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OCC and FDIC Propose “Madden Fix” Rules to Codify “Valid-When-Made” Principle

By: William S. C. Goldstein

New-Development-IconThe long-running saga of Madden v. Midland Funding is entering a new phase.  Last week, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) proposed rules that would codify the concept that the validity of the interest rate on national and state-chartered bank loans is not affected by the subsequent “sale, assignment, or other transfer of the loan.” See Permissible Interest on Loans That Are Sold, Assigned, or Otherwise Transferred, 84 Fed. Reg. 64229, (proposed Nov. 18, 2019); FDIC Notice of Proposed Rulemaking, Federal Interest Rate Authority, FDIC (proposed Nov. 19, 2019).  Under these rules, an interest rate that is validly within any usury limit for such a bank when it is made would not become usurious if the loan is later transferred to a non-bank party that could not have charged that rate in the first instance.

The proposed rules are a long-awaited response to the Second Circuit’s decision in Madden, which held that a non-bank purchaser of bank-originated credit card debt was subject to New York State’s usury laws.  786 F.3d 246, 250-51 (2d Cir. 2015).  In so holding, the Second Circuit cast doubt on the scope of National Bank Act (NBA) preemption, which exempts national banks from most state and local regulation, allowing them to “export” their home state interest rates without running afoul of less favorable usury caps in other states (FDIC-insured state banks are afforded similar protections).  Before Madden, it was widely assumed that “a bank’s well-established authority [under the NBA] to assign a loan” included the power to transfer that loan’s interest rate.  See Permissible Interest on Loans That Are Sold, 84 Fed. Reg. at 64231. The Madden decision also did not analyze the “valid-when-made” rule, a common law principle providing that a loan that is non-usurious at inception cannot become usurious when it is sold or transferred to a third party. See, e.g., Nichols v. Fearson, 32 U.S. (7 Pet.) 103, 109 (1833) (“[A] contract, which, in its inception, is unaffected by usury, can never be invalidated by any subsequent usurious transaction.”).  Madden has been widely criticized by a host of commentators, including the Office of the Solicitor General.

The OCC and FDIC rules aim to remedy the confusion caused by Madden.  OCC’s rule “would expressly codify what the OCC and the banking industry have always believed and address recent confusion about the impact of an assignment on the permissible interest.”  Permissible Interest on Loans That Are Sold, 84 Fed. Reg. at 64231-64232.  Likewise, the FDIC rule would rectify “uncertainty about the ongoing validity of interest-rate terms after a State bank sells, assigns, or otherwise transfers a loan.” Notice of Proposed Rulemaking at 2-3.  Both proposals cite Madden as the source of the confusion.

Notably, neither proposal purports to address the emerging “true lender” doctrine, which some courts have used to apply state usury or consumer protection laws to non-bank entities that have partnered with banks in issuing loans and that retain a “predominant economic interest” in the loan. See, e.g., People ex rel. Spitzer v. Cty. Bank of Rehoboth Beach, Del., 846 N.Y.S.2d 436 (N.Y. App. Div. 2007).  Under that doctrine, courts look at whether the bank or the third-party was the “true lender” in the first place, taking loans facing a true lender challenge outside the ambit of Madden and the OCC and FDIC fixes.  In that regard, the OCC proposal notes simply that “[t]he true lender issue . . . is outside the scope of this rulemaking.”  See Permissible Interest on Loans That Are Sold, Fed. Reg. at 64232.  The FDIC proposal likewise notes that the new rules do not address true lender issues, but goes on to express support for the concern animating the true lender doctrine: “the FDIC supports the position that it will view unfavorably entities that partner with a State bank with the sole goal of evading a lower interest rate established under the law of the entity’s licensing State(s).”  Notice of Proposed Rulemaking at 4.  

Comments are due on the OCC rule by January 21, 2020, and on the FDIC rule shortly thereafter.