Bank-fintech partnerships win key battle, but war is far from over

WASHINGTON — Fintechs can more comfortably avoid state interest rate caps by partnering with banks after two recent court decisions — at least for now.

The Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency each scored big victories in the U.S. District Court for the Northern District of California on Feb. 8, when Judge Jeffrey S. White dismissed complaints brought against the agencies by attorneys general in states led by California, Illinois and New York.

The FDIC and OCC, led by Trump administration appointees when the lawsuits began in 2020, had issued rules to assure banks and fintechs they could continue to partner and do business across state lines after the 2015 court decision Madden v. Midlands Funding limited such activity. Under a typical arrangement, a bank funds a loan on behalf of its fintech partner that can then be deployed in other states that may have stricter interest rate controls.

But the states, with the support of many consumer activists, could appeal the judge's rulings. And it's possible the agencies, now led by Democratic appointees who have vowed to make consumer protection a priority, could change positions.

“This is a big win for the bank model in the short term, but I don't think the war is over,” said Scott Pearson, leader of the consumer financial services practice at Manatt.

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The AGs had argued the FDIC and OCC violated the Administrative Procedure Act when they promulgated separate rulemakings to affirm the legal principle of “valid when made” — a doctrine that holds the terms of a legally made loan can continue after a transfer to a third party in a separate jurisdiction.

In similarly structured lawsuits, the state AGs had argued the two agencies had violated the APA by publishing rules that would “facilitate predatory lending through sham ‘rent-a-bank’ partnerships designed to evade state law,” according to the lawsuit filed against the FDIC in August 2020. The APA, which governs the federal rulemaking process, bars agencies from introducing rules that are “arbitrary” or “capricious.”

In both cases, White found the states' arguments unconvincing, ruling the “valid when made” rules issued by the OCC and FDIC were “neither arbitrary nor capricious.”

The financial services industry applauded the decisions last week, even as legal analysts warned that it could still take months or years for the matter of interest rate exportation in bank-fintech partnerships to be firmly settled.

Still, analysts say that the decision marks an important win as banks and nonbank fintech firms increasingly look to partnerships to bolster their competitiveness. The secondary loan market for banks has experienced significant legal uncertainty since the Madden decision put the principle of "valid when made" in doubt.

“Absent these partnerships, fintechs would be subject to the interest rate caps in each of the 50 states,” said Jaret Seiberg, a policy analyst with the Cowen Washington Research Group. “That matters as it can be difficult to determine which state's cap applies as consumers can be located in one state but reside in a different state.”

Some lawyers and consumer advocates remain concerned that the existing regulation makes it far too easy for expensive loans to be exported by banks to nonbanks to be deployed in states that would otherwise ban them through interest rate caps and other usury laws.

“It’s a significant blow to people who care about state usury laws,” said Christopher Petersen, a law professor at the University of Utah’s S.J. Quinney College of Law and a former special advisor at the CFPB. “From a consumer protection perspective, it’s a bad development for consumers who hope their elected state leaders will protect them from debt collectors who purchase predatory loans from out-of-state banks.”

The states’ attorneys general have yet to announce whether they will appeal the Feb. 8 decision, which would likely push the case into the U.S Court of Appeals for the 9th Circuit. Analysts believe an appeal is likely, boosting the prospects that the matter could one day arrive on the docket of the U.S. Supreme Court.

“The rulings are an important — and very positive — outcome for those partnerships and for banks generally,” said Karen Solomon, senior of counsel at the law firm Covington & Burling. “That said, I think it's likely that the state attorneys general will appeal the cases to the 9th Circuit. And, if the 9th Circuit's decision is different from the 2nd Circuit's in the Madden case, the case could ultimately end up before the Supreme Court.

“So, we could be a long way from final resolution of the underlying issue,” Solomon said.

The leadership of the banking agencies has also flipped political parties since the “valid when made” rules were first introduced, meaning that the regulators themselves could change their legal positions or tweak the actual regulations in the coming months. “I think you'll see an appeal, and you could also see the FDIC and the OCC now, under new leadership, go back to the drawing board and reverse their own rule,” Pearson said.

Even without an appeal, Lauren Saunders of the National Consumer Law Center noted, the court rulings in favor of the FDIC and OCC would “not prevent states from bringing true lender challenges to rent-a-bank schemes.” She pointed to a lawsuit brought by the District of Columbia last year, which resulted in a $2 million settlement against the subprime consumer lender OppFi in December.

“We urge the OCC and FDIC, which are under new leadership, to revisit the rules, to crack down on predatory rent-a-bank lending, and to prevent banks from selling questionable charged-off debts to debt buyers,” Saunders said.

It remains to be seen whether the regulators will adjust their position on “valid when made” under Democratic leadership. The FDIC recently came under the control of acting Chairman Martin Gruenberg, while the OCC has been run by acting comptroller Michael Hsu since May 2021. Both are Democrats who replaced Republicans.

Hsu told reporters shortly after taking office that the OCC’s “valid when made” rulemaking was “not under review.” But in a statement released by the OCC following the judge's decision last week, Hsu issued a more cautious note.

“This legal certainty should be used to the benefit of consumers and not be abused. I want to reiterate that predatory lending has no place in the federal banking system,” Hsu said. “The OCC is committed to strong supervision that expands financial inclusion and ensures banks are not used as a vehicle for ‘rent-a-charter’ arrangements.”

Solomon, a former senior official at the OCC, said it was unlikely that the national bank regulator would flip its core position on the matter, even under more progressive Democratic leadership.

“If there is an appeal, I would not expect a material change in the OCC's approach to the litigation,” Solomon said. “The litigation is about the scope of a national bank's authority to charge interest under section 85 — a provision original to the National Bank Act in 1864. The OCC has taken a pretty consistent view of that authority over time.”

But Ellen Harnick, an executive vice president with the Center for Responsible Lending, said more must be done to ensure there are guardrails in place that allow states to protect their residents from potentially predatory rent-a-bank arrangements.

“It's very clear, and courts have been clear, that what's needed is to look behind appearances, behind the facial presentation of an arrangement, to see what's really going on — to follow the money and see who's really behind the loan,” Harnick said. “There is no reasonable basis for essentially blowing up the state's ability to protect their own residents, simply because some online lender has chosen to partner with a bank.”

Kate Berry contributed to this article.