The Supreme Court recently “raised the stakes” concerning its potential review of a significant ruling of the Second Circuit by asking the Obama Administration whether the Supreme Court should review the case. The Obama Administration’s recommendation could potentially nudge the Court into reviewing the significant case that could permanently alter the national marketplace lending industry moving forward by jeopardizing a prevalent funding model used in the industry.
The matter, Madden v. Midland Funding, concerns the current bank-partnership model that many marketplace or alternative lenders use to avoid compliance with individual states’ usury laws and interest-rate caps. The Second Circuit, in the underlying matter involving the sale of charged-off credit card debt by a major national bank’s subsidiary, barred the transfer to the debt buyer of the bank’s authority to charge interest rates in excess of state usury caps. The decision in May 2015 created significant uncertainty for the sustainability of marketplace lending models.
Marketplace lenders have created sustainable bank-partnership models by taking advantage of an originating bank’s interest rate exportation authority. Under this, a bank may export the favorable interest rate authority from the state in which the bank is located—for example, Utah—to consumers residing in other states. Marketplace lenders can export these higher interest rates and avoid state-by-state usury laws that would otherwise cap the interest rates marketplace lenders could charge consumers. National banks are exempt from state interest rate caps, while many nonbank financial services companies—including marketplace lenders—are not. Hence, marketplace lenders rely on an originating bank’s ability to export interest rates, the very substance of which Midland Funding has called into question.
The defendants in Midland Funding applied for a writ of certiorari to the Supreme Court, which at present is weighing whether to accept the matter for consideration. Should the Second Circuit’s holding be upheld, either by the Court’s review on appeal or by refusing to grant the petition for certiorari, marketplace lenders could be forced to comply with interest-rate caps imposed by individual states. The Court’s decision clearly carries significant risk for marketplace lenders.
The Supreme Court’s recent order asks the Obama Administration—through the Solicitor General—for its opinion on whether the Court should grant review of the Second Circuit’s opinion. The decision likely opens the door for the Obama Administration—and with it, the relevant federal banking and consumer protection agencies—to weigh in on both the defendant’s petition for certiorari as well as the underlying issues the Second Circuit addressed. The Supreme Court will likely assign significant weight to whether the Obama Administration believes the Court should review the Second Circuit’s decision.
The Court’s request of the Obama Administration extends the Court’s review period of the Second Circuit decision, with oral argument not likely occurring until the fall should the Court grant the petition for certiorari. This delay means continued uncertainty for all marketplace lending participants.
Should the Court refuse to grant the defendant’s petition for certiorari, the Second Circuit’s holding will be effective only in the Circuit’s jurisdiction of New York, Connecticut and Vermont. Given the recent death of Justice Antonin Scalia and the possibility that the Supreme Court could operate in the fall session with only eight justices, the Court could also grant the defendant’s petition for certiorari but affirm via an equally divided court, ensuring the same result as above but creating even further uncertainty for the marketplace lending industry. Any outcome besides the Court overturning the Second Circuit’s opinion likely has broader implications on, and creating exceptional uncertainty for, the marketplace lending industry in all states.
Some marketplace lenders, such as Lending Club, have taken proactive steps to address potential issues in their lending portfolios created by the Midland Funding opinion. Lending Club’s originating bank will now retain an interest in all loans after selling the loans off Lending Club’s platform, allowing Lending Club to export the Utah interest rates from inception. Marketplace lenders must decide whether to follow Lending Club in altering funding contracts to allow interest rate exportation. Otherwise, lenders may risk significant structural impacts to their business models should the Supreme Court adopt the Second Circuit’s holding. Investors in marketplace lending products are likewise viewing the Supreme Court’s actions—and the industry’s response—with great concern, given the impact the Court’s ruling could have on their investments in these loans.
We will provide a further update once the Solicitor General has filed its responsive brief to the Supreme Court’s inquiry.