OCC’s True Lender Rule Challenged in New Lawsuit

FinTech Litigation Update

In January, seven states and the District of Columbia filed litigation in the Southern District of New York aiming to overturn the “True Lender” Rule finalized by the Office of the Comptroller of the Currency in October 2020. See copy of Complaint here. The seven states are New York, New Jersey, Minnesota, California, Colorado, North Carolina, and Massachusetts.

With the administration change, legitimate uncertainty exists about the continued viability of the True Lender Rule, so it is unclear how OCC will respond to the lawsuit. The same can be said for OCC’s “Valid-When-Made” Rule (and the corresponding rule issued by FDIC)—a similar set of states has already filed litigation challenging those rules.

As we have written about before, the True Lender Rule states that the “true lender” in a financial transaction is the institution that is named in the underlying financing documents or the institution that funds the loan.

The application and interpretation of the True Lender Rule has a broad impact. Among other things, the rule affects state usury laws and, consequentially, the partnerships between banks and nonbanks. A national bank is essentially exempt from state usury limitations because the National Bank Act requires that national banks comply with the interest-rate caps of their home state only, regardless of where they do business. Nonbanks often want to partner with national banks to take advantage of this usury exemption—but some states (including those that have initiated this round of litigation) have taken the position that the nonbank partner cannot avail itself of the bank’s ability to “export” its home state’s usury limitation.

The nonbank in these partnerships is often a consumer or small business lender. States opposed to these partnerships argue that the nonbank lenders are targeting state residents with predatory lending practices. Attorneys general use the derogatory term “rent-a-bank” to describe the practice.

Legally, the issue turns on the question of which party in the partnership is the “true lender.” Courts generally hold that the true lender is the party having the “predominant economic interest” in the financial transaction—and they use various multi-factor tests to make that determination.

From a market perspective, the outcome of these multi-factors tests is uncertain—so banks and nonbanks must weigh their risks with imperfect information. By contrast, OCC’s True Lender Rule provides a “bright line” that eliminates uncertainty, encourages bank/nonbank partnerships, and allows participants to more accurately evaluate the risks of entering a new market.

The newly filed litigation challenges OCC’s True Lender Rule on these grounds:

• The rule is arbitrary and capricious under the Administrative Procedure Act because it was enacted through rushed and non-deliberative process, because it is unreasonable when compared with the multi-factor test used by courts, and because it reverses long-standing policy without sufficient and reasoned explanation.
• The National Bank Act and other federal banking laws do not authorize OCC to issue a True Lender Rule.
• OCC did not follow standards and procedures under the Dodd-Frank Act for issuing a rule that purports to preempt state consumer finance laws.

We continue to follow the litigation closely.

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