Who Bears the Risk? Federal Court Holds That a Purchaser of Unsecured Consumer Loans Is the “True Lender,” Voiding Enforceability of the Loans

By Irene C. Freidel and David D. Christensen

A California federal court has held that the purchaser of small-dollar consumer loans is the “true lender” and thus subject to state usury laws, even though a separate tribal entity funded and closed the loans in its own name. See Consumer Financial Protection Bureau v. CashCall, Inc*. The court’s holding, which adopts the arguments of the Consumer Financial Protection Bureau (“CFPB”) and renders the loans serviced by CashCall unenforceable, challenges the business model that many marketplace lending platforms use to offer alternative, unsecured loans to consumers. Generally speaking, partnerships between marketplace platforms and tribal entities, state-chartered (and federally insured) banks, or national banks are intended to protect the platforms from the substantial licensing and compliance burden of state lending and licensing laws, and also to permit loans that might otherwise exceed the borrower’s home state usury limit. The recent CashCall decision, however, is another reminder that state and federal regulators, as well as plaintiffs’ attorneys, may be able to pierce these partnerships where a court finds that the financial institution funding and closing the loan does not bear substantial risk on those loans.

In the California case, the CFPB alleged that CashCall engaged in unfair, deceptive, and abusive acts and practices under the Consumer Financial Protection Act of 2010, 12 U.S.C. § 5536(a)(1)(B) (“CFPA”), “by servicing and collecting full payment on loans that state-licensing and usury laws had rendered wholly or partially void or uncollectable.” The CFPB’s theory of liability hinged on showing that CashCall, and not the tribal entity that funded and closed the loans, was the “true lender.” As in similar cases**, the court held that the determining factor for such an inquiry is whether the partner financial institution (here, the tribal entity) bore a sufficient monetary burden on the loans. In CashCall, the court held that it did not.

Specifically, the court found that, among other things, (1) the tribal entity funded the loans through a reserve account into which CashCall deposited money sufficient to fund two days of loans; (2) CashCall purchased all of the tribal entity’s loans and paid more than the funded amount for each loan; (3) CashCall promised the tribal entity a minimum monthly payment of $100,000; (4) CashCall purchased each loan before any payments were due and assumed all default risk upon assignment; and (5) CashCall agreed to indemnify the tribal entity with respect to any civil, criminal, or administrative actions that arose from the lending program. In short, the court held that “the entire monetary burden and risk of the loan program was placed on CashCall.”

Rejecting the loan agreements’ choice-of-law provision in favor of the Cheyenne River Sioux Tribe (which the court found had no substantial relationship to the parties or the transactions), the court held that the loans at issue were void or uncollectable under the usury and consumer protection laws of most of the borrowers’ home states. The court concluded that, because CashCall was collecting on unenforceable loans and did not notify borrowers that their loans were void, CashCall had engaged in deceptive conduct in violation of the CFPA. It entered partial summary judgment for the CFPB against CashCall, as well as against CashCall’s default servicer Delbert Services and CashCall’s CEO and sole owner J. Paul Reddam.

In ruling in the CFPB’s favor, the court rejected each of the defendants’ arguments, including that: (i) Congress did not authorize the CFPB to “transform a state law violation into a violation of federal law” under the CFPA; (ii) the CFPB is seeking to establish a usury limit, which is expressly prohibited by the CFPA; (iii) the CFPB is violating defendants’ due process rights by seeking to penalize them for UDAAP violations without fair notice; and finally, (iv) the CFPB’s structure is unconstitutional.

Even if the lending arrangement involved in the CashCall case is not typical of marketplace lending platforms’ bank partnerships, the case is nevertheless a stark reminder that platforms face scrutiny from regulators and plaintiffs’ counsel. Participants in these arrangements may need to reassess their terms to ensure that the funding institution maintains a sufficient level of risk on the subject loans. We will continue to monitor and report on further developments in this area.

*No. 15-cv-7522-JFW (C.D. Cal. Aug. 31, 2016).

**See, e.g., Commonwealth v. Think Finance, Inc., 2016 WL 183289 (E.D. Pa. Jan. 14, 2016); CashCall, Inc. v. Morrissey, 2014 W. Va. Lexis 587 (May 30, 2014).