New Federal Court Decision Applies the “True Lender” Doctrine to Internet-Based Payday Lender

Regulatory risk

A recent decision of the U.S. District Court for the Eastern District of Pennsylvania has highlighted once again the regulatory risks that the so-called “true lender” doctrine can create for internet-based lenders who partner with banks to establish exemptions from applicable state consumer protection laws (including usury laws). Although the Court did not reach a final decision on the merits, it declined to accept federal preemption as grounds to dismiss an enforcement action brought by the Commonwealth of Pennsylvania against an internet-based payday lender who arranged for a state-chartered bank to fund loans at interest rates exceeding the Pennsylvania usury cap.

The case is Commonwealth of Pennsylvania v. Think Finance, Inc. (January 14, 2016).

The defendants Think Finance and affiliated companies (the “Defendants”) had for a number of years operated internet-based payday lenders that made loans to Pennsylvania residents. The interest rates on these loans far exceeded those permitted under Pennsylvania usury laws.

Internet vs physical presence

The Defendants initially made these loans directly to Pennsylvania residents and did so lawfully as the Pennsylvania Department of Banking (the “Department”) took the position that the usury laws applied only to lenders who maintained a physical presence in Pennsylvania. In 2008, the Department reversed its position and published a notice stating that internet-based lenders would also be required, going forward, to comply with the usury laws. The Defendants nevertheless continued to arrange payday loans for Pennsylvania residents under a marketing agreement with First Bank of Delaware, an FDIC-insured state chartered bank (the “Bank”), pursuant to which the Bank would originate loans to borrowers solicited through the Defendants’ websites. The exact nature of the financial arrangements made between the Defendants and the Bank is not made clear in the Court’s opinion, but it appears that the Bank did not retain any substantial interest in the loans and that the Defendants received most of the related economic benefits.

Violation of usury laws

The Attorney General of Pennsylvania brought suit against the Defendants, claiming that the Defendants had violated not only Pennsylvania’s usury laws, but by engaging in certain deceptive and/or unlawful marketing and collection practices, had also violated a number of other federal and state statutes, including the Pennsylvania Corrupt Organizations Act, the Fair Debt Collection Practices Act and the Dodd-Frank Act. The Attorney General argued in her complaint that the Defendants could not lawfully collect any interest owed on the loans in excess of the 6% usury cap and asked the Court to impose various sanctions on the Defendants, including the payment of restitution to injured borrowers, the payment of a civil penalty of $1,000 per loan ($3,000 per loan in the case of borrowers 60 years or older) and the forfeiture of all associated profits.

Federal preemption argued

In a motion to dismiss the claims, the Defendants argued that federal preemption of state consumer protection laws permitted the Bank to offer the loans at interest rates exceeding the Pennsylvania usury cap. Specifically, the Depository Institutions Deregulation and Monetary Control Act of 1980 permits federally-insured state-chartered banks (such as the Bank) to charge loan interest in any state at rates not exceeding the higher of (i) the maximum rate allowed by the state in which the loan is made, and (ii) the maximum rate allowed by the Bank’s home state. As the Bank was based in Delaware, and Delaware permits its banks to charge loan interest at any rate agreed by contract, the Defendants argued the Bank was not bound by the Pennsylvania usury cap and lawfully made the loans to Pennsylvania residents. The Defendants therefore asked the Court to dismiss the Attorney General’s claims.

True lender funded and serviced the loans

The Attorney General responded that the Bank was only a “nominal” lender and that the Defendants should be treated as the “true” lenders for regulatory purposes as they marketed, “funded” and serviced the loans, performed other lender functions and received most of the economic benefit of the lending program. The Attorney General contended in this regard that the Defendants had operated a “rent-a-bank” program under which they improperly relied upon the Bank’s banking charter to evade state regulatory requirements (including the usury laws) that would otherwise apply to them as non-bank consumer lenders.

The opposing arguments of the Attorney General and the Defendants therefore required the Court to consider whether the Defendants were entitled to dismissal of the usury law claims because the Bank had originated the loans (thereby making preemption applicable) or whether the Attorney General’s allegations could support a finding that the Defendants were the “true lenders” and as such remained subject to the state lending laws.

Similar true lender claims

Similar “true lender” claims have been asserted by both regulators and private plaintiffs against other internet-based lenders who market loans for origination by bank partners. In certain cases, the courts have held that as the “true lender” the website operator was not entitled to exemption from state usury or licensing laws. In others, the courts have placed greater emphasis on the bank’s role as the named loan originator and held that preemption applied even though the website operator marketed and serviced the loans and had the predominant economic interest.

No clear rule has emerged although regulatory challenges almost certainly are more likely to be made when excessive interest rates and/or abusive sales or collection practices are involved. In this case, the loans imposed interest rates of 200% to 300%.

Denied motion to dismiss

In the present case, the Court held that the facts alleged by the Attorney General were sufficient to support an “inference that the [Defendants] are the true lenders” and it denied the motion to dismiss.

The Court in particular found support for that inference in the “high rate of payment” received by the Defendants on the loans and the “level of control” which the Defendants exerted. The Court further stated that controlling precedent in the Third Circuit (the federal judicial circuit which includes Pennsylvania, Delaware and New Jersey) distinguishes between banks and non-banks in applying federal preemption (with only claims against banks being preempted).

Since the Attorney General’s lawsuit made no claims against the Bank, said the Court, the claims against the Defendants could proceed and were not subject to dismissal on federal preemption grounds.

Next steps

It is important to note that the Court’s ruling was made on...

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