On June 27, debt collectors suffered a big legal blow as the Supreme Court allowed a class-action claim against debt collector Encore Capital Group Inc.’s Midland Unit to proceed, refusing to hear its claim that it should be exempt from state usury laws that cap interest rates for lending. In rejecting Midland’s Petition for Certiorari, the Supreme Court left intact Second Circuit's May 2015 ruling that when the debt collector bought unpaid loans from Bank of America, it was not exempt from state usury laws.
Companies like Midland purchase tens of millions of dollars of soured loans from banks for pennies on the dollar. These debt collectors seek to recover a portion of the overdue debt that the bank has given up on collecting. In the Second Circuit, Midland argued that the U.S. National Bank Act preempted New York’s usury law because they bought the lead plaintiff’s loan from a Bank of America unit that is regulated under the National Bank Act, which is a federal law. However, the court said the federal statute did not apply to Midland because it is not a national bank and it was not acting on behalf of one.
The Lawsuit Details
The class action was brought by Saliha Madden, a resident of New York who argues that she should not have to pay the 27 percent interest Midland claims she owes on credit card debt that the debt collector bought from Bank of America because her home state caps interest rates for lending at 25 percent. The Second Circuit ruled that borrowers in some circumstances can invoke their state’s usury laws even if the loan originates in another state. This ruling applies only to borrowers in the three states in the Second Circuit’s jurisdiction: New York, Connecticut and Vermont. However, consumers in other states are likely to bring similar lawsuits.
The Supreme Court’s rebuff to the debt collector was a victory for borrowers, giving them more power to enforce state limits on interest rates. Furthermore, it is a blow not only to debt collectors but also to online consumer loan companies such as LendingClub Corp. and Prosper Marketplace Inc. The Supreme Court’s upholding of the Second Circuit decision may prevent these online marketplace lenders from avoiding usury laws by originating loans in states without rate caps. These lenders match up people seeking consumer or small-business loans with hedge funds, pensions, and individual investors. LendingClub has stayed one step ahead of the changing legal landscape by stopping lending at rates above rate caps. In February, the company said that it was changing its relationship with its issuing bank. In order to continue bypassing usury laws, the issuing bank will maintain an economic interest in all loans after they are sold.
Lawyers who have studied the ruling say that its reach is more limited than what some industry officials claim. It would likely not apply, for example, to credit cards, because even when the debt is bundled and sold to non bank investors as part of securitizations, the bank retains a relationship with the borrower. The original interest rate on the credit card would still be charged after sale of the debt because of this continuing relationship between the bank and the borrower.
Uncertain OutcomesThe exact reach of the Second Circuit ruling in the entire securitization and lending industry is uncertain. It may have a destabilizing effect on the industry because of the high number of participants that operate through a bank partnership model. Online marketplace lenders and other entities that participate in bank partnership programs may have a harder time acquiring loans originated by depository institutions because they will no longer be able to collect the interest permitted by the underlying credit agreements. In turn, this will narrow borrowers’ choice in lenders. Nevertheless, what is clear is that the Supreme Court’s decision not to grant Midland’s petition empowers consumers in New York, Connecticut, and Vermont to fend off debt collectors who attempt to charge unreasonably high interest rates that exceed the state-imposed caps.