Key Takeaways
- A long-awaited Third Circuit decision held that securitization trusts holding student loans are “covered persons” subject to the CFPB’s enforcement and investigative powers because they “engage” in offering or providing consumer financial products or services.
- The Third Circuit’s decision was rooted in the language of the trust agreement, which provided that the trusts’ purpose was to “engage in” certain activities relating to the ownership of the student loans.
On March 19, 2024, the U.S. Court of Appeals for the Third Circuit issued an opinion in Consumer Financial Protection Bureau v. National Collegiate Master Student Loan Trust et. al that involved fifteen special-purpose trusts (the “Trusts”) formed in connection with the securitization of over 800,000 student loans.1 In the ordinary course of the securitizations, the Trusts contracted with third-party administrators, servicers and special servicers through various agreements, which “[made] clear that the Administrator will ‘perform’ the ‘duties of the [Trusts]’ as well as ‘the duties and obligations of the Owner Trustee on behalf of the [Trusts] under … the Trust Agreement.’”2 Certain of those responsibilities were delegated by the administrator to servicers and/or special servicers, and sometimes further delegated to subservicers.3 In 2014, the Consumer Financial Protection Bureau (“CFPB”) commenced an investigation into allegations that servicers and sub-servicers had engaged in unfair and deceptive debt collection and litigation practices as part of their collection efforts.4 As part of the investigation, the CFPB issued a civil investigative demand to each Trust “for information on collections lawsuits brought against borrowers for defaulted student loans.”5
The issues before the Third Circuit were (1) whether the Consumer Financial Protection Act (“CFPA”) is unconstitutional because it limits the President’s power to remove its director and, relatedly, whether the CFPB was required to ratify the underlying action and (2) whether the Trusts are “covered persons” subject to the CFPA.6
The Trusts first argued that the statute establishing the CFPB7 was unconstitutional because the CFPB’s director was improperly insulated from the President’s removal power.8 Both the District Court and the Third Circuit agreed with the Trusts that the statutory limitation on the President’s removal power was unconstitutional, but severed the unconstitutional language from the statute and left the rest of the statute intact.9 The Third Circuit, however, rejected the Trusts’ argument that the CFPB was required to ratify the lawsuit prior to the expiration of the statute of limitations, and agreed with the CFPB that the lawsuit may proceed notwithstanding this constitutional deficiency.
The Trusts also argued that they were not “covered persons” under the scope of the CFPB.10 The CFPB is allowed to take action “to prevent a covered person or service provider from committing or engaging in an unfair, deceptive or abusive act…”11 Under the CFPA, a “covered person” is “any person that engages in offering or providing a consumer financial product or service.”12 The Trusts acknowledged that their subservicers “offer[ed] or provid[ed] a consumer financial product or service,” as they collected debt on student loans, but contended that they were not “engaged” in any conduct because they outsourced the activities to third parties.13 Acknowledging that there was room for reasonable disagreement, the District Court rejected the Trusts’ argument and explained that “[t]he Trusts cannot claim that they were not ‘engaged in’ a key part of their business just because they contracted it out.’”14 The Third Circuit agreed, relying on several dictionary definitions of “engage” and a Supreme Court case that clarified that, in various other statuary contexts “engaged” means “occupied, employed or involved in something.”15 The court also looked to the Trust Agreements, which stated that “[t]he purpose of the Trust is to engage in the following activities and only these activities…”16 Echoing the District Court, the Third Circuit determined that “[t]he Trusts cannot claim that they did not ‘take part in’ collecting debts” just because they hired a third party provider to do so on their behalf.17
With the interlocutory appeal questions decided, the case now will return to the District Court.
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As we wait for the District Court to make a determination on the merits, market participants are left to grapple with the consequences of the ruling that securitization trusts can be “covered persons” within the meaning of the CFPA. Under the CFPA, “covered persons” may not “engage in any unfair, deceptive, or abusive act or practice,”18 and may be required in certain cases to open their books and records to the CFPB.19
In addition, the CFPB regulates not only “covered persons,” but also any “service provider” that, subject to certain exceptions, “provides a material service to a covered person in connection with the offering or provision by such covered person of a consumer financial product or service.”20 “Service providers” are subject to the same prohibition against engaging in unfair, deceptive or abusive acts or practices as covered persons,21 and in certain cases may be subject to direct supervision by the CFPB.22 Various statutory provisions and regulatory guidance govern the relationship between certain covered persons and their service providers, and the CFPB has indicated that it expects certain covered persons to perform due diligence on the service provider, monitor the service provider for compliance, and to promptly address any problems that arise with the service provider.23
The CFPA also authorizes the CFPB to bring a lawsuit or an administrative proceeding against a “covered person” to enforce the provisions of the CFPA, and may obtain a panoply of relief in such actions, including (i) the recission and reformation of contracts, (ii) a refund of money or return of real property, (iii) restitution, (iv) disgorgement or compensation for unjust enrichment, (v) payment of damages or other monetary relief, (vi) public notice of the violation, (vii) limitations on the activities or functions of the person, and (viii) civil monetary penalties, which may be up to $1,000,000 for each day during the continuance of any violation.24
Trusts typically indemnify other parties for expenses, claims and judgements as long as they are not caused by willful misconduct or bad faith. If the Third Circuit’s decision is not appealed, and if other jurisdictions are to follow, then depending on the terms of the trust agreements and governing securitization documents, it is possible that judgments obtained by the CFPB against a securitization trust could be collected from trust property. We expect that specter to haunt forthcoming securitization documents in a number of ways. In particular, investors, sponsors and other securitization participants—now exposed not only to the risk of litigation brought by investors and other affected parties, but also by the CFPB—may be incentivized to seek a more active role in service provider diligence and oversight.
While it is impossible to predict how broadly such a holding might be interpreted, issuers and underwriters can take certain steps to protect themselves while the issue continues to play out in the courts. Issuers and sponsors should review their organizational and securitization documents to understand the potential ramifications of an enforcement action against the securitization issuer and confirm that disclosure documents are up to date. Additionally, sponsors should evaluate their diligence procedures to ensure that service providers retained in connection with a securitization are appropriately licensed and have appropriate procedures in place to ensure compliance with applicable law. Indeed, most securitizers already implement practices designed to mitigate the types of risk reflected in this case.
Lastly, it is important to keep in mind two procedural points. First, the Third Circuit’s decision affirmed the District Court’s denial of the Trusts’ motion to dismiss the case. The Trusts may either ask the Supreme Court of the United States to reverse the Third Circuit’s decision (i.e., file a petition for certiorari), or ask for a rehearing in front of the full Third Circuit, rather than a panel of three judges (i.e., file a petition for a rehearing en banc). Second, the Third Circuit’s holding is not binding on all federal courts. The Third Circuit’s decision is controlling precedent in the states of Delaware, New Jersey and Pennsylvania, as well as territorial courts in the Virgin Islands, but federal courts in other jurisdictions are not required to follow the Third Circuit’s holding. Of course, other federal courts may look to the Third Circuit’s opinion as persuasive, though not binding, precedent. With this win under its belt, the CFPB has signaled that it will act quickly and aggessively against the Trusts for the actions of their servicers. On May 6, 2024, the CFPB filed a complaint against the Trusts and the Pennsylvania Higher Education Assistance Agency, a student loan servicer, together with two proposed stipulated final judgments and orders, for alleged servicing failures, including allegedly failing to respond to borrower requests for relief. If approved by the court, the proposed stipulated final judments and orders would require the Trusts and the Pennsylvania Higher Education Assistance Agency to pay $400,000 and $1.75 million, respectively, in penalties, and would impose certain requirements on the defendants relating to pending borrower requests fo relief.25
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Without appellate, legislative or divine intervention, the Third Circuit’s decision will stand, and as of now, the litigation will continue in the District Court.
Footnotes
1. Consumer Financial Protection Bureau v. Nat’l Collegiate Master Student Loan Tr., No. 22-1864 (3d Cir. 2024) *26 (hereinafter “Third Circuit Decision”).
2. Id. at 9 (quoting In Re NCLST, 251 A.3d at 131).
3. Id. at 10.
4. CFPB v. Nat’l Collegiate Master Student Loan Trust, 575 F. Supp. 3d 505, 509–10 (D. Del. 2021).
5. CFPB v. Nat’l Collegiate Master Student Loan Tr., No. CV 17-1323 (MN), 2021 WL 1169029, at *2 (D. Del. Mar. 26, 2021).
6. Third Circuit Decision at 1.
7. 12 U.S.C. § 5491(c).
8. Under the Constitution, subject to certain exceptions, the President can remove the head of any agency without cause. However, the authorizing statute of the CFPB provides that the CFPB director can only be removed “for cause.” Id. at 11.
9. Id. at 36.
10. Id. at 14.
11. 12 U.S.C. § 5481(6)(A).
12. Id. (emphasis added).
13. Third Circuit Decision at 29.
14. CFPB v. Nat’l Collegiate Master Student Loan Trust, 575 F. Supp. 3d 505, 509–10 (D. Del. 2021), (citing Barbato v. Greystone All., LLC, 916 F.3d 260, 266–68 (3d Cir. 2019) (finding that a “passive debt owner” counted as a “debt collector” under the Fair Debt Collection Practices Act when it contracted with a third party to collect debt on its behalf)).
15. Third Circuit Decision at 27 (quoting Saxon v. Sw. Airlines Co., 993 F.3d 492, 495 (7th Cir. 2022)) (internal quotations removed) (discussing enforcement of an arbitration clause under the Federal Arbitration Act which applied to a “class of workers engaged in foreign or interstate commerce”) (emphasis added).
16. Id. at 28.
17. Id. at 32.
18. 12 U.S.C. § 5536(a)(1)(B).
19. 12 U.S.C. § 5536(a)(2).
20. 12 U.S.C. § 5481(26).
21. 12 U.S.C. § 5536(a).
22. 12 U.S.C. § 5514(e).
23. CFPB Bulletin 2012-03, Service Providers, April 12, 2012, available at https://files.consumerfinance.gov/f/20120212_cfpb_ServiceProvidersBulletin.pdf.
24. 12 U.S.C. § 5565.
25. Press Release, Consumer Financial Protection Bureau, CFPB Takes Action to Require National Collegiate Student Loan Trusts and Pennsylvania Higher Education Assistance Agency to Pay More than $5 Million for Student Loan Servicing Failures (May 6, 2024), https://www.consumerfinance.gov/about-us/newsroom/cfpb-takes-action-to-require-national-collegiate-student-loan-trusts-and-pennsylvania-higher-education-assistance-agency-to-pay-more-than-5-million-for-student-loan-servicing-failures/.
