Knowing When to Walk Away
U.S. Supreme Court to Consider “Valid When Made” Doctrine
Last year, the influential Second Circuit Court of Appeals handed down a troubling, and to many banking lawyers, plainly-wrong decision in Madden v. Midland Funding LLC.[i] In that case, Midland had bought a credit card debt originated by a Delaware national bank, attempted to enforce the debt against the borrower, and apply the 27% interest rate under the credit card agreement. However, the borrower was a New York citizen, and the rate charged exceeded the New York criminal usury rate of 25%. Even though the originating lender was a national bank, the Second Circuit held that the national bank's debt buyer could not rely on the National Bank Act preemption of state usury law.[ii] The case is a departure from years of precedent, it creates a circuit split, and the debt buyer has asked the United States Supreme Court to review the decision.[iii]
As a national bank, BANA can export the interest rates permitted in its home state or any state where it has a branch or performs certain activities. It had combined its credit card activities with a national bank headquartered in Delaware. In 2008, after the borrower ceased making payments, BANA sold the account to Midland. Midland sent a collection letter to the borrower, and sought interest at the rate of 27%. A non-bank, Midland had no separate authority to charge this rate, only derivative authority as an assignee of the national bank. The New York criminal usury cap was 25%.
The borrower filed a class action lawsuit asserting violations of the Fair Debt Collection Practices Act and the state usury statute. The trial court held that the bank's assignee was entitled to rely on the National Bank Act, and the borrower appealed to the Second Circuit, arguing that Midland was not a national bank or an affiliate of a national bank, and could not rely on NBA preemption. The Second Circuit agreed, and further found that application of the criminal usury statute to an assignee did not "substantially interfere" with the operations of national banks.
In its opinion, the Second Circuit ignored the common law "Valid-When-Made" doctrine, that if a loan is non-usurious when made, then it remains non-usurious.[iv] Over in the Seventh Circuit, Judge Posner has written that the law "puts the assignee in the assignor's shoes, whatever the shoe size."[v]To hold otherwise creates several layers of uncertainty, with different usury rules applicable to institutions of different types and located in different jurisdictions, potentially resulting in multiple changes in applicable interest rates as loans change hands by assignment. Obviously, such uncertainty chills the free flow of commercial paper.
The Second Circuit's ruling also creates a split among the circuits, as the Fifth, Seventh and Eighth Circuits have reached different results.[vi]
Finally, the Second Circuit's finding that refusal to extend NBA preemption to assignees of national bank-originated debt would not "substantially interfere" with bank operations ignores the inevitable chilling effect it will have on the securitization and sale of loans and commercial paper.
Midland has filed a petition for certiorari with the United States Supreme Court, which has been supported by a number of financial industry associations. The Supreme Court recently asked the borrower for a response brief. It will be interesting to see if the court chooses to reconsider this unfortunate decision.
[i] 786 F.3d 246 (2d Cir. 2015).
[ii] 12 U.S.C. Â§ 85.
[iii] The resolution of this case will be of great interest to readers of the recent three-part Client Alert series on charge-off collections, note sales, and debt buying, authored by my colleague, Elizabeth L. Thompson.
[iv] FDIC v. Lattimore, 656 F.2d 139 (5th Cir. 1981). See generally R. Vance, "Galloping Preemption: Developments in Banking Law," University of Kentucky College of Law Conference of Financial Institutions Law, April 2006.
[v] Olvera v. Blitt & Gaines, PC, 431 F.3d 285 (7th Cir. 2005).
[vi] See id.; Krispin v. May Dept. Stores, 218 F.3d 919 (8th Cir. 2000).