Editor’s note: This post originally appeared in slightly altered form on the
In a recent
Applying valid-when-made is appropriate
The
Levitin argues that the Madden case is different. In Madden, the ultimate purchaser of the loan (Midland Funding) wanted to take advantage of the state usury law preemption enjoyed by the originator of the loan (the bank). Levitin argues that valid-when-made has nothing to do with the issue in Madden and similar arrangements where banks sell loans to nonbanks.
Levitin is certainly right that the Nichols case and the similar 19th-century cases reflect a different fact pattern than was presented in Madden. It does not necessarily follow, however, that the principle of valid-when-made should not also apply under the Madden facts. The drafters of the Madden fix bills might have set themselves up for trouble by saying that valid-when-made “as provided by Nichols v. Fearson” (emphasis added), since that implies that the court created the doctrine, or set out its boundaries in the Nichols case. But this isn’t what happened. Instead, the Nichols court cited a preexisting maxim and applied it to a certain set of facts. Proponents of the Madden fix can’t cite Nichols as controlling legal precedent (or else we wouldn’t be having this debate), but that doesn’t mean that the maxim of valid-when-made is limited to the Nichols facts or shouldn’t apply in the present case.
In fact, courts have cited Nichols and the principle of valid-when-made in other contexts. Perhaps the most direct example is the case of
"If, in its inception, the contract which that instrument purported to evidence was unaffected by usury, it was not invalidated by a subsequent transaction.”
This proposition was articulated by the Supreme Court as one of the “cardinal rules in the doctrine of usury.”
In Lattimore, as well as in Madden, the original borrower is trying to assert a usury defense because the loan changed hands. This case is not identical to the issue in Madden, because the loan in Lattimore went from a nonbank to a bank. As the United States Solicitor General and Office of the Comptroller of the Currency
Applying valid-when-made is just
There is also a strong argument that applying valid-when-made to cases like Lattimore and Madden is just. Recall Levitin’s argument that X, the original borrower, should not get out of her original and valid contract simply because a usurious transaction happened downstream. In the present case, we have a borrower who took out a legal loan, something happened to the loan downstream (a sale) that did not change the original borrowers’ obligations, and now the original borrower wants to use that downstream event to get out of their obligation to repay. Why should the borrower get a windfall because a loan is sold?
Levitin
And why should the validity of the loan hinge on who holds it anyway? Levitin argues that banks are subject to an “alternative federal regulatory regime” that does not apply to nonbanks, and therefore nonbanks should not be entitled to the benefits of federal regulation.
However, it is unclear what relevant regulation banks are subject to that nonbanks aren’t. The issue at question in Madden, the interest charged on the loan, was set by the bank at the loan’s inception. The borrower got the benefit of the federal regulatory regime, which includes the incorporation of the bank’s home state usury law, when the loan was created, and the relevant characteristics did not change. So why is there suddenly a problem?
Further, Levitin seems to accept that a bank should be allowed to shift the credit risks of the loan off of its portfolio. Why should a bank be allowed to shed risk via securitization (which he acknowledges may be implicated by Madden) or financial engineering but not a direct sale of the loan? Such efforts to shift credit risk would also seem to undo another supposed benefit of Madden, that it forces banks to take greater care underwriting. Banks shifting credit risk off their books, regardless of method, could lower their underwriting standards, but they still face the reality that selling interests in loans that fail to perform will be punished by the market.
Regardless of whether the bank sells the loan, securitizes it, or offers some sort of participation interest, the loan can only ever be what the bank is allowed to offer under its federal regulatory regime (or else it isn’t valid). If the loan remains what the borrower, the lender, and the law thought was acceptable when the loan was made, why should a change in ownership of the loan destroy the contract? Contrary to Levitin’s assertion, fixing Madden is not about repealing usury laws, it is about making clear that the usury laws applicable to a loan do not change suddenly and arbitrarily.
It is also unclear just how different the relevant law between banks and nonbanks actually is. As the Treasury Department
Levitin calls for various new requirements for loans, including an ability to repay component, dictating certain loan characteristics other than the interest rate, and a prohibition on forced arbitration. All these requirements are beyond the scope of the laws implicated by Madden. While they may have merit as a matter of policy, that is a separate debate from the question posed by the Madden decision — whether a borrower should be held to the terms of her original contract if her loan is sold.
The impact of Madden on innovative credit is harmful to borrowers
Levitin argues that there is no policy justification for applying valid-when-made in the aftermath of Madden. However, this isn’t true. Besides the question of justice discussed above, Madden also appears, as would be expected, to be
Even if the Madden decision does reduce credit availability, Levitin finds the reduction acceptable; after all, we don’t let people “
This hyperbole also ignores the reality that access to credit is often consumer protective. For example, it is important to keep in mind that the majority of marketplace loans are used to
As Levitin acknowledges, usury caps are crude tools. Interest rate caps impact only part of what determines the cost of a loan. Usury caps can lead to loan arrangements being distorted in ways that make the loans legal but worse for the borrower. We see examples of this in the shift from payday to “payday
Levitin is right that we don’t know if the borrowers being cut off from marketplace loans are finding credit elsewhere. Even if borrowers are finding credit elsewhere, however, we should be concerned that the replacement credit is inferior to the marketplace loans they are being denied. The burden is on those who advocate denying borrowers their first choice to show that the borrower isn’t being harmed.
Madden should not be the end of the discussion
With the expansion of nonbank credit providers, the role of technology, and evolving regulation and