In a state enforcement action alleging violations of California’s lending law and seeking to enjoin continued lending to state residents, a California Court of Appeal has ruled that tribal sovereign immunity shielded the two tribally affiliated entities that operated the Internet payday lending businesses at issue.

In The People of the State of California v. Miami Nation Enterprises, et al., the appellate court affirmed the trial court’s order dismissing the enforcement action for lack of subject matter jurisdiction, based on the defendants’ entitlement to tribal sovereign immunity. One of the payday loan operators was a tribal entity “wholly owned and controlled” by a federally recognized Indian tribe. The other operator was a “chartered tribal corporation” that was wholly owned by a second federally recognized Indian tribe.

Both entities were formed for the stated purpose of funding governmental services provided by their respective tribes, including social welfare programs, and the articles of incorporation or tribal legislation underlying their formation provided that the entities would have sovereign immunity from suit.

The appellate court concluded that both tribal entities qualified for tribal sovereign immunity based on an “arm of the tribe” analysis. The court observed that the most significant factors in determining whether such immunity protects a tribal entity are “the tribe’s method and purpose” for creating the entity and that such factors “should be given predominant, if not necessarily dispositive, consideration.”

Refusing to be distracted by the state regulator’s pejorative characterization of online payday lending, the court noted that “tribal immunity does not depend on our evaluation of the respectability or ethics of the business in which a tribe or tribal entity elects to engage.” According to the court, absent “extraordinary circumstances,” a tribal entity functions as an “arm of the tribe” if it “has been formed by tribal resolution and according to tribal law, for the stated purpose of tribal economic development and with the clearly expressed intent by the sovereign tribe to convey its immunity to that entity, and has a governing structure both appointed by and ultimately overseen by the tribe.”

Most notably, the court rejected the state regulator’s attempt to characterize the tribal payday lending businesses as a “sham” or “rent-a-tribe” scheme based on the delegation of the businesses’ day-to-day operations to a third-party, non-tribal entity and the tribal entities’ receipt of only a modest percentage of the gross revenues. In the court’s view, a tribal entity’s entitlement to sovereign immunity should not be based on whether it contracted “with non-tribal members to operate the business” or “could have insisted on a higher percentage than they actually received.”

The court found it persuasive that the tribal entities were not “merely passive bystanders” and instead, under the management agreements with the third party, had final authority to approve or disapprove loans, and had oversight and control over day-to-day management. We note that the decision did not address the legality of the operators' conduct, merely whether they could be subject to a lawsuit.

In contrast to the California court, a federal court in New York recently refused to enjoin a New York regulator from taking direct and indirect actions that would impair the operations of online tribal lenders. The court rejected the tribal lenders’ attempt to assert tribal sovereign immunity as a sword against the state regulator in part on the ground that New York’s action was directed at activity that took place entirely off of tribal lands, involving New York residents who never left the state. It is unknown at this time whether the court would have reached a different decision if the New York regulator’s actions had included an attempt to sue them directly.

Tribal payday lending has also been a target of the Consumer Financial Protection Bureau, which rejected the request of tribal lenders to set aside civil investigative demands they received from the Bureau based on the argument that, as “arms of the tribes,” they were entitled to sovereign immunity against federal government suits. A key difference between the Bureau’s investigation and the California case is the identity of the enforcement agency—in one case a state agency and in the other case a federal agency.

Ballard Spahr’s Consumer Financial Services Group is nationally recognized for its guidance in structuring and documenting new consumer financial services products, its experience with the full range of federal and state consumer credit laws throughout the country, and its skill in litigation defense and avoidance (including pioneering work in pre-dispute arbitration programs).

For more information, please contact CFS Practice Leader Alan S. Kaplinsky at 215.864.8544 or kaplinsky@ballardspahr.com or CFS Practice Leader Jeremy T. Rosenblum at 215.864.8505 or rosenblum@ballardspahr.com.


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