Last Wednesday, the attorneys general of Illinois, California, and New York filed a lawsuit in the United States District Court for the Northern District of California challenging the Office of the Comptroller of the Currency’s proposed “Madden Fix.” This proposed rule, which we have discussed in detail, is designed to resolve some of the legal uncertainty introduced in 2015 by the Second Circuit Court of Appeals’ decision in Madden v. Midland Funding by confirming the “valid when made” doctrine. Although not unexpected as Illinois, California, and New York joined 19 other states in filing a comment opposing the OCC’s proposal, this lawsuit represents the first major challenge of a rule that is expected to bring long-awaited certainty to the secondary credit market, bank-partnership, and fintech spaces.
The OCC’s proposed rule, like its counterpart issued by the FDIC (which is not a subject of the pending lawsuit), is relatively simple. The proposal amends 12 C.F.R. 7.4001 and 12 C.F.R. 160.110 to state that “[i]nterest on a loan that is permissible [under either 12 U.S.C. § 85 or 12 U.S.C. § 1463(g)(1)] shall not be affected by the sale, assignment, or transfer of the loan.” The AGs’ legal complaint challenges this amendment on both procedural and substantive grounds.
First, the complaint alleges that the OCC neglected to comply with procedures required by the Administrative Procedures Act, as well as procedures relating to the preemption of state law under Title X of the Dodd-Frank Act. Second, the complaint asserts that the OCC lacks authority to issue the rule under the National Bank Act (NBA) because the rule allegedly purports to govern the terms and conditions of loans held by non-banks. Finally, the AGs challenge the proposed rule as generally arbitrary and capricious. Notably, the AGs’ complaint contains a broad-side attack against the valid when made doctrine itself, contending that the doctrine lacks both the historical bona fides and practical benefits asserted by its defenders.
Of course, we anticipate that the OCC will contest these characterizations, especially given the existence of case law stretching back to the early 19th century that lays the groundwork for the valid when made doctrine. Moreover, existing research suggests the Madden decision negatively affected access to credit within the states comprising the Second Circuit (Connecticut, New York, and Vermont). Additionally, the AGs’ argument that the OCC lacks authority to confirm the valid when made doctrine is undermined by the NBA’s express grant of authority allowing nationally chartered banks to enter contracts, sell loan contracts, and “exercise . . . all such incidental powers necessary to carry on the business of banking.” Taken together, there is fertile ground for the OCC to mount a robust defense of this lawsuit.
Nevertheless, this lawsuit means that there will be continued legal uncertainty surrounding the fintech industry, the bank partnership model of lending, and the general assignment of loans within the state in the Second Circuit. Fortunately, there are practices available to reduce the risk posed by Madden and its effective “cousin:” the True Lender doctrine. Banks, fintechs, and other interested parties should continue to structure deals and partnerships in ways that reduce the risk of a challenge under Madden. We will continue to monitor this litigation for developments and will keep a lookout for additional relevant litigation.