In 2015, the US Court of Appeals for the Second Circuit in New York stunned markets when it issued an opinion in Madden v. Midland Funding, LLC that ignored the “valid-when-made” principle of usury law that had been in place for decades. That decision impugned much of the secondary consumer debt market, including credit card securitizations, and has created uncertainty in the market that remains far from settled, even with some recent securitization-friendly court case opinions.
The so-called “valid-when-made” doctrine is (i) a longstanding common-law contracts principle providing that a non-usurious loan cannot later become usurious on its transfer to another party, combined with (ii) the National Bank Act preemption of state usury laws for national banks and federal thrifts (federally regulated banks). Valid-when-made traditionally preserves a debt contract’s original terms when a federally regulated bank transfers debt exceeding the applicable state usury rate (above-usury) to a nonbank investor that otherwise would not be permissible under the particular state law. If valid-when-made were suddenly to disappear, then depending on the state, the above-usury debt underlying many secondary transactions could become void, unenforceable, subject to forfeiture, or even criminal.
Madden did exactly that, disappearing valid-when-made. In Madden, a national bank sold a nonperforming above-usury loan to a nonbank secondary purchaser (a debt collector), and the debtor brought suit challenging the purchaser’s attempts at collection of 27% interest in New York (which caps interest civilly at 16% and criminally at 25%). Valid-when-made should have mooted the debtor’s claims. Astoundingly, however, Madden failed to consider any valid-when-made analysis, and instead issued a finding that federal law did not preempt New York state usury law as applied to the nonbank debt purchaser. The validity of the Madden debt, and along with it the entire secondary market for above-usury consumer debt, was thus kneecapped.
More recently, in September 2020, the US New York District Courts for the Western District in Peterson v. Chase Card Funding, LLC, and the Eastern District in Cohen v. Capital One Funding, LLC, distinguished Madden and upheld standard credit card securitizations. Nevertheless, both District Courts ruled from within the restrictive Madden precedent rather than return to a robust, and renewed, valid-when-made framework. As a result, some questions remain, and the dust is far from settled.
Bound by the Madden precedent, Peterson and Cohen nonetheless distinguished Madden factually and narrowed its effect as to credit card securitizations. Both the Peterson and Cohen securitizations employed standard sales of credit card receivables by a national bank lender to a non-bank affiliate and then on to a nonaffiliated, nonbank issuer trust, which issued notes backed by the receivables that then were sold to investors. The bank meanwhile retained ownership of the underlying account, including the right to set above-usury interest rates. This structure differed markedly from the facts in Madden, where not just the receivables but rather the entire debt contract was sold to a nonbank entity. Because the national bank still owned the account and could set the interest rate, Peterson and Cohen found that federal law preempted state usury law, thus preserving the standard credit card securitization structure.
Interestingly, both Peterson and Cohen sidestepped any reliance on valid-when-made, which in the interim had evolved in response to market concern. Peterson obliquely addressed, but ultimately did not rely on, the arguably applicable “Madden fix” final rule published by the Office of the Comptroller of the Currency (OCC) in June 2020, which regulates federally chartered banks, that resuscitated and codified valid-when-made as a matter of federal preemption for debt originated by federally chartered banks. Cohen meanwhile dodged the defense’s New York common-law valid-when-made argument as “moot” following its analysis distinguishing Madden. Consequently, both Courts left credit card securitizations open to attack under the precedential Madden framework in the event of, for example, a securitization portfolio sale by an originating bank: swapping in a nonbank account owner would apparently still result in the securitized debt becoming usurious and potentially unenforceable.
Further caution is warranted. First, both Peterson and Cohen concerned federally chartered banks subject to the OCC regulation, and, arguably, the July 2020 regulation issued by the Federal Deposit Insurance Corporation (FDIC) as a twin to the OCC regulation, covered state-chartered FDIC-insured banks. However, these administrative actions have not been tested in the US Court of Appeals for the Second Circuit, which decided Madden. In addition, the Attorneys General of California and New York have brought lawsuits jointly in the US District Court for the Northern District of California challenging the OCC and FDIC regulations.
Finally, should public awareness of this matter grow, perhaps filtered through predatory lending concerns raised by plaintiff-side amicus briefing in Cohen, a new presidential administration might eventually rescind both “Madden fix” regulations, or unpredictable action might be taken at the congressional, judicial or state levels. As such, Peterson and Cohen notwithstanding, there are miles to go before the law of interest rates and securitizations is settled.