On June 27, 2016, the Supreme Court denied certiorari in Madden v. Midland Funding. The decision is unsettling for the banking and marketplace lending industries, which had hoped the Supreme Court would seize the opportunity to reverse the Second Circuit’s controversial holding. As a result of the denial, secondary (non-bank) debt purchasers operating within the Second Circuit are ostensibly prohibited from collecting interest charges in excess of state usury caps – a practice that traditionally had not been an issue as long as the interest charges were permissible under the original loan agreements.
The Solicitor General and the OCC had argued in a brief to the Supreme Court that the Second Circuit clearly misunderstood the underlying law. Despite heavily criticizing the Second Circuit’s reasoning, the Solicitor General recommended that the Supreme Court deny certiorari primarily because there was no actual circuit split and the defendant could succeed based on a choice-of-law question on remand. The Supreme Court likely relied heavily on the Solicitor General’s brief when making its decision. Some commentators have speculated that the Court simply decided to wait to address the issue until after Antonin Scalia’s vacancy has been filled.
Concerned investors now turn their attention to the District Court for the Southern District of New York, where the controversy returns on remand to settle the unresolved choice-of-law question. In reaching its decision, the Second Circuit indicated that a choice-of-law clause contained in the cardholder’s amended agreement could ultimately allow Midland (the secondary investor) to charge higher interest rates permissible under Delaware law. (See Madden v. Midland Funding, LLC, 786 F.3d 246, 253 (2d Cir. 2015). The Supreme Court’s refusal to hear the case has arguably raised the stakes for this issue, as many lenders hope that the District Court’s holding will allow them to utilize choice-of-law provisions to maneuver around the Second Circuit’s holding. However, such lenders may be overly optimistic. Judicial review of choice-of-law clauses generally requires a fact-specific inquiry, which means that any review will be costly. Further, courts often chose to ignore such clauses to progress policy concerns – especially in the context of consumer contracts, which comprise a large portion of the secondary debt market.
Ultimately, the longevity of the Second Circuit’s holding is questionable. The holding appears to squarely contradict the well-established “valid-when-made” doctrine, which essentially states that an assigned debt carries its original legal treatment (i.e., a debt that was not usurious when made does not become usurious when the identity of the debtholder changes). Other circuits are likely to invoke the doctrine, which will create a ripe circuit split for the Supreme Court to review.
Furthermore, the holding will likely be reconsidered after the economic fallout from the Second Circuit’s decision. As long as the decision remains in effect, loans originating in the Second Circuit will be much less attractive to secondary investors (a fact that prices will certainly reflect), and compliance costs will increase as lenders rush to understand the effects of state usury laws upon extensions of credit that had previously not been subject to such laws.