The OCC’s “True Lender” Rule is Facing a Potential Reversal

Controversy and a high-profile lawsuit have surrounded the banking rule since the Office of the Comptroller of the Currency issued it last fall

Key takeaways:

• OCC’s True Lender rule faces a potential reversal by Congressional resolution.
• The rule is also the subject of a January 2021 lawsuit filed by the Attorneys General of seven states and Washington D.C.
• The rule offers a “bright line” definition of which entity in a bank-nonbank partnership arrangement is the “true lender.”
• Opponents of the rule charge that it facilitates the violation of state usury laws and enables predatory lending.
• OCC and its defenders claim the rule resolves uncertainty and will boost the economy by encouraging competition and innovation. 

The brief life of a much-contested ruling could be nearing its end. 

The National Banks and Federal Savings Associations as Lenders Rule (the “True Lender” Rule) became a target of legal action shortly after its effective date of December 29, 2020. And the question it aimed to answer definitively has been a cause for debate for much longer. 

A lawsuit and recent activity by Democratic lawmakers in opposition to the rule charge that it facilitates the violation of state usury laws and enables predatory lending. The Office of the Comptroller of the Currency (OCC) and its defenders claim the rule resolves the uncertainty surrounding bank and nonbank partnerships and will boost the economy by encouraging competition and innovation. 

OCC’s attempt to settle the “true lender” issue was viewed as a boon to banks and their fintech partners, “shrinking” the effects of Madden v. Midland Funding and joining another highly contested “Madden-fix” rule, the FDIC’s “Valid-When-Made” doctrine. 

The rule’s fate and the subsequent impact on lending markets could be determined by the new administration, Congress, or a lawsuit ruling. 

A brief timeline

In July 2020, OCC attempted to resolve the question raised by a growing amount of case law of which entity in a bank-nonbank partnership arrangement is the “true lender.” OCC proposed a clear test to establish when a bank makes a loan. 

The final rule, finalized in October 2020, goes further. It states that the “true lender in a financial transaction is the institution that is named at the point of origination in the underlying financial documents or the institution that funds the loan.” 

OCC’s final rule was criticized by consumer advocates and legislators who believe it will enable predatory lending and what they refer to as ‘rent-a-bank schemes,’ or partnerships entered into by third-party lenders to avoid complying with states’ usury laws. OCC addressed the comments by clarifying that the bank, as a “true lender” of a loan, must follow the compliance obligations associated with origination. 

On January 5, 2021, a coalition led by the attorneys general of seven states and the District of Columbia filed a civil action in the Southern District of New York challenging OCC’s rule on several grounds. The litigation charges OCC with failure to comply with terms of the Administrative Procedures Act, the National Banking Act, and the Dodd-Frank Act. The plaintiffs claimed that OCC’s “bright-line” rule deviated from “centuries” of usury law and would “infringe on the States’ historical police powers and facilitate predatory lending.”

The lawsuit’s pre-trial conference date was set for early April. As of this writing, no other proceedings of note have occurred or been scheduled.

In March, more than 325 civil rights, community, consumer, faith, housing, labor, legal services, senior rights, small business, and veterans’ organizations were represented in a letter to Congress to repeal the True Lender Rule. The letter called on lawmakers to reverse it, claiming the rule will “eviscerate the power of state interest rate caps and rid state regulators of the single most effective tool to protect consumers from predatory lending.”

Shortly afterward, Democratic lawmakers declared their intention to seek an appeal to the True Lender Rule. On March 25, 2021, Senator Chris Van Hollen (D, MD), along with Senate Banking Committee Chair Sherrod Brown (D, OH), initiated the rule’s potential reversal by a Senate resolution. 

If passed, the resolution would overturn OCC’s rule using the Congressional Review Act, which allows Congress to discard federal regulations finalized within the previous 60 legislative days by a simple majority vote in both chambers. The resolution would not only repeal the final rule. It will also prohibit OCC from issuing a rule “in substantially the same form … unless the reissued or new rule is specifically authorized by a law enacted after the date of the joint resolution.” 

Will the “bright line” be diminished?

The fate of the true lender rule is of particular interest to the banking industry overall and the fintech sector specifically.

As a result of the uncertainty that will hit markets as if the rule is struck down, financial technology firms may pull out of planned partnerships or limit their operations in certain jurisdictions. Some business models may be unable to withstand an abundance of scrutiny by government and consumer advocacy groups. OCC maintains that the return to legal uncertainty about which lending rules apply could restrict access to affordable credit and stifle “innovative lending relationships.”

It is too soon to know whether the True Lender Rule will survive its many political and legal challenges. Its future—and what types of regulations take its place to clarify relationships among lenders—will be determined by many factors. Not the least of these is the question of whom will be appointed Comptroller of the Currency and how the Southern District of New York rules on the pending litigation filed by various states’ attorneys general. 

To be continued…

Johnston Clem Gifford’s attorneys are trusted advisors to our clients and thought leaders in the financial services legal market. Contact us online or by calling (214) 974-8000.