United States: The Uncertain Legacy Of Madden

On June 27, 2016, the US Supreme Court (Supreme Court) declined to review the Second Circuit's controversial decision in Madden v. Midland Funding, LLC. As a result, the appellate court's ruling regarding the applicability of state law usury limits to non-bank debt purchasers will remain the law of the land in the Second Circuit.[1] After briefly discussing the background of the case, this client alert will discuss: (1) the important choice of law issues that remain unresolved in the case; (2) the uncertain scope and precedential effect of Madden, both within the Second Circuit and outside of it; and (3) how Madden will affect originating banks and secondary market debt purchasers going forward.

Background

Saliha Madden, a New York resident, opened a credit card account with Bank of America (BoA). Her account was later transferred to FIA Card Services, N.A. (FIA). After the transfer to FIA, the account's terms and conditions were amended upon the receipt by Madden of a document titled "Change in Terms," which contained a Delaware choice-of-law clause. In 2008, her account was charged-off by FIA and sold to Midland Funding, LLC (Midland Funding), a non-bank entity. After the sale to Midland Funding, neither FIA nor BoA had any further interest in the account. Midland Credit[2] sent a letter to Madden attempting to collect payment of her debt and stating an annual interest rate of 27 percent (which exceeded various New York usury limits) applied. Madden filed a class-action lawsuit in the Southern District of New York alleging violation of New York state usury law and the Fair Debt Collection Practices Act. The suit objected to the interest charges that accrued after the account had been transferred to Midland—not to those that were accrued and charged by FIA prior to the assignment.

Midland argued that, as an assignee of a loan originated by a national bank, the assignee was entitled to the preemption of the National Bank Act (NBA) over the New York law usury limits. Section 85 of the NBA provides that a national bank may charge interest at the rate allowed by the state where it is located. Midland also argued that since the Change in Terms provided that Delaware law applied to the agreement with FIA, defendants were permitted to charge a higher rate. The district court granted defendants' summary judgment motion on the basis of their preemption argument, but without issuing any findings on their Delaware choice of law argument.

The Second Circuit reversed the district court's findings of NBA preemption. It gave two reasons for doing so. First, neither Midland Funding nor Midland Credit was a national bank, nor were they subsidiaries or agents of, or acting for the benefit of, such a bank. Second, the application of the New York state law on usury to Midland Funding and Midland Credit did not "significantly interfere" with a national bank's ability to exercise its powers under the NBA. The court did not discuss whether Delaware or New York usury law should apply. That issue was remanded to the district court.

Defendants then filed a petition for a writ of certiorari with the Supreme Court, which has now been denied.

Choice of Law Issues

Even after denial of the writ of certiorari by the Supreme Court, important choice of law issues remain unresolved and will now need to be litigated at the district court level. Midland argued in the courts below that, even if Madden's claims were not preempted by the NBA, her credit card agreement contains a choice of law provision that mandates the application of Delaware law. The Second Circuit did not decide that issue, but instead remanded that question for the district court to consider. If, on remand, the district court decides that Delaware law applies, then the interest rate charged likely would be found to be permissible, notwithstanding the absence of NBA preemption, because Delaware does not impose a usury limit on bank-made loans. This would, however, require the district court to conclude that the New York usury statutes do not represent a fundamental public policy of New York that would require their application notwithstanding the Delaware choice of law provision in the contract. Even if the New York usury laws were applied, Midland still could prevail if the district court decides that New York usury law itself incorporates the valid-when-made principle (as discussed below). However, this assumes that the district court finds that Midland preserved that argument.

The remainder of this alert will assume, for the sake of argument, that the district court finds against defendants—i.e., that the New York usury limits do in fact apply.

The Uncertain Scope of Madden within the Second Circuit

Borrowers located in the Second Circuit (Second Circuit Borrowers) who are in circumstances similar to the Madden plaintiffs will be encouraged to bring cases similar to Madden (i.e., alleging that the related third party debt buyers are charging impermissible interest rates). Any third party debt buyer subject to personal jurisdiction in the Second Circuit could potentially be sued on these grounds. However, given the specific facts of the Madden case and the Second Circuit's holding, the courts in such cases will likely be required to revisit many of the same issues and Madden may only have limited precedential value.

First, the Madden court merely dealt with whether the NBA preempts state law usury limits on loans held by third-party debt buyers. While the court held that such preemption would not apply, the court did not address the "valid-when-made" doctrine (i.e., the common law principle that the usurious nature of a loan should be judged at inception and not thereafter).[3] As such, defendants will continue to be able to rely upon that doctrine and a court will likely be required to reconcile it with the Madden holding in any subsequent case.

In addition, defendants in subsequent cases will likely question the Madden court's preemption analysis. That analysis was very specific to the NBA and relied on a version of preemption discussed in Barnett Bank of Marion Cnty., N.A. v. Nelson,[4] which provided that in order to apply NBA preemption to an action taken by a non-national bank entity, application of state law to that action must significantly interfere with a national bank's ability to exercise its powers under the NBA. The Madden holding focused on New York state's usury limits not "significantly interfering" with a national bank's ability to exercise its powers generally. The court did not directly address the preemptive effect of Section 85 of the NBA itself, which expressly specifies the interest rates that national banks may charge. Many commentators, including the U.S. Solicitor General, feel that the court's preemption analysis should have focused on how Section 85 specifically interacts with state usury law limits (particularly when read in conjunction with the ability of national banks to sell loans).[5]

Furthermore, the Madden holding is limited to the preemptive effect of the NBA on loans originated by national banks —it does not address the preemptive effect of Section 27 of the Federal Deposit Insurance Act (FDIA) upon loans originated by FDIC-insured state banks.[6]

Plaintiffs may argue by analogy that the same reasoning should apply to third party purchasers of loans originated by state-chartered banks—that is, that a third party debt purchaser should not be able to avail itself of such preemption because it is not itself a state-charted bank. However, as noted above, the Second Circuit's analysis in Madden was based on a very specific interpretation of preemption under the NBA. It is therefore not settled that third party debt buyers of state-bank originated loans are bound by Madden.

It is also worth noting that Madden involves charged-off, defaulted credit card debt and the ability of an assignee to charge higher interest rates after purchasing such charged-off debt. In any future cases involving performing loans, the defendants may be able to distinguish Madden on the basis that, unlike the ability to sell charged-off debts, limiting national banks ability to sell performing loans would "significantly interfere" with a national bank's ability to exercise its powers under the NBA.

Madden as Precedent in Other Circuits

Madden also has the potential to be cited as precedent in, and used as the basis for, litigation in other circuits. Of course, defendants are free to question the Second Circuit's reasoning in Madden, including the lack of consideration of the valid-when-made doctrine and the version of the preemption analysis on which the court relied. Concerned parties would be well advised to consider the treatment of the valid-when-made doctrine in their own circuit and whether there is sufficient precedent to deny a Madden-based challenge.

However, from the perspective of an originator or debt purchaser, this does raise the question of whether there is now a split between the Second Circuit, on the one hand, and the Eighth (and Fifth) Circuit, on the other, and, accordingly, whether such parties should evaluate loans made to borrowers located in such jurisdictions in a different manner. In the U.S. Solicitor General's amicus brief opposing the writ of certiorari, the Solicitor General argues that there is no such split given the particular facts of each of the most notable cases. The Solicitor General notes that Madden is a case addressing whether federal preemption applies to interest rates charged by an assignee in a situation where the originating national bank entirely terminates its relationship with the borrower. By contrast, the Solicitor General notes that: Phipps v. FDIC, 417 F.3d 1006 (8th Cir. 2005) only addressed whether mortgage-loan fees charged by a national bank (as opposed to an assignee) was interest not subject to preemption; Krispin v. The May Department Stores 218 F.3d 919 (8th Cir. 2000) addressed a situation where a national bank retained a credit card customer's accounts, along with the processing and servicing responsibilities, and only assigned the related receivables to a non-bank; and FDIC v. Lattimore Land Corp., 656 F.2d 139 (5th Cir. 1981) involved a loan originated by a state regulated entity (as opposed to a national bank). For that and other reasons, the Solicitor General argued that there was no circuit split requiring resolution by the Supreme Court.

However, from a practical perspective, it cannot be denied that Madden creates a precedent (regarding the treatment of interest charged by non-bank assignees) in the Second Circuit that is simply lacking in the other circuits. The uncertainty created by such precedent will not be resolved until another district court in the Second Circuit (or perhaps the court of appeals itself) addresses the applicability of the valid-when-made doctrine to a loan held by a non-bank assignee.

Market Impact

In the short run, until that uncertainty is resolved, third party debt buyers, warehouse lenders and securitization vehicles may avoid purchasing, and/or reduce their purchases of, consumer and small business loans made to Second Circuit Borrowers and, as a result, such loans may trade at a discount. Subsequent assignees may need to amend their customer agreements to lower the rates they charge in order to prevent potential violations of state usury law. Assignees may also attempt to take advantage of any put-back rights or indemnity claims against sellers, to the extent the sellers have breached any representations and warranties regarding the enforceability of usurious interest rates.

Originating banks, on their own initiative or at the behest of third party debt buyers, may also revise their customer agreements to include governing law clauses, or choice of venue provisions, designating jurisdictions that are outside of the Second Circuit and that have liberal usury laws. However, courts may not enforce such provisions if they are found to be contrary to public policy. Different jurisdictions will also have different approaches to honoring choice of law provisions.

More fundamentally, the Madden decision will change the way third parties structure their purchases of debt. It has already had that effect. The Madden court distinguishes between (1) entities acting as an "equivalent to national banks" (such as operating subsidiaries and agents) or purchasers of interests in loans from banks who continue to have some interest in the loans, on the one hand, and (2) non-bank, unrelated third party purchasers of debt, on the other. Depending upon the facts, the former group may be entitled to the NBA's preemption of state usury law limits, as such preemption is understood by the Second Circuit. The latter group is not so entitled. Accordingly, Madden will, and already has, encouraged debt buyers to restructure their purchases so that they fall into the first group. For example, certain platforms have recently announced an "enhanced program structure" (whereby the issuing bank maintains an on-going economic interest in all loans made after they are sold).

As a result, many banks and debt purchasers will be required to fundamentally reconsider their business models—if originate-to-distribute is no longer viable (in the Second Circuit), what is the nature of the interest that should be retained by the bank? Some banks may opt to retain a portion of every originated loan. Others may opt to maintain some economic exposure to the interest and fee income over the life of the loan. Others may take the approach in Krispin—maintaining the account and servicing relationship but assigning the receivable. Given the diversity of financing structures in the marketplace, no one approach will predominate.

Conclusion

The Madden holding affects fundamental assumptions about the free assignability of financial assets in our financial system and the nature of the preemption doctrine as applied to national banks. Nevertheless, the legacy of Madden remains unclear. Now that the Supreme Court has denied certiorari, the district court's interpretation of the choice of law issue will be closely monitored by the market.


[1] The Second Circuit encompasses the states of New York, Connecticut and Vermont.

[2] Midland Credit Management, Inc. (Midland Credit), an affiliate of Midland Funding, services Midland Funding's consumer debt accounts. It is also a defendant in the case and is a non-bank entity.

[3] The Madden defendants requested that the Second Circuit rehear their case to take into account the valid-when-made doctrine. This request was denied.

[4] 517 U.S. 25, 33 (1996).

[5] In the Solicitor General's amicus brief opposing the writ of certiorari, it notes that "The Court of appeals' decision is incorrect. Properly understood, a national bank's Section 85 authority to charge interest up to the maximum permitted by its home State encompasses the power to convey to an assignee the right to enforce the interest-rate term of the agreement. That understanding is reinforced by 12 U.S.C. 24(Seventh), which identifies the power to sell loans as an additional power of national banks."

[6] Section 27 of the FDIA is the corresponding federal statute which permits state chartered banks to charge interest rates based upon the state in which they are located even if such rates exceed usury limits in the borrower's resident state.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.