We expect certainty in the law, especially when it comes to a commercial transaction. A valid and enforceable contract should not become unenforceable simply because it was sold. And worse, it should not be unlawful for the buyer to enforce the purchased contract.
But that is the decision of the U.S. Court of Appeals for the Second Circuit in Madden v. Midland. The facts are not remarkable. Ms. Madden applied for and received a credit card from Bank of America, a national bank. Bank of America transferred her account to FIA Card Services, also a national bank, who issued her a change in terms agreement applying Delaware law.
The National Bank Act and State Usury Law
The National Bank Act allows national banks to export the lawful rates of interest of their home state to a foreign jurisdiction – regardless of what interest rate ceilings (called usury laws) the foreign state imposes. So here, Ms. Madden’s agreement allowed FIA to charge interest of 27 percent per annum, which was permitted by Delaware law.
Madden defaulted on her credit card debt and approximately $5,000 was “charged-off” as uncollectable. FIA sold the debt to Midland. Midland asked Madden to pay the charged-off balance, plus the agreed to annual interest of 27 percent that had accrued since its purchase. Madden’s response was to file a putative class action complaint alleging that because New York’s usury law capped annual interest at 25 percent, Midland’s effort to collect the agreed 27 percent annual interest violated the Fair Debt Collection Practices Act (FDCPA).
Midland fought the allegation, relying on well-settled law that because the credit card agreement provided for a lawful interest rate in the hands of FIA, it was lawful for Midland to collect the valid, agreed upon rate. The trial court agreed and dismissed Madden’s case.
Legal Today – Illegal Tomorrow
Madden appealed the decision. The Second Circuit recognized that the National Bank Act expressly allows national banks to “charge on any loan … interest at the rate allowed by the laws of the State, Territory, or District where the bank is located.” See 12 U.S.C. § 85. The Act also “provide[s] the exclusive cause of action” for usury claims against national banks and thus preempts claims under state usury laws.
This would seem to favor Midland because, as the assignee of a national bank, it should receive the benefit of the National Bank Act, deem the loan legal and recover interest at the rate allowed by Delaware, the state where the assignor bank is headquartered.
Not so, said the Second Circuit, reasoning that, while under certain circumstances preemption under the National Bank Act could be extended to entities that are not national banks, in order for this exception to apply the state law at issue must “significantly interfere with a national bank’s ability to exercise its power under the Act.” For example, the U.S. Supreme Court has held that operating subsidiaries and agents of national banks are entitled to National Bank Act preemption. Thus, the Court noted, in most of the cases where the National Bank Act has been extended to a non-national bank entity, the non-bank entity was acting on behalf of a national bank in the process of conducting the bank’s business. It concluded that if the national bank did not retain an ownership interest, the National Bank Act ceased to be effective against the contract.
Under the Court’s rationale, charging an illegal rate of interest is permissible so long as the entity charging the illegal rate is a national bank or a person collecting interest for a national bank. The National Bank Act, under this reading, preempts a state from enforcing its usury law as long as the contract remains in the hands of a national bank.
Other Circuits Disagree
Two decisions from the Eighth Circuit Court of Appeals appear to conflict. In Krispin v. May Department Stores, 218 F. 3d 919 (8th Cir. 2000), the Eighth Circuit applied the National Bank Act to preempt state law usury claims against a department store chain (that was not a national bank) which issued credit cards and later assigned the accounts to a wholly-owned national bank. The key here was that the account assignment to the national bank caused the bank, and not the store, to be the originator of the account.
In Phipps v. FDIC, 417 F.3d 1006 (8th Cir. 2005), the plaintiffs sued under Missouri law to recover a “finder’s fee” paid to a non-bank entity upon the sale of mortgage loans. The court held that the fees constituted “interest” under the National Bank Act and held that the originating bank, not the assignee, was the real party in interest and the claims were preempted.
The Second Circuit distinguished these decisions on the basis that a national bank always retained some interest in the credit account. Others would say that the Eighth Circuit’s decisions focus on the credit account at its origination, so that if the National Bank Act made the credit account valid at the time of origination, it continues to remain valid and enforceable.
Decision Can Devalue Purchased Debt
One of the purposes of the National Bank Act is to prevent the application of state law which would “significantly interfere” with the operations of a national bank. It is well-settled that state usury laws pose such interference. The Second Circuit acknowledged that its decision might decrease the value of portfolios, but that devaluation does not “significantly interfere” with the operation of a national bank.
Others would disagree. The Office of the Comptroller of the Currency, which regulates national banks, notes that debt sales can turn “nonperforming assets into immediate cash proceeds” while “reducing the use of internal resources to collect delinquent accounts.” OCC Bulletin 2014-37, Risk Management Guidance (August 4, 2014).
Application Beyond the Second Circuit
The decision applies to litigation of the issue in federal courts within the Second Circuit (New York, Connecticut, Vermont and Puerto Rico). It impacts debt purchased from national banks where the rate of interest exceeds the state usury interest rate. The decision only addressed interest charged when the debt was acquired by the non-bank debt buying company.
Other laws provide exceptions to state usury interest rates. These laws are not addressed by the decision.
It is expected the decision will be used in FDCPA litigation outside the Second Circuit. It remains to be seen whether courts beyond the Second Circuit will adopt the decision. We will touch on this decision in our June 18 webinar, Collecting Statutory Prejudgment Interest – The FDCPA Risks.
