We have posted twice before on the Second Circuit Court of Appeals’ incorrect decision in Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015). There, the court of appeals reversed a district court ruling and refused to enforce a Delaware choice of law provision citing the public policy inherent in the New York criminal usury statute.¹

The problem with the case is that the defendant, a nonbank, had acquired loans with an admittedly high interest rate, exceeding 25%. The loans were made by a national bank and were valid when made under Delaware law. The court of appeals ignored the Valid When Made doctrine, respected for more than a century² and adopted in cases by the Fifth, Seventh and Eighth Circuits.³ The result is that a loan that is “valid when made” can become usurious depending on who becomes the owner of the loan through sale, assignment, or other transfer. That kind of uncertainty adds risk to the debt-buying markets (yes, I know these creditors aren’t sympathetic victims, but the added risk results in higher costs of credit, affecting more sympathetic consumers).

The defendant in Madden filed a petition for a writ of certiorari with the United States Supreme Court. Oddly, as we reported earlier,⁴ the Department of Justice criticized the Second Circuit ruling as incorrect, while recommending that the Court decline to take the case! The United States Department of Justice argued that the ruling was interlocutory and the error could be corrected on remand.

The error was not corrected on remand, as the case – a class action – was settled. Thus, the defective ruling is still in effect in the Second Circuit and is binding precedent in federal courts in New York, Connecticut, and Vermont. A remedial bill was introduced in Congress, but got nowhere.⁵

Interestingly, the federal banking regulators have recognized the problem and have now proposed a regulatory fix. In late 2019, the Office of the Comptroller⁶ and the Federal Deposit Insurance Corporation⁷ announced proposed rules that would reverse the Madden decision, at least for financial institutions subject to their jurisdiction. The OCC explains that the new rules would provide that “interest on a loan that is permissible under [the National Bank Act and the Home Owners Loan Act⁸ shall not be affected by the sale, assignment, or other transfer of the loan.” The OCC goes on to state that the rules “would expressly codify what the OCC and the banking industry have always believed and address recent confusion about the impact of an assignment on the permissible interest.”

The legal analysis supporting the FDIC rule is slightly different, as it is based on the Federal Deposit Insurance Act;⁹ the FDIC proposes a more lengthy new rule to be promulgated at 12 C.F.R. 331, but the effect is analogous to the OCC proposal. The FDIC noted that the uncertainty of state banks’ ability to sell or transfer loans has “the potential to chill state banks’ willingness to make the types of loans affected by the proposed rule.” The FDIC stated that the rule is intended to address such possible reduction in the availability of credit.

The OCC is taking comments through January 21, 2020, and the FDIC is taking comments through February 4, 2020.

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¹Creditors’ Sidebar, January 28, 2016.
²Nichols v. Fearson, 32 U.S. 103, 109 (1833).
³See FDIC v. Lattimore Land Corp., 656 F.2d 139 (5th Cir. 1981); Olvera v. Blitt & Gaines, 431 F.3d 285, 289 (7th Cir. 2005) (“the common law puts the assignee in the shoes of the assignor, whatever the shoe size”); Krispin v. May Department Stores, 218 F.3d 919 (8th Cir. 2000).
⁴Creditors’ Sidebar, January 4, 2017.
⁵The Protecting Consumers’ Access to Credit Act of 2016, H.R. 5724.
⁶84 Fed. Reg. 64229 (November 21, 2019).
⁷84 Fed. Reg. 66845 (December 6, 2019).
⁸12 U.S.C. Sections 85 and 1464.
⁹12 U.S.C. Sections 24 and 27.