The Office of the Comptroller of the Currency (OCC) issued a final rule that creates a bright-line test to determine when a national bank or federal savings association (bank) makes a loan and is the "true lender," including in the context of bank-fintech partnerships. The OCC hopes that by settling the "true lender" question, in conjunction with its recent "valid-when-made" rule—which provides that when a bank sells, assigns or otherwise transfers a loan, the interest rate permissible before the transfer continues to be permissible after the transfer (see our prior alert)—it can resolve the legal challenges and uncertainty surrounding certain of these partnership models. Assuming that this final rule on the "true lender" issue withstands the expected legislative and legal challenges, it would also clarify the extent to which state usury ceilings apply to loans made through these partnership models, with federal law preempting most state usury limits for a loan as to which a bank is treated as the "true lender."
Background on "true lender" challenges
The "true lender" question arose in the context of certain lending arrangements between banks and nonbank entities such as marketplace lenders or other fintech companies, in which the nonbank entity typically markets the loan, makes the credit decision and directs its bank partner to originate and temporarily hold the loan before purchasing it from the bank. Underpinning these arrangements is the authority under federal law for banks to charge interest at the maximum rate permitted to any state-chartered or licensed lending institution in the state where the bank is located, regardless of the location of the borrower. This "most favored lender" lender status permits a bank to originate a loan to a borrower in any state without the need to comply with local maximum interest rate restrictions or lender licensing requirements. Nonbank lenders do not benefit from the same status, and, as a result, must comply with both the maximum interest rate and lender licensing requirements of the state in which they are originating a loan to a borrower. As a result, nonbank entities that lend to borrowers across the United States are subject to a patchwork of state-level maximum interest rate and licensing requirements.
Critics have described these lending arrangements—in which a bank originates and temporarily holds a loan before selling it to a nonbank partner that marketed and authorized the loan—as "rent-a-charter" or "rent-a-bank" schemes that improperly permit the nonbank entity to benefit from the broad protection of the exportation doctrine as to the loan's interest rate and to claim its own exemption from applicable state lender licensing and usury limits by not acting as the lender. These critics argue that the nonbank entities should be considered the "true lender" in the transactions because the bank is not sufficiently engaged in the lending program and does not receive the benefits or take the risks generally expected of a lender. These critics also claim, that for all functional purposes, the borrowers in these transactions are customers of the nonbank partner, rather than of the bank. However, such a rigid view of bank-fintech partnerships may be overly reductionist. In practice, the nature of such partnerships is nuanced and their structures can be highly variable on a case-by-case basis.
Private plaintiffs and state regulators have pursued "true lender" challenges against various bank partnership programs for violations of state usury and consumer protection laws. As a result, some courts have examined the economic realities of such lending arrangements by considering a variety of factors designed to determine which entity is the actual lender in the transaction. While courts have adopted differing analytical approaches, their analyses generally seek to determine which of the bank or its nonbank partner holds the "predominant economic interest" in the loan and is, thus, the "true lender," subject to the banking or credit laws in question.
"True lender" litigation significantly increases legal and business risks for nonbank entities purchasing loans originated by banks. If successful, a "true lender" challenge exposes the nonbank entity to significant penalties for usury and unlicensed lending as well as threatens the validity and enforceability of the loan under state law. In an effort to mitigate such risks, nonbank and bank partners have moved towards more participation-based partnership structures in which the bank only sells a participation interest up to a certain percentage of the loan receivables to the nonbank partner. While increased bank involvement in the lending program provides a better fact pattern to defend against "true lender" challenges, the lack of formal agency guidance or rulemaking prior to the OCC's recent actions on the "true lender" and "valid-when-made" issues perpetuated legal uncertainty for banks and nonbanks that participate in such lending arrangements.
The OCC's final rule
In response to the growing body of case law introducing divergent standards for resolving the issue of which entity in a bank partnership model is the "true lender," on July 22, 2020 the OCC set forth proposed rules for determining when a bank makes a loan. Under the proposed rule, a bank would be deemed to make a loan if, as of the date of origination, it (1) was named as the lender in the loan agreement or (2) funded the loan. The final rule uses the same test, while also clarifying that if, as of the date of origination, one bank is named as the lender in the loan agreement and another bank funds that loan, the bank that is named as the lender in the loan agreement makes the loan and is the "true lender." The final rule is effective December 29, 2020.
The OCC's adopting release accompanying the final rule, in order to address "rent-a-charter" concerns, emphasizes the OCC's supervisory expectations for banks that are involved in those types of lending arrangements, including that a bank that makes a loan within the meaning of the final rule pursuant to a partnership or similar arrangement with a nonbank entity must comply with a number of legal requirements and supervisory expectations of the OCC, including (i) following prudent credit underwriting practices and standards, (ii) ensuring that the loan complies with applicable federal laws, including federal consumer protection laws and fair lending laws, (iii) taking into account the borrower's ability to repay the loan according to its terms and otherwise avoid predatory lending practices in connection with the loan and (iv) complying with OCC guidance on managing the risks of third-party relationships.
The adopting release also clarifies that the funding prong of the final rule does not include funding arrangements where a bank does not fund a loan at the time of origination. For example, the funding prong would generally not cover lending or financing arrangements such as warehouse lending, indirect auto lending (through bank purchases of retail installment contracts), loan syndication or other structured finance arrangements. In contrast, the funding prong would apply, and a bank would be the "true lender," in the case of a table funding arrangement where the bank funds the loan at origination. Although the OCC expresses confidence that the final rule provides a clear and simple test, the OCC encourages banks to contact the agency with questions about whether a specific funding arrangement results in "true lender" status.
Despite the OCC's efforts to settle the question, "true lender" challenges and efforts to block the final rule are likely to continue. Following the OCC's release of the final rule, Senate Banking Committee Ranking Member Sherrod Brown released a statement promising to use every available legislative tool to overturn it. Senator Brown will likely take action under the Congressional Review Act, which allows Congress to prevent a rule from taking effect by a joint resolution of disapproval signed by the President. The likelihood of success of a Congressional Review Act challenge is heavily dependent on the outcome of the upcoming elections, and Senator Brown is expected to wait on the election results before acting.
The final rule is expected to face legal challenges as well, including from the states that have already sued to block the OCC's "valid-when-made" rule. These challenges would likely involve arguments similar to those raised in comments to the June 2020 proposed rule, including that:
- the OCC lacks the legal authority to issue the "true lender" rule because it would contravene federal banking law, which it has been argued requires courts to look to the substance rather than the form of a loan transaction;
- the rule constitutes an impermissible attempt by the OCC to exempt nonbank entities from compliance with state law;
- the rule improperly preempts the state laws that would govern the issue of whether a loan is made by a nonbank lender;
- the rule is unreasonable in that it departs from federal case law holding that state "true lender" law applies to lending relationships between banks and nonbank entities;
- the rule contravenes the OCC's obligation under federal banking law to ensure that banks treat customers fairly; and
- the OCC did not fulfill its procedural obligations, including those that apply when the OCC preempts a state consumer financial law and those under the Administrative Procedure Act (specifically, that the rule is arbitrary and capricious and the alleged change to form over substance constitutes a reversal of OCC policy for which the OCC did not give notice or provide the factual, legal and policy reasons for doing so).
Along with the "valid-when-made" rule, the final "true lender" rule is another important step towards restoring certainty for industry participants, including banks, their nonbank partners and investors, but at least some ambiguity around bank-fintech partnerships is likely to persist at the present time.
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