New York, California and six other States filed a widely expected lawsuit on January 5 seeking to invalidate the "True Lender" Rule recently issued by the Office of the Comptroller of the Currency ("OCC"). As we previously reported, the OCC's True Lender Rule — finalized in October and effective since December 29 —provides bright-line tests for determining, in the context of a lending partnership between a national bank (or federal thrift) and a third-party (often a FinTech or other non-bank firm), which entity actually "made" the loan, i.e., which entity was the "true lender."
Identifying the "true lender" in these partnerships can be critical in the application of state-law usury limits because a national bank (unlike a non-bank) can "export" the usury limit from the state where it is "located" when that limit is higher than the usury cap in the borrower's state. The practical effect of the True Lender Rule's bright-line tests, in cases where they point to the national bank as the maker of the loan, is to preclude arguments that the non-bank partner was the "true lender" (and thus subject to a lower usury cap) under quite different, multi-factor tests in some recent judicial opinions that generally purport to elevate "substance over form."
In the OCC's view, bright-line tests provide needed certainty for the promotion of economically beneficial partnerships between banks and non-banks, which among other things can expand access to credit for unbanked and underbanked consumers. Under the True Lender Rule's most important test, the national bank will be the true lender if it is "named as the lender in the loan agreement," a test that aligns with how the Truth-in-Lending Act has determined for decades which entity is the "creditor" under that law.
The plaintiff States in this lawsuit generally argue that the True Lender Rule "facilitate[s] predatory lending" by effectively depriving the States of their ability to impose their usury limits on consumer loans to borrowers in their jurisdictions. Those usury limits should apply to most bank partnerships, they contend, because most often the non-bank partner would be designated as the "true lender" under the multi-factor tests they believe are more appropriate. The States believe that many of these lending partnerships are "sham rent-a-bank schemes."
These general arguments from the States are quite similar to those made by three States last year in their still-ongoing challenge to the OCC's "Valid-When-Made" Rule, which also seeks to promote partnerships between banks and non-banks. Another group of eight States also challenged the corresponding "Valid-When-Made" Rule applicable to state-chartered banks, issued by the FDIC. (The FDIC revealed recently that it does not intend to issue a "true lender" rule with respect to such banks.) The two Valid-When-Made Rules provided that if the interest rate on a bank-made loan was valid at the time a bank originates a loan, that interest rate does not become invalid if the loan is later assigned to a non-bank institution.
In this week's lawsuit, the plaintiff States' specific contention is that the True Lender Rule violates the federal Administrative Procedure Act ("APA") for the following reasons, among others: (1) the OCC rushed the rule-making, and thereby ignored many of the 4,000 comments it received on the proposed rule; (2) the federal banking statutes relied on by the OCC, which describe national banks' lending powers, do not authorize the OCC to determine who the "true lender" is in a lending partnership; (3) the bright-line tests adopted by the OCC are unreasonable, given the different, multi-factor tests found in caselaw; (4) the OCC is in effect preempting "State consumer financial law," which under the Dodd-Frank Act it may not do without following standards now codified in 12 U.S.C. § 25b; and (5) the OCC is in effect reversing a long-standing policy against "rent-a-bank" schemes without a reasoned explanation.
The OCC anticipated and addressed many of these APA arguments in the Preamble to the final True Lender Rule issued last October. It is not yet entirely clear, however, how the OCC ultimately will respond to this lawsuit, given the likelihood of a change in its leadership after President-Elect Biden is inaugurated and some Democrats' expressed antipathy toward these lending partnerships. We will continue to monitor for developments in this and related areas of the law that impact bank partnerships with FinTech and other firms.
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