Installment Lender Using Bank Partner Model Needs Maryland License, Court of Appeals Rules
The Maryland Court of Appeals, the state's highest court, in CashCall, Inc. et al. v. Maryland Commissioner of Financial Regulation, recently affirmed the judgment of the Court of Special Appeals (MCSA) directing CashCall to cease doing business in Maryland without a Credit Services Business Act (MCSBA) license and to pay $5.6 million in penalties in connection with loans already made. While much attention has been focused on the risks created by Madden v. Midland Funding, LLC and the so-called "true lender" issue, the CashCall decision illustrates how the bank partner structure used by many lenders can be threatened by state licensing statutes as well.
The case arose out of CashCall advertising on its website to consumers and offering them a method to apply for loans online. The loans were made by out-of-state, state-chartered banks at interest rates significantly in excess of the maximum rate permitted by Maryland law, and the banks also charged loan origination fees. Shortly after origination, the banks sold the loans to CashCall, which collected all payments on the loans.
The Commissioner contended that CashCall was a "credit services business" as defined by state law, because it assisted consumers in obtaining an extension of credit "in return for the payment of money or other valuable consideration." CashCall argued that, in the absence of a direct payment to it from the consumer, it could not be properly classified as a credit services business.
The Maryland Court of Appeals granted certiorari ostensibly to review two issues—whether the MCSA erred in holding that the MCSBA does not require a direct payment from the consumer despite a seemingly contrary 2012 ruling by the Court of Appeals that the MCSBA only applies where a payment comes directly from the consumer; and whether a borrower's repayment of principal and interest can be treated as a direct payment in return for CashCall's assistance in obtaining the loan simply because the principal included an origination fee, the economic benefit of which inured entirely to the banks. However, the court narrowed its focus, "consolidating" and rephrasing the questions to the single question of whether the MCSBA definition of "credit services business" requires a "direct payment from a consumer to an entity whose primary business is to market, facilitate, and ultimately acquire the loans it arranged."
In affirming the MCSA's judgment, the Court of Appeals ruled that the MCSA had correctly concluded that no direct payment is required by the MCSBA where a company is exclusively engaged in assisting consumers to obtain loans. The Court of Appeals agreed with the MCSA that the direct payment requirement in its 2012 ruling should be limited to "'mainstream' businesses that, like [the income tax preparer involved in the ruling, which assisted consumers in obtaining refund anticipation loans], offer loan arrangement services as an ancillary service, separate and distinct from the principal services they provide to Maryland consumers."
According to the court, CashCall was a "credit services business" because it received compensation "in return for" assisting consumers in obtaining loans. In the court's view, such compensation took the form of "the exclusive right to collect all payments of principal, interest and fees, including the origination fee." The court also agreed with the MCSA that, in any event, CashCall did receive direct payment in return for services to consumers when it acquired the loans and collected "the full value of the loan, including the origination fee paid by the consumer."
Although the decision did not expressly turn on a "true lender" theory, the court appears to have been influenced by it in deciding the licensing issue. In particular, the court found that CashCall was "the de facto lender" because it "received payment from the consumer for the 'origination fee,'" which Black's Law Dictionary defines as a "fee charged by a lender for preparing and processing the loan."
The Court of Appeals reached an ominous conclusion regarding the impact of federal preemption on the CashCall program. As the court noted, the MCSBA prohibits a credit services business from assisting a consumer in obtaining a loan at an interest rate that exceeds the maximum rate permitted by Maryland law "except for federal preemption of State law." However, according to the court, "[a]lthough federal law allows federally insured banks to charge out-of-state consumers the same interest rate permitted by the bank's home state, regardless of the interest rate caps imposed by the law of the consumer's resident state," the MCSBA does not permit a credit services business to "assist a consumer in obtaining a loan from any in-state or out-of-state bank, at an interest rate prohibited by Maryland law."
Under the court's reading, the MCBSA would effectively prohibit CashCall from assisting a bank in the origination of loans at rates expressly authorized by federal law. In Barnett Bank, however, the U.S. Supreme Court made it clear that any state law that materially impairs the exercise of a federal banking power is preempted. It is unclear whether CashCall intends to seek certiorari from the U.S. Supreme Court on this issue.
While apparently driven by the underlying facts involving a business that was viewed not to be in the "mainstream," the decision demonstrates how a state financial regulator can potentially use its licensing powers to effectively shut down an online business using the bank partner model. In addition to such state licensing threats, marketplace lenders continue to face uncertainty as a result of the U.S. Supreme Court's recent denial of certiorari in Madden. In light of these developments, and ongoing licensing inquiries by other state regulators, participants in marketplace lending programs and others utilizing the bank partnership model would be well-advised to revisit their compliance with state licensing laws and their vulnerability to "true lender" and Madden challenges.
Ballard Spahr's Marketplace Lending Task Force is nationally recognized for counseling marketplace lending businesses in both the peer-to-peer and small business spaces. We offer soup-to-nuts guidance, working with startup alternative lenders, long-established market leaders, institutional investors, and others. We document and advise on the structure and strategy of bank, platform, and investor relationships, assist in concluding account servicing arrangements, and provide extensive consumer regulatory advice and state licensing guidance.
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