Maryland Legal Alert for Financial Services

We reported in our July 2016 Maryland Legal Alert that the U.S. Supreme Court had declined to review the decision of the U.S. Court of Appeals for the Second Circuit in Madden v. Midland Funding, LLC. The Madden decision sowed uncertainty and confusion among debt buying and bank-partnership model lending businesses, because of its holding that the purchaser of debt from a national bank was not a beneficiary of the preemptive interest rate authority of the lender because the national bank was not the “true lender” in the transaction. Under Madden’s holding, even though a loan was valid when made, a purchaser of the loan could be subject to usury limitations under state law. The Madden rationale also called into question bank-partnership models involving state-chartered banks.

In early 2017, the Administrator of the Colorado Uniform Consumer Credit Code (UCCC) filed lawsuits against two large FinTech providers working with state-chartered banks to originate consumer loans made to Colorado residents. The FinTech providers worked with state-chartered banks located in states with interest rate limitations that were higher than consumer installment loan interest rate limits in Colorado. The FinTech providers marketed and facilitated the origination of loans made in the name of partner banks, then the FinTech providers purchased a large participation interest in and serviced the loans. The Colorado regulator alleged that the partner banks retained no — or insignificant — risk under the arrangements, as the FinTech providers paid all costs of the bank partners and indemnified the bank partners against losses. The Colorado regulator argued that the partner banks were not the true lenders because the FinTech providers had the predominant economic interest in the loans under the partnership models. The lawsuits alleged that, because the FinTech providers were the true lenders of the loans, the FinTech providers were prohibited from enforcing loan interest rates that the bank partners could have enforced.

On August 18, 2020, the FinTech providers and the Colorado regulator settled the lawsuits. The settlement, in the form of a joint assurance of discontinuance, provides a safe harbor for FinTech providers operating in Colorado, but it may also provide useful guidance for FinTech providers operating in other states. The safe harbor outlines several requirements including:

• Oversight criteria;
• Disclosure and funding criteria;
• Licensing criteria;
• Consumer terms criteria; and
• Structural criteria.

A summary of the safe harbor requirements is as follows:

Oversight Criteria: A bank-partnership model and the loans originated under the model must be subject to the oversight by the respective bank partner’s regulator (e.g., FDIC, OCC and applicable state banking regulators). The bank partner must retain ultimate approval authority over all loan origination services, marketing content and credit terms under the arrangement. In addition, the bank partner must retain the ability to approve significant subcontractors engaged by the FinTech provider. The FinTech provider must also have in place a compliance management system acceptable to the bank partner, and the partner bank must test the FinTech provider’s compliance management system — at least once annually.

Disclosure and Funding Criteria: Loan documents under the program must identify the bank partner as the lender. Marketing materials under the program must identify the bank partner as the lender. The bank partner must fund all loans using its own funds. Funds may not be provided to the bank partner by the FinTech provider.

Licensing Terms Criteria: The FinTech provider must obtain appropriate Colorado UCCC licensing to take assignment of and collect loans made under the program. The FinTech provider must issue an annual compliance report that provides the Colorado regulator with specified information concerning loans made under the program.

Consumer Terms Criteria: Loans under the program must not have an Annual Percentage Rate (APR) greater than 36% (as calculated under federal law) and loan agreements must specify that Colorado law applies to the loans, except to the extent preempted by federal law. Under the terms of the settlement, “Specified Loans” are loans originated under the program with an APR greater than that permitted under the Colorado UCCC, but less than 36%.

Structural Criteria: Permissible arrangements include those where the FinTech provider:

• Evaluates Specified Loans originated by the bank partner on a case-by-case basis (uncommitted forward flow option);
• Agrees in advance to purchase economic interests in Specified Loans of up to 49% of the total origination volume in any calendar year (maximum committed forward flow option); or
• Agrees in advance to purchase not more than 85% of the economic interest in all loans originated through the program (and not more than 35% of the total originated principal amount of all loans originated through the program) for Specified Loans and other loans (maximum overall transfer option).

Under the uncommitted forward flow option, the arrangement between the FinTech provider and the bank partner may not include an indemnification provision where the FinTech provider indemnifies the bank partner for the performance of loans or losses from nonpayment of loans. The maximum committed forward flow option and maximum overall transfer option each contemplate the securitization of loans originated through the program. The settlement also leaves open alternative arrangements separately approved by the Colorado regulator.

The settlement also requires the FinTech providers to pay substantial fines and make contributions to a Colorado nonprofit that promotes financial literacy.

Practice Pointer:While the settlement applies to FinTech providers and banks operating bank-partnership arrangements in Colorado, it has some key features other state regulators could elect to adopt. FinTech providers and related bank partners should consider arrangements with an overall 36% APR cap and take steps to re-enforce that the bank partner is viewed as the true lender under the program. Steps to solidify true lender status include the bank partner having sufficient oversight over the program and retaining sufficient economic risk for loans originated through the program.

For questions concerning this topic, please contact Christopher R. Rahl.

Christopher R. Rahl
410-576-4222 • crahl@gfrlaw.com