business Lenders, LLC, No. 1:19-cv-01552-RBJ (D. Colo. Aug. 12, 2020).