A California federal district court judge rejected challenges to the OCC’s and FDIC’s Madden-fix rules brought in two separate lawsuits by state attorneys general. The OCC rule is codified at 12 C.F.R. Section 7.4001(e) and the FDIC rule is codified at 12 C.F.R. Section 160.110(d). The rules provide that a loan made by a national bank, federal savings association, or federally-insured state-chartered bank that is permissible under applicable federal law (Section 85 of the National Bank Act (NBA) or Section 27 of the Federal Deposit Insurance Act (FDIA)) is not affected by the sale, assignment, or other transfer of the loan.
In People of the State of California, et al. v. OCC, Judge Jeffrey White first rejected the AGs’ argument that the OCC rule is invalid because the OCC had not complied with the NBA provision (Section 25b) that establishes the standard for OCC preemption determinations. Instead, he agreed with the OCC’s argument that rather than preempt state law, the rule interprets the substantive meaning of Section 85 by clarifying the scope of federal authority granted by Section 85.
Judge White also rejected the AGs’ argument that the Second Circuit’s Madden decision had implicitly construed the terms of Section 85, thereby trumping the OCC’s construction. Citing U.S. Supreme Court authority that holds a prior judicial construction of a statute trumps an agency’s construction only when the court has held that its construction follows from a statute’s unambiguous terms, Judge White found that the Second Circuit did not clearly hold that Section 85 was ambiguous. Rather, it had distinguished prior cases extending preemption to non-national banks on the basis that the national banks had not completely divested their interests in the accounts at issue while, in contrast, the national bank in Madden had not retained an interest in the transferred account.
Judge White also found that the OCC rule was entitled to Chevron deference. In conducting the first step of a Chevron analysis, he found that Section 85 did not directly speak to the issue of what happens to the interest rate set by a national bank “once it has been incorporated into a contract, let alone a contract that is subsequently transferred.” In Chevron step two, he found the OCC rule to be a reasonable interpretation of Section 85 that is neither arbitrary nor capricious, nor “manifestly contrary to Section 85.” In doing so, he rejected the AGs’ argument that the OCC’s interpretation was unreasonable because the privilege of preemption cannot be transferred or assigned. According to Judge White, their argument was not persuasive because:
[T]he Final Rule does not grant a non-bank the same most favored status a national bank holds with respect to the power to set interest rates. Instead, commensurate with a national bank’s power to transfer or assign loans, the Final Rule states the national bank has the power to do so without altering the interest rate upon which it and the borrower initially agreed.
He also rejected the AGs’ argument that the rule is arbitrary and capricious because the OCC had not considered the rule’s impact on “rent–a-bank schemes” and the rule was not based on evidence of Madden’s negative effects on credit availability. Judge White found that OCC had considered whether the rule would facilitate predatory lending and had evidence of Madden’s negative effects.
In People of the State of California, et al. v. FDIC, Judge White first addressed the AGs’ argument that the FDIC exceeded its authority in promulgating its “Madden-fix” rule because the rule permits the FDIC to impermissibly regulate the conduct of non-FDIC banks and has the effect of impermissibly preempting state laws. He found that the rule fell within the FDIC’s authority to issue rules it deems necessary to carry out the FDIA and “does not purport to regulate either the transferee’s conduct or any changes to the interest rate once a transaction is consummated.”
Judge White then concluded that the FDIC’s rule was also entitled to Chevron deference. He found that the rule passed Chevron step one because, like Section 85 on which it was modeled, Section 27 did not address what happens to the validity of a loan’s interest rate upon transfer. In conducting Chevron step two, he found that the rule was a reasonable interpretation of Section 27 because the FDIC could reasonably conclude that its interpretation would assist FDIC banks in maintaining liquidity by creating greater certainty about an interest rate’s validity when a loan is transferred. He also found the rule is not arbitrary or capricious because, like the OCC, the FDIC considered the impact of its rule on “rent-a-bank schemes” and based the rule on evidence about the uncertainty created by Madden.
While the two decisions certainly represent a very positive development, it is possible the AGs will appeal the decisions to the Ninth Circuit. The decisions also do not remove the uncertainty that continues to exist for participants in bank-model programs as a result of “true lender” threats. The OCC’s “true lender” rule, which would have provided a clear bright line test for determining when a bank is the “true lender” in a bank model program, was overturned by Congress under the Congressional Review Act.
In addition, banks participating in such programs should expect their participation to be closely scrutinized by regulators. Within hours of the release of Judge White’s decisions, Acting Comptroller of the Currency Hsu issued the following warning about abuses of the OCC’s Madden-fix rule:
The district court affirmed the validity of the OCC’s rule, which provides that when a national bank or state or federal savings association sells, assigns, or otherwise transfers a loan, the interest permissible before the transfer continues to be permissible after the transfer.
This legal certainty should be used to the benefit of consumers and not be abused. I want to reiterate that predatory lending has no place in the federal banking system. The OCC is committed to strong supervision that expands financial inclusion and ensures banks are not used as a vehicle for “rent-a-charter” arrangements.
In addition to “true lender” threats, non-bank participants in bank-model programs will continue to face state licensing threats. Given such continuing threats, bank and non-bank participants would be well-advised to revisit their vulnerability to “true lender” challenges and their compliance with state licensing laws.
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