The Family Farmer Relief Act of 2019: Will the Increased Debt Limit Lead to an Uptick in Chapter 12 Filings?

The Family Farmer Relief Act of 2019: Will the Increased Debt Limit Lead to an Uptick in Chapter 12 Filings? The United States Senate passed the “Family Farmer Relief Act of 2019” (H.R. 2336), which substantially increases the debt limit for agricultural producers seeking to file for relief under Chapter 12 of the United States Bankruptcy Code. The bipartisan legislation, which passed the U.S. House of Representatives in June and is expected to be signed into law by President Trump, raises the debt limit for Chapter 12 bankruptcy filings from approximately $4.3 million to $10 million.

The debt limit increase will dramatically expand Chapter 12 bankruptcy eligibility at a time of turmoil for the U.S. agriculture industry, precipitated by years of depressed farm income, crop overproduction, increased debt loads, natural disasters, extreme weather events, and, more recently, retaliatory tariffs on many U.S. agricultural products as part of a renewed trade war. As noted by the American Farm Bureau Federation, even before passage of the Family Farmer Relief Act, Chapter 12 bankruptcy filings were up 13% over the past year, and farm loan delinquency rates were at a six-year high. Farm bankruptcies under Chapter 12 can only be expected to rise sharply now that farmers with debts as high as $10 million dollars are eligible to file for Chapter 12 relief.

A farm seeking to reorganize its operations, restructure its debt, and continue as an ongoing business may consider relief under several chapters of the Bankruptcy Code:

Chapter 13

In a Chapter 13 proceeding, the debtor commits all of his or her future disposable income to pay all or part of the debtor’s outstanding debts under the terms of a confirmed Chapter 13 plan. Certain debts, including residential mortgages, must be paid in accordance with the terms of the mortgage, either through or outside the plan (any pre-petition arrearage on the mortgage can be provided for and paid through the plan). Chapter 13 eligibility is limited to individuals (i.e., not corporations, LLCs or partnerships) with unsecured debts of less than $419,275 and secured debts of less than $1,257,850.

Chapter 11

Chapter 11 bankruptcy is most commonly used to reorganize large corporations. Chapter 11 has some provisions aimed at small business debtors, and individuals whose debts exceed the limits for Chapter 13 may be eligible to file for Chapter 11. As a practical matter, however, Chapter 11 cases are costly and complex, which frequently limits its availability to larger debtors with the means to fund a case. In Chapter 11, the debtor will typically reorganize its debts in accordance with a confirmed Chapter 11 plan, which must classify the types of claims against the estate and provide for treatment of each class. The plan must be accompanied by a detailed disclosure statement containing sufficient information for creditors to make a determination as to whether to vote to accept the plan. Creditors whose claims are “impaired” under the plan may vote on the plan.

Chapter 12

Chapter 12, which was initially enacted during the farm debt crisis of the 1980s, provides many benefits for small to medium-sized family farming operations as compared to Chapter 11 or Chapter 13. Chapter 12 is reserved for “family farmers” or “family fisherman” with “regular annual income.” A “family farmer” may be an individual (or an individual and spouse), or a corporation or partnership (with certain restrictions), so unlike the case with Chapter 13 bankruptcies, which is limited to individuals, a family farm that is structured as a corporation or partnership may be eligible for relief under Chapter 12.

Chapter 12 has numerous other benefits over both Chapter 11 and Chapter 13 for parties who are eligible. Like Chapter 13, Chapter 12 contemplates that the debtor will use future disposable income to fund a plan; however, a Chapter 12 reorganization plan can provide for payments to be made seasonally, when the farm earns most of its income. Moreover, a Chapter 12 debtor has 90 days from the petition date to file a proposed plan and need not begin making plan payments prior to plan confirmation, in contrast to Chapter 13 debtors who must propose a plan and begin making plan payments much more quickly. Therefore, Chapter 12 debtors have a longer breathing spell before they must start funding the plan.

Chapter 12 is considerably less expensive than Chapter 11 — the Chapter 11 filing fee alone is $1,717, versus $275 for a Chapter 12 case. Moreover, if the debtor does not qualify as a “small business debtor,” as defined in the Bankruptcy Code, an official committee of unsecured creditors will be appointed in a Chapter 11 case, with the costs of the committee’s professionals (in addition to its own professionals) to be borne by the debtor. The unsecured creditors’ committee has broad authority to investigate the assets, liabilities, financial condition and transactions of the debtor, which can substantially increase the costs of the case, even if the scope of such investigation is limited.

A typical business reorganization will often include the sale of underperforming or unneeded assets. Asset sales in Chapter 12 have many advantages for the debtor over those in over Chapter 11. In order to sell assets “free and clear” of liens, claims, and encumbrances in Chapter 11, the debtor must satisfy the stringent requirements of section 363(f), which can be hotly contested by stakeholders. The Chapter 12 debtor, on the other hand, may sell any property free and clear of liens under section 1206 so long as the property is “farmland or farming equipment.” With narrower statutory grounds for objecting to an asset sale in Chapter 12, the process is typically less contentious and less expensive. Also, asset sales in Chapter 12 have significant tax advantages over those in Chapter 11. Any tax liability for capital gains generated by a sale in Chapter 11 is treated as a priority claim that must be paid in full at plan confirmation. By contrast, in Chapter 12, any tax arising from the sale of property used in the debtor’s farming operation is treated as an unsecured claim of the debtor that may be discharged in bankruptcy. This allows the debtor to retain the upside from the sale of farming assets.

Finally, one of the biggest advantages of Chapter 12 over Chapters 11 or 13 is that Chapter 12 debtors may modify any secured loan — including residential mortgages, nonresidential mortgages, equipment loans and vehicle loans — through a so-called “cram down.” In a cram down, the debtor pays secured creditors based on the current value of collateral rather than the amount owing on the loan. In Chapter 11 and Chapter 13 cases, a debtor cannot cram down the mortgage on the debtor’s principal residence. Chapter 12 does not contain this restriction, so a Chapter 12 debtor may cram down his residential mortgage along with any other secured debts. This can be a powerful tool for family farmers who frequently live and farm on the same land.

Given the clear advantages of Chapter 12 over Chapters 13 and 11 for family farmers seeking to reorganize under the Bankruptcy Code, the newly expanded eligibility for Chapter 12 bankruptcy – combined with the troubled economic climate for U.S. farmers – may well lead to a proliferation of Chapter 12 filings. If the current problems facing the U.S. agricultural industry are transitory in nature, Chapter 12 may well provide small to mid-sized farmers with the relief they need to weather the temporary downturn. If, on the other hand, the downturn is symptomatic of a more fundamental reordering of the industry and its place in the global economy, then expanded eligibility for Chapter 12 may not solve the long-term problems facing smaller farming operations.

HUD Proposed Rule Demands More Disparate and More Impact to Establish Disparate Impact Liability

By Austin Holland, Heather Howell Wright and Christopher K. Friedman on August 12, 2019 Posted in Affordable Housing, Banking, Commercial Lending, Compliance, Credit Reporting Industry, Disparate Impact, Fair Housing, Fair Lending, Foreclosure, HUD, HUD Requirements, Mortgage Loan Originators, Tenant Protection

HUD Proposed Rule Demands More Disparate and More Impact to Establish Disparate Impact Liability The United States Department of Housing and Urban Development (HUD) released a sweeping proposed rule on August 1 seeking to amend HUD’s interpretation of the Fair Housing Act’s disparate impact standard. According to HUD, the proposed rule is designed to better reflect the U.S. Supreme Court’s 2015 ruling in Texas Department of Housing and Community Affairs v. Inclusive Communities Project, Inc. HUD will submit the proposed rule to HUD’s congressional authorizing committees – the House Financial Services and Senate Banking Committees – for a 15-day review period. After the congressional review period, HUD will publish the proposed rule in the Federal Register where the public will have 60 days to submit comments. Comments may be submitted to HUD through www.regulations.gov or by physical mail.

The Fair Housing Act prohibits discrimination in many housing-related activities on the basis of race, color, religion, sex, disability, familial status, or national origin. For at least the past four decades, HUD and federal courts have read the Fair Housing Act to ban conduct that has a discriminatory effect even while not motivated by discriminatory intent. This theory of liability is known as “disparate impact.” In February 2013, HUD codified its long held view that the Fair Housing Act bans housing practices that disparately impact protected classes through a final rule entitled Implementation of the Fair Housing Act’s Discriminatory Effects Standard. The rule established a three-part burden-shifting test for determining when a housing practice with a discriminatory effect violates the Fair Housing Act.

In 2015, the U.S. Supreme Court decided Texas Dept. of Housing and Community Affairs v. Inclusive Communities, in which a non-profit organization claimed that policies of the Texas Department of Housing and Community Affairs regarding the distribution of low-income housing development tax credits resulted in discrimination against African Americans in violation of both 42 U.S.C. § 1983 and the Fair Housing Act. In Inclusive Communities, Justice Kennedy’s majority opinion did not rely on HUD’s disparate impact burden shifting test. Rather, the court undertook its own analysis resulting in standards that differed from the rule. While holding that the Fair Housing Act prohibited disparate impact discrimination, the decision also established several guard rails designed to “protect potential defendants against abusive disparate impact claims.” For instance, the court held that a disparate impact claim cannot be sustained solely by evidence of a statistical disparity. Rather, the court enacted a “robust causality” rule requiring that a plaintiff show that a policy or procedure actually caused the disparity.

HUD’s proposed rule seeks to align the department’s disparate impact analysis with the standards applied by the court in Inclusive Communities. Specifically, the proposed rule creates a new burden-shifting framework where a plaintiff raising a disparate impact claim under the Fair Housing Act would be required to establish, as a threshold matter, that a specific policy or practice caused the discriminatory effect, and that the policy or practice was “arbitrary, artificial, and unnecessary to achieve a valid interest or legitimate objective.” If the plaintiff makes this prima facie case, then the burden shifts to the defendant to “identify a valid interest or interests which the challenged policy or practice serves…” Once the defendant makes that identification, the burden shifts back to the plaintiff to establish the following four elements:

A “robust causal link between the challenged policy or practice…”
That the “challenged policy or practice has an adverse effect on members of a protected class.” In other words, under the new rule, it is insufficient to allege merely that the individual plaintiff was harmed as a result of the policy.
That the disparity caused by the policy or practice is “significant” or “material.”
That the “complaining party’s alleged injury is directly caused by the challenged policy or practice.

In the proposed rule, HUD provides several detailed examples of particular defenses a defendant may use to rebut allegations of housing discrimination. The proposed rule also contains several clarifications related to issues such as vicarious liability, the rule’s impact on state insurance regulations, and the scope of remedies in state and federal court, among others.

The theory of disparate impact liability has always been complicated. Although HUD’s proposed rule appears to benefit defendants, the rule imposes additional layers of complexity to the burden-shifting analysis. Thus, while the proposed rule likely will come as welcome relief to businesses that have been vulnerable to disparate impact claims, it will likely not decrease the number of fair housing claims and may very well increase the cost to defend those claims.

Stay of Litigation and Compliance Date Continued in Payday Lending Rule Lawsuit

By Preston H. Neel and Kelley J. Hails on August 9, 2019 Posted in Compliance, Litigation Developments, Payday Lending, Small-Dollar Lending

Stay of Litigation and Compliance Date Continued in Payday Lending Rule Lawsuit Following the status report filed last week by the parties involved in the lawsuit challenging the CFPB’s Payday, Vehicle Title, and Certain High-Cost Installment Loans Rule, the Texas district court faced with the case ordered that the stay of litigation and the stay of the compliance date for the rule’s payment provisions are continued. The court’s order, which was entered on August 6, requires the parties to “file a Joint Status Report informing the court about proceedings related to the Rule and this litigation as the parties deem appropriate, but no later than Friday, December 6, 2019.” (Emphasis in original)

The parties’ status report informed the court that the CFPB issued a final rule on June 6 delaying the compliance date for the underwriting provisions of the rule until November 19, 2020, and that the bureau continues progressing on its other rulemaking, which proposed to remove the underwriting provision. The order indicates that neither party requested that the court “lift the stay of litigation or the stay of the compliance date at this time.”

With the prior August 19 compliance deadline for the payment provisions looming, this order seems to solidify the delay of the compliance date until potentially as late as December 6.

Big Picture Loans Lands Big Win for Tribal Lenders in Sovereign Immunity Case

By Josh Dhyani and Brian R. Epling on August 8, 2019 Posted in Banking, Class Actions, Compliance, Installment Lending, Licensing, Litigation Developments, Short-Term Loans, Small-Dollar Lending, Unsecured Lending

Big Picture Loans Lands Big Win for Tribal Lenders in Sovereign Immunity Case In a recent decision by the Fourth Circuit, Big Picture Loans, LLC, an online lender owned and operated by the Lac Vieux Desert Band of Lake Superior Chippewa Indians, a federally recognized Indian tribe (“Tribe”), and Ascension Technologies, LLC, the Tribe’s management and consultant company successfully established that they are each arms of the Tribe and cloaked with all of the privileges and immunities of the Tribe, including sovereign immunity. As background, Big Picture Loans and Ascension are two entities formed under Tribal law by the Tribe and both are wholly owned and operated by the Tribe. Big Picture Loans offers consumer financial services products online and Ascension offers marketing and technology services solely to Big Picture Loans.

Plaintiffs, consumers who had taken out loans from Big Picture Loans, brought a putative class action in the Eastern District of Virginia, arguing that state law and other various claims applied to Big Picture Loans and Ascension. Big Picture Loans and Ascension moved to dismiss the case for lack of subject matter jurisdiction on the basis that they are entitled to sovereign immunity as arms of the Tribe. Following jurisdictional discovery, the U.S. District Court rejected Big Picture Loans and Ascension’s assertions that they are arms of the Tribe and therefore immune from suit.

The Fourth Circuit held that the U.S. District Court erred in its determination that the entities were not arms of the Tribe and reversed the district court’s decision with instructions to dismiss Big Picture Loans and Ascension from the case, and in doing so, articulated the arm-of-the-tribe test for the Fourth Circuit. The Fourth Circuit first confronted the threshold question of who bore the burden of proof in an arm-of-the-tribe analysis, reasoning that it was proper to utilize the same burden as in cases where an arm of the state defense is raised, and “the burden of proof falls to an entity seeking immunity as an arm of the state, even though a plaintiff generally bears the burden to prove subject matter jurisdiction.” Therefore the Fourth Circuit held the district court properly placed the burden of proof on the entities claiming tribal sovereign immunity.

The Fourth Circuit next noted that the Supreme Court had recognized that tribal immunity may remain intact when a tribe elects to engage in commerce through tribally created entities, i.e., arms of the tribe, but had not articulated a framework for that analysis. As such, the court looked to decisions by the Ninth and Tenth Circuits. In Breakthrough Management Group, Inc. v. Chukchansi Gold Casino & Resort, the Tenth Circuit utilized six non-exhaustive factors: (1) the method of the entities’ creation; (2) their purpose; (3) their structure, ownership, and management; (4) the tribe’s intent to share its sovereign immunity; (5) the financial relationship between the tribe and the entities; and (6) the policies underlying tribal sovereign immunity and the entities’ “connection to tribal economic development, and whether those policies are served by granting immunity to the economic entities.” The Ninth Circuit adopted the first five factors of the Breakthrough test but also considered the central purposes underlying the doctrine of tribal sovereign immunity (White v. Univ. of Cal., 765 F.3d 1010, 1026 (9th Cir. 2014)).

The Fourth Circuit concluded that it would follow the Ninth Circuit and adopt the first five Breakthrough factors to analyze arm-of-the-tribe sovereign immunity, while also allowing the purpose of tribal immunity to inform its entire analysis. The court reasoned that the sixth factor had significant overlap with the first five and was, thus, unnecessary.

Applying the newly adopted test, the Fourth Circuit held the following regarding each of the factors:

Method of Creation – The court found that formation under Tribal law weighed in favor of immunity because Big Picture Loans and Ascension were organized under the Tribe’s Business Entity Ordinance via Tribal Council resolutions, exercising powers delegated to it by the Tribe’s Constitution.
Purpose – The court reasoned that the second factor weighed in favor of immunity because Big Picture Loans and Ascension’s stated goals were to support economic development, financially benefit the Tribe, and enable it to engage in various self-governance functions. The case lists several examples of how business revenue had been used to help fund the Tribe’s new health clinic, college scholarships, create home ownership opportunities, fund office space for Social Services Department, youth activities and many others. Critically, the court did not find persuasive the reasoning of the district court that individuals other than members of the Tribe may benefit from the creation of the businesses or that steps taken to reduce exposure to liability detracted from the documented purpose. The court also distinguished this case from other tribal lending cases that found this factor unfavorable.
Structure, Ownership, and Management – The court considered relevant the entities’ formal governance structure, the extent to which the entities were owned by the Tribe, and the day-to-day management of the entities by the Tribe. Here the court found this factor weighed in favor of immunity for Big Picture Loans and “only slightly against a finding of immunity for Ascension.”
Intent to Extend Immunity – The court concluded that the district court had erroneously conflated the purpose and intent factors and that the sole focus of the fourth factor is whether the Tribe intended to provide its immunity to the entities, which it undoubtedly did as clearly stated in the entities’ formation documents, as even the plaintiffs agreed on this point.
Financial Relationship – Relying on the reasoning from Breakthrough test, the court determined that the relevant inquiry under the fifth factor is the extent to which a tribe “depends . . . on the [entity] for revenue to fund its governmental functions, its support of tribal members, and its search for other economic development opportunities” (Breakthrough, 629 F.3d at 1195). The court reasoned that, since a judgment against Big Picture Loans and Ascension would significantly impact the Tribal treasury, the fifth factor weighed in favor of immunity even if the Tribe’s liability for an entity’s actions was formally limited.

Based on that analysis, the Fourth Circuit recognized that all five factors weighed in favor of immunity for Big Picture and all but one factor weighed in favor of immunity for Ascension, resulting in a big win for Big Picture Loans and Ascension, tribal lending and all of Indian Country engaged in economic development efforts. The court opined that its conclusion gave due consideration to the underlying policies of tribal sovereign immunity, which include tribal self-governance and tribal economic development, as well as protection of “the tribe’s monies” and the “promotion of commercial dealings between Indians and non-Indians.” A finding of no immunity in this case, even if animated by the intent to protect the Tribe or consumers, would weaken the Tribe’s ability to govern itself according to its own laws, become self-sufficient, and develop economic opportunities for its members.

Takeaways

Although the time for appeal to the U.S. Supreme Court has not expired in this case, needless to say, this is a major victory for tribal lending. The order also restates an important principle from the U.S. Supreme Court case in Bay Mills that “it is Congress–not the courts–that has the power to abrogate tribal immunity” and that just because a court does not like the “business in which a tribe has chosen to engage,” it cannot seek to remove its right to immunity on that basis.

CFPB Extends the Comment Period for Proposed Debt Collection Rule in Response to Consumer Advocate and Industry Requests

By Lee Gilley, J. Riley Key and Jonathan R. Kolodziej on August 2, 2019 Posted in CFPB, Debt Collection

The Consumer Financial Protection Bureau (CFPB) formally extended the comment period for its proposed debt collection rulemaking on Friday, August 2. Rather than requiring that all comments be submitted by August 19, 2019, anyone interested in submitting a comment now has an extra 30 days to do so. The official comment period for the debt collection notice of proposed rulemaking will now close on September 18, 2019.

The CFPB initially released its notice of proposed rulemaking to amend Regulation F on May 7, 2019, and published it in the Federal Register on May 21, 2019. From that point, the CFPB initially set out a 90-day comment period. However, numerous consumer advocacy groups and industry trade associations recently requested that the CFPB provide additional time for all interested stakeholders to opine on the proposed rule. In response to those requests, the CFPB decided that an additional 30 days is warranted.

As discussed in prior posts, the proposed debt collection rulemaking will have broad implications for consumers, entities that qualify as debt collectors, and first-party creditors. As such, engaging in the rulemaking process now and providing the CFPB with feedback is important and can pay dividends in the future. We have seen in the past with other significant CFPB rulemakings that it is extremely challenging to make substantive changes to the law after final rules are issued, and even more so after they become effective. Particularly if you believe that the current proposal will have unintended consequences on your business or that additional guidance in certain areas is needed, it would be prudent to utilize the extra time that is now being afforded and engage with the CFPB to let them know your thoughts on the proposed rule before it is too late.

Gambling on a DOJ Enforcement Action: State of the Wire Act

By Benjamin William Perry and Alex McFall on August 1, 2019 Posted in Anti-Money Laundering, Banking, Compliance, Federal Agencies, Payment Systems, Regulatory Supervision, Vendor Management

Gambling on a DOJ Enforcement Action: State of the Wire Act Banks and payment processors involved with acceptance or processing of funds relating to gambling or state lottery systems can breathe a sigh of relief—at least for now—based upon a New Hampshire district court judge’s recent interpretation of the Wire Act, which rejected a much broader Department of Justice (DOJ) position that initially sent shockwaves throughout the financial services industry. Although appellate review is sure to follow, these entities can rest assured that the DOJ will not initiate any prosecutions based upon its controversial interpretation in the meantime until the appeals process runs its course.

Background of The Wire Act

If you have placed a bet on a sporting event anytime in the last several decades, chances are the mob had no involvement (we hope, at least). But that was not always the case. In the 1960s, the mob largely controlled sports betting, and the enormous profits were the mob’s primary source of income. As the country’s telephone networks expanded, the mob began using telephones and telegraphs to accept bets remotely. This garnered the attention of the federal government, who responded by enacting the Interstate Wire Act of 1961.

The Wire Act was designed to target the means by which bets were placed with the mob. Specifically, the Wire Act prohibits the use of a “wire communication facility” to transmit information assisting in the placement of certain bets or wagers. For many years, it was unclear whether the Wire Act applied solely to sports gambling or to all forms of gambling. The DOJ issued its first formal guidance on the issue in 2011 (2011 Memo), when New York and Illinois requested clarification on the Wire Act’s applicability to the use of out-of-state transaction processors for the sale of in-state lottery tickets. Rather than limiting its response to the narrow question posed, the DOJ issued a much broader opinion, finding that the Wire Act applies to sports gambling only. In an unprecedented reversal of the 2011 guidance, the DOJ issued a new memo dated November 2, 2018, (2018 Memo) opining that the Wire Act does, in fact, apply to all forms of Internet gambling, as opposed to solely sports gambling.

New Hampshire Strikes Back

This marked policy change reflected by the 2018 Memo was met with resistance. In response to the 2018 Memo, the New Hampshire Lottery Commission (Commission) and its service provider filed a lawsuit in the U.S. District Court for the District of New Hampshire against Attorney General Bill Barr and the DOJ seeking an injunction to prevent enforcement actions based upon the 2018 Memo and declaratory relief regarding the scope of the Wire Act. On June 3, 2019, the court entered a memorandum opinion granting the Commission’s motion for summary judgment, holding that while the plain language of the Wire Act is ambiguous, the legislative history and “significant contextual evidence” support the Commission’s interpretation that the Wire Act applies solely to sports gambling. As a result, the court set aside the 2018 Memo and entered judgment in favor of the Commission on June 20, 2019. The deadline for the DOJ to appeal the judgment is August 29, 2019.

SCOTUS Raises Questions about Enforceability of Wire Act

While the U.S. Supreme Court has not squarely addressed the constitutionality of the Wire Act, it has decisively rejected an outright ban on sports gambling. The Professional and Amateur Sports Protection Act of 1992 (PASPA) banned sports betting nationwide while carving out certain exemptions for a handful of states. In May 2018, the Supreme Court issued a decision in Murphy v. Nat’l Collegiate Athletic Ass’n, holding that PASPA is unconstitutional because it dictates to the states what they may or may not legislate.

Although not central to the opinion, the Court briefly addressed the Wire Act, stating that it only applies “if the underlying gambling is illegal under state law.” The Court noted that it is federal policy to “respect the policy choices of the people of each state on the controversial issue of gambling.” With regard to sports gambling in particular, the Court held that Congress is free to regulate it—not ban it—and if Congress elects not to, states are free to step in.

Practical Implications

Ultimately, the extent of a financial institution or investor’s investment in this ever-evolving industry is a test of risk appetite. For banks and other financial institutions looking to get involved, the prevention of interstate routing of data related to these transactions is paramount. In order to remove themselves from the purview of the Wire Act, financial institutions should take extra precautions (i.e., specific contractual provisions in contracts with data processors, etc.) to ensure that all data related to sports betting is processed within the state. To that end, businesses considering entering the online sports betting market (provided sports gambling is legal under the relevant state’s laws) could partner with community financial institutions and intrastate payment processors to minimize the risk of interstate data transmission.

For those unable to completely insulate data transmissions, the good news is that the Wire Act’s days may be numbered. Tidbits such as the Supreme Court’s comments in the Murphy case indicate that the DOJ’s interpretation of the Wire Act (and, perhaps, the Wire Act itself) may not survive constitutional scrutiny in front of the Supreme Court. Stay tuned.

Data Modeling Remains Auto Finance Target in CFPB’s Fair Lending Governance

By C. Meade Hartfield on July 29, 2019 Posted in Automobile Finance, CFPB, Data Privacy, Fair Lending

Data Modeling Remains Auto Finance Target in CFPB’s Fair Lending Governance The Consumer Financial Protection Bureau made it clear that it will continue to target auto finance lenders as one of its top supervisory and enforcement priorities in the Fair Lending Report of the Bureau of Consumer Financial Protection , which was released in June 2019. In addition to adding student loan origination to its watchdog list the CFPB will target model-use practices in auto servicing debt collection in an effort to more closely monitor discriminatory policies and practices based upon consumer data. The report specifically referenced the use of models that predict recovery outcomes.

In a world of increasingly available consumer data, lenders continue to augment the scope of information they may choose to evaluate to underwrite and service auto loans. Examples of alternative data include:

Data showing trends or patterns in traditional loan repayment data.
Payment data relating to non-loan products requiring regular (typically monthly) payments, such as telecommunications, rent, insurance, or utilities.
Checking account transaction and cash flow data and information about a consumer’s assets, which could include the regularity of a consumer’s cash inflows and outflows, or information about prior income or expense shocks.
Data that some consider to be related to a consumer’s stability, which might include information about the frequency of changes in residences, employment, phone numbers or email addresses.
Data about a consumer’s educational or occupational attainment, including information about schools attended, degrees obtained, and job positions held.
Behavioral data about consumers, such as how consumers interact with a web interface or answer specific questions, or data about how they shop, browse, use devices, or move about their daily lives.
Data about consumers’ friends and associates, including data about connections on social media.

In the report, the bureau devoted an entire subsection to a modeling discussion in its summary of steps taken to improve access to credit. In fact, the bureau directly acknowledged that “[t]he use of alternative data and modeling techniques may expand access to credit or lower credit cost and, at the same time, present fair lending risks.” The bureau also seemed to acknowledge that part of the purpose for its supervisory activities is to educate the bureau regarding modeling techniques, to “keep pace” with technological advances, and to “learn about the models and compliance systems” available via third-party vendors. In taking a hands-on approach to learning, the bureau can, at the same time, assess fair lending risks to consumers. It seems that education is leading the bureau beyond monitoring data use in credit applications to monitoring data use in all facets of auto finance servicing.

The move is particularly interesting, given the CFPB’s no-action letter to Upstart Network, Inc., which was issued in September 14, 2017, actively monitored in 2018, and referenced in the June 2019 Fair Lending Report. There, the scope of the no-action letter was “limited to Upstart’s automated model for underwriting applicants for unsecured non-revolving credit.” Upstart mixes both traditional underwriting factors, such as credit score and income, with non-traditional data points, such as education and employment history.

The CFPB made clear that its issuance of a no-action letter would not serve as an official endorsement of or expression of the bureau’s views on the use of any particular modeling techniques. While no-action letters are not binding on the bureau, the Upstart no-action letter, in conjunction with the June 2019 Fair Lending Report, seems to indicate that modeling techniques in general will receive heightened scrutiny from the bureau going forward.

Ultimately, it remains to be seen whether the bureau’s exploration into the impact of alternative data on credit access will result in an enforcement action involving model use within auto servicing. Given the bureau’s announcement that the issue is now squarely on its radar, in the least, CFPB investigations seem inevitable.

Notably, the bureau seems to recognize the potential benefits to using alternative data beyond traditional credit file data to provide access or better pricing for those consumers who face barriers to accessing credit or those that traditionally pay more for credit. However, the bureau seems to embrace the idea with caution, ever vigilant to protect nondiscriminatory access to credit, lest the techniques or the data itself present fair lending threats.

Accordingly, to the extent that auto finance companies are using modeling techniques via a third-party vendor or their own proprietary formula in their vehicle recovery processes, they would do well to proactively examine the methods and data used for any potentially discriminatory impact on consumers.

Proposed American Bar Association Resolution Could Affect Auto Dealers

By Lesley Smith DeRamus on July 25, 2019 Posted in Automobile Finance, Fair Lending

Proposed American Bar Association Resolution Could Affect Auto Dealers The American Bar Association’s (ABA) Civil Rights and Social Justice Section, State and Local Government Law Section, and Commission on Homelessness and Poverty has proposed a resolution affecting automobile dealers that will be considered by the ABA House of Delegates in early August. The resolution is directed squarely at various issues related to vehicle sales and financing and is part of the ABA’s advocacy and policy-making efforts. The ABA indicates that the primary intent of the resolution is to urge Congress to amend the Equal Credit Opportunity Act (ECOA) to require documentation and collection of an applicant’s race, gender and national origin for non-mortgage transactions, including vehicle-secured transactions, and to urge Congress and legislative bodies to adopt laws and policies requiring an enhanced nondiscrimination compliance system for vehicle loans. Currently, under the ECOA, lenders are only required to collect so-called “government monitoring information” (race, ethnicity, sex, marital status and age) in connection with loans secured by a principal dwelling (Regulation B, 12 CFR § 1002.13).

The proposed ABA Resolution calls for:

Federal, state, local, territorial and tribal governments to adopt and enforce fair lending laws and other laws targeting unfair or deceptive acts or practices to address discrimination in vehicle sales and financing;
Amendment of the ECOA to require collection and documentation of applicant race, gender, and national origin for vehicle credit transactions through applicant self-identification;
Adoption of legislation requiring timely notice and disclosure of the pricing of add-on or voluntary protection products by dealers on each vehicle (such as via pricing sheet or website) before a consumer negotiates a vehicle purchase;
Adoption of laws and policies that reduce dealer discretion by limiting dealer markup or reserve, or eliminating dealer discretion to mark up interest rates, by using a different method of dealer compensation, such as a flat fee for each transaction; and,
Bar associations to offer educational programming to help lawyers and consumers understand the purchase and financing of vehicles and consumers’ legal rights in such transactions.

The ABA cites prior reports and investigations by the National Fair Housing Alliance, among others, relating the history of discrimination in auto lending to support its reasoning for this resolution. With regard to the proposal supporting amendment of the ECOA, the ABA cites the National Consumer Law Center’s position that prohibiting non-mortgage lenders from collecting certain applicant characteristic information makes it very difficult to determine if discrimination occurs. The background report in support of the resolution also discusses the support of certain state attorneys general for collection of such data in connection with disparate impact liability and their enforcement of anti-discrimination laws.

Another concern prompting this ABA proposed resolution is related to dealer reserves or markups. The ABA references the concerns of a group of U.S. senators that minority car purchasers are harmed by discriminatory practices through dealer markups as one reason for this proposed resolution. The ABA also indicates that “[T]he promotion of an enhanced nondiscrimination compliance system, as voluntarily promoted in the Fair Credit Compliance Policy & Program through the National Association of Minority Automobile Dealers (NAMAD), the National Automobile Dealers Association (NADA), and the American International Automobile Dealers, can be an effective way to ensure a rigorous review of exceptions to a flat-percentage fee in order to provide robust processes for fair pricing of dealer markups to all consumers in a nondiscriminatory manner” (ABA Proposed Resolution 115G, p. 11).

With respect to add-on or voluntary protection products, the ABA report provides that the “insidious effects of the wide disparities in car loan pricing are evident when compared to in nature.” The ABA points out that, by contrast, an insurance agent’s commission is not based on charging differing consumers differing prices for the same product, as the ABA believes is the case for dealers selling add-on products.

The ABA concludes that the resolution will affirm the ABA’s commitment to actively opposing discrimination, as well as strengthen consumer protections and promote economic justice.

Auto finance companies and dealers should carefully consider this proposed resolution in connection with their own advocacy efforts, as well as considering how, if this resolution is adopted by the ABA, it could eventually impact the operations and practices of auto finance companies and dealers.

New Law Expands Protections for Manufactured Homeowners and Tenants in New York

By Jason R. Bushby and Austin Holland on July 23, 2019 Posted in Affordable Housing, Manufactured Housing

New Law Expands Protections for Manufactured Homeowners and Tenants in New York Effective July 14, 2019, the State of New York greatly expanded tenant protections with a large package of bills covering topics ranging from rent control to eviction restrictions to rent-to-own contracts for manufactured homes (MH). A majority of the law is aimed at protections for apartment renters in New York City and throughout the state. In addition to those expanded protections, the new law also creates new and expanded protections for owners and tenants of manufactured homes. Despite there being only one MH park in New York City, MH parks fill a vital affordable housing need across much of the rest of the state. The major impact of these new MH-related laws will mostly be felt by the owners and managers of MH parks. Additionally, the impact will be felt by investors, developers, or any other party looking to purchase an MH park with the purpose to change the use of the MH park to something other than MH site rentals.

The new protections for owners and tenants of MH include:

MH park owners must provide MH owners and tenants at least two years of notice before beginning eviction proceedings if the MH park’s use will be changed to something other than for MH site rentals.
Up to a $15,000 stipend per MH, if the MH park is being sold and the park’s use will be changed to something other than for MH site rentals.
MH park owners must provide with each lease a copy of a document, produced by the New York Commission of Housing and Urban Renewal, detailing an MH owner’s and tenant’s rights.
MH owners must be offered an annual lease for site rental, whether or not their site rental account is in good standing. Previously, New York law only required that an annual lease be offered if the MH owner’s rental account was in good standing.
Late fees are now limited to 3% of the delinquent payment, and late charges may not be compounded or considered as additional rent.
Previously, an MH park owner could collect attorneys’ fees from an MH owner incurred because of the MH owner’s breach of the lease by considering the attorneys’ fees as additional rent. This practice is now barred. MH park owners now may only receive attorneys’ fees if awarded by a court.
Annual rent increases are now capped at 3%, unless the MH park owner can provide justification under the law for an increase above that amount. Despite this, in no case may an MH park owner increase the rent by more than 6% annually, unless specifically granted emergency relief by a court.
Previously, New York law granted MH owners the ability to purchase the MH park from the MH park owner, if the park owner intended to sell the park to a third party that proposed to change the use of the MH park for a purpose other than site rental. This right of the MH owners to purchase the MH park has been expanded to make it easier for MH owners to purchase the park.

A major new addition to the law are provisions focused on rent-to-own contracts between MH park owners and MH owners. According to the new provisions, a rent-to-own contract is any agreement between an MH park owner or operator and an MH renter that provides that after a specified term or other contingency the MH renter will take ownership of the rented MH. The portions of the law detailing the rent-to-own agreements include many new provisions, including the provisions highlighted below:

If an MH park owner is selling an MH in a rent-to-own agreement, they must possess documentation of ownership for the MH.
Every rent-to-own contract must be in writing and must include, if applicable, various required information as provided by the new law. The required information includes provisions that the rent-to-own purchaser cannot be charged any additional fees to transfer ownership at the end of the lease and title transfers at the end of the rent-to-own agreement shall be free of superior interests, liens, and encumbrances.
Valuation information used to determine the fair market value of the MH in a rent-to-own contract must be based on an independent party or system.
Until ownership of the MH is transferred to the tenant, MH park owners are responsible for compliance with the warranty of habitability, including but not limited to all major repairs and capital improvements during the life of the rent-to-own contract.
Annual leases must be offered to the MH tenant for at least the life of the rent-to-own contract.
An annual itemized payment listing must be provided to the MH tenant.
Any successor to ownership of the MH park will be bound by the terms of a rent-to-own contract entered into after July 14, 2019.
If the MH park owner terminates an MH tenant’s tenancy during the term of the rent-to-own contract, all paid rent-to-own payments must be refunded to the tenant.
MH park owners may not attempt to obtain a waiver from the MH renter of any protection or rights provided in the rent-to-own sections of the new law.
If an MH park owner violates any of the provisions of the rent-to-own laws or evicts an MH tenant who is a party to a rent-to-own contract, a court may award the tenant treble damages, including all rent to own payments and attorneys’ fees.
If an MH park owner fails to comply with any of the rent-to-own laws, the MH tenant has an unconditional right to cancel the rent-to-own contract and receive an immediate refund of all payments and deposits made on account of or in contemplation for the lease with the rent-to-own contract.

The new MH laws implemented in New York introduce numerous new protections for owners and tenants of manufactured homes and expand protections already provided. All MH park owners in the state will need to take steps to ensure they are implementing policies and procedures to ensure compliance with all of the new requirements. Further, for investors and developers in the state looking to acquire and develop an MH park for a reason other than MH site rentals, the new law increases both the lead time needed before a piece of land can be purchased and likely the total amount of investment necessary to purchase the property. New York is regularly regarded as a tenant-friendly state, and its laws are often a model adopted by other states. If your MH-related business is outside of New York, be sure that you are regularly receiving updates on new MH laws and updating your policies and procedures to meet any new or modified requirements.

FTC Imposes $110 Million Fine Against Payment Facilitator and Its Executives

By Graham W. Gerhardt and Josh Dhyani on July 18, 2019 Posted in Credit Card, FTC, Identity Theft / Privacy, Payday Lending, Short-Term Loans, Small-Dollar Lending, Unsecured Lending

FTC Imposes $110 Million Fine Against Payment Facilitator and Its Executives Payment processor/facilitator Allied Wallet, its CEO, and two other corporate officers, recently agreed to settle Federal Trade Commission (FTC) charges that they assisted or knowingly processed fraudulent transactions for merchant-clients. This action indicates that enforcement actions against payment processors are alive and well, despite the FTC’s previously announced end of “Operation Chokepoint,” which, among other goals, targeted payment processors and facilitators whose merchant clients engaged in activities perceived to be fraudulent.

The FTC alleged that Allied Wallet and the other defendants violated Section 5(a) of the FTC Act, 15 U.S.C. § 45(a), which prohibits “unfair or deceptive acts or practices in or affecting commerce.” According to the allegations, Allied Wallet, through its payment processing business, knowingly processed payments for merchant-clients engaged in fraudulent and criminal activities. The FTC alleged that the payment processor, in concert with its vendor, failed to adhere to rules and monitoring standards that would have prevented the criminal activity.

Allied Wallet’s business, in part, involved enabling e-commerce merchant-clients to accept card payments from consumers. A merchant account is a special type of business bank account that allows a business to accept different types of payment, typically debit and credit card payments. In order to setup payment processing, various merchants entered into agreements with Allied Wallet, which acted as an intermediary between the merchant and financial institutions known as an acquiring bank or “acquirer.” Allied Wallet’s payment processing model consisted of Allied Wallet acting as a “payment facilitator,” meaning that it was an authorized merchant registered by acquirers to process transactions on behalf of other merchants engaged in e-commerce who did not have merchant accounts of their own.

The FTC alleged that Allied Wallet failed to adequately vet merchants before acting as a payment facilitator for them. Specifically, the FTC alleged that merchants using Allied Wallet as a payment facilitator misidentified their locations, annual sales volume, and revenue transfers. The FTC also alleged that Allied Wallet failed to have an adequate compliance monitoring system in place to detect certain patterns that would indicate a merchant was engaging in fraud or criminal activity.

The FTC also emphasized that Allied Wallet continued to accept referrals from an entity run by an individual who had previously been convicted of various payment processing violations. Importantly, the FTC did not act to restrain this bad actor from acting as a referral source for payment facilitators, and the company this individual was currently running had no investigations or convictions against it. Nonetheless, the FTC suggested that Allied Wallet should not have used such a referral source, despite no per se rule against such an arrangement.

Under the stipulated final order, Allied Wallet, its affiliates, and its CEO agreed to a $110 million equitable monetary judgment. Another executive was subject to a $320,429.82 equitable monetary judgment, and Allied Wallet’s COO was hit with a $1 million fine and a lifetime ban in the industry.

The action serves as another stark reminder to mind the company you keep and to monitor card payments being processed on behalf of others.