On June 2, 2020, the Office of the Comptroller of the Currency (“OCC”) published a final rule clarifying the permissible interest rates on transferred loans in relation to the “valid-when-made” doctrine. According to the “valid-when-made” doctrine, a loan is valid at its inception and cannot become invalid or unenforceable based on its original terms due to a subsequent transfer of the loan. The new OCC rule clarifies that the interest rate set forth in the original terms of the loan is valid upon transfer, regardless of state usury laws capping interest rates. This rule sought to correct confusion in the common law, and recent case law, regarding the applicability of original interest rates through the “valid-when-made” doctrine.
The global economy is grounded in liquidity and the efficient and reliable exchange of value. One of the major assets and streams of revenue for national banks is the sale and transfer of loans to other entities. The “valid-when-made” doctrine, which was established over 100 years ago, provided banks with the assurance that transferring loans to other entities would result in enforceable contracts based on the original terms of the loan. This allowed banks to securely and reliably transfer and sell loans without fear of legal consequences or potential unenforceability of the loan.
However, the Second Circuit cast doubt on the “valid-when-made” doctrine when it ruled in its 2015 decision in Madden v. Midland Funding that the original terms of the loan may not be upheld upon transfer if the state usury laws conflict with the original interest rate. This decision caused confusion in the loan finance market, resulting in significant drops in the sale and transfer of loans from national banks for fear that state usury laws would render the loan unenforceable.
On November 2019, the OCC, together with the Federal Deposit Insurance Corporation (“FDIC”), published a proposed rule clarifying that interest rates outlined in the initial loan agreement will not be subject to state usury laws upon subsequent transfer or sale of the loan. While most in the industry applauded the rule for resolving the confusion in the common law and providing security and assurance regarding loan transfers, some were strongly opposed, arguing that the OCC rule exceeded its agency authority and was contrary to the Congressional intent in the National Bank Act, which sets forth limits on setting interest rates based on applicable state law.
After analyzing the comments sent in response to the proposed rule, the OCC rule was finalized, providing that when a national bank or state or federal savings associations sells, assigns, or transfers a loan, the interest that was permissible prior to the transfer continues to be permissible following the transfer, regardless of state usury laws which implement caps on interest rates. The new rule effectively codifies the “valid-when-made” doctrine, stating that loan transfers will not affect the original terms of the loans, regardless of various state laws in the jurisdiction of the transferee. The promulgation of this new rule should greatly reduce litigation concerning loan transfers and is expected to positively impact the loan finance market and availability of loan sales and transfers. The FDIC still needs to finalize its proposal.
*Special thanks to Chana Ben-Zacharia for her assistance in preparing this post