Podcast: Deep Dive into Bank Partnerships: Lending, Litigation, Legislative Trends, and True Lender

The next installment in McGlinchey’s Deep Dive into Bank Partnerships Series features a podcast on lending, presented by attorneys Joe Apatov, Aaron Kouhoupt, and Robert Savoie. Their discussion centers on the evolving landscape of bank partnership programs, focusing on litigation and legislative trends. Key topics include state regulations, compliance management, the Depository Institutions Deregulation and Monetary Control Act (DIDMCA), and True Lender concerns.

Aaron Kouhoupt: Hi, I am Aaron Kouhoupt. I am a partner in McGlinchey Stafford’s Consumer Financial Services division in Cleveland, Ohio. And I’m super excited today to be joined by my partners, Robert Savoie, who is also in the Consumer Financial Services team, also in Cleveland, and Joe Apatov, who is a member of our Consumer Financial Services Litigation group. And he’s joining us from our Fort Lauderdale office.

And today, we’re going to talk about the ever-evolving legal landscape of bank partner programs. And if anybody thought that this was going to slow down at some point, it has not; both in the number of programs that have been launched over the last few years, it doesn’t really slow down. You’ll notice a lot of state developments in particular. There’s not a whole lot going on in the federal, although there has been some talk amongst federal regulators and some guidance that’s been put out that’s going to be the subject of some deep dive later in the session.

But, you know, some of those things are third-party oversight and how to properly manage a program. And the federal has really been focused on the compliance management aspect of these bank partner programs. As I said, we’re going to talk about that another time. Today, we’re going to focus on the states and what the states are doing in this space and the courts, and we’ll see where that’s going.

So, Robert, I’ll start with you. On the legislative side, I just previewed what you’re not seeing outside of the management program and how to structure these things. You don’t see a lot on the federal level trying to come up with a federal licensing system, for example, or some sort of cohesion on the federal side, but the states are certainly very active in this space.

Robert Savoie: Yeah, absolutely. It may help to take a minute and think about how the states have approached bank partner programs and, more broadly, the interconnectivity between depository institutions and non-depository institutions over the last 10 to 15 years as the programs have grown and expanded and sort of the field of different programs has widened in terms of the scope of their activities. If you go back maybe 15 years, what you saw was true lender litigation or valid when made litigation before the Federal Deposit Insurance Corporation (FDIC)’s regulations where you had plaintiffs or regulatory agencies seeking to attack the program via litigation. That was high risk and high profile, but it was speculative, and people were very worried about that initially. Alongside that, you saw state regulators sponsoring bills or some legislatures sponsoring bills focusing on regulating the non-bank entities.

But it was more about service provider licensing, right? It was, “Hey, our law regulates a lender.” Well, now we see that you’re taking applications or soliciting loans. Let’s add a loan solicitation license. Let’s amend our definition of what a lender includes to say somebody that arranges a loan, or you’re servicing this consumer loan for the bank or where the bank owns the loan, or for an investor, well, let’s add loan servicing to our licensing set, maybe in a servicing license, maybe in an amendment to our debt collection law, or maybe as an amendment to the definition of a lender that is subject to licensure. And you saw that evolve for several years. A new change starting with the Illinois Predatory Loan Prevention Act is a different form of state regulation. What they are trying to do is blend in substantive regulations that cover the program in a way that, in some cases, avoids interfering or attempts to avoid interfering with depository institutions, federal right to export their home state interest rate, or in other cases can take a direct attack on that underlying authority in or blended.

The initial modern example of that was a few years ago, which is the Illinois Predatory Loan Prevention Act (PLPA). That law basically drew a line in the sand tied to the 36% interest rate restriction that was in Illinois. It did a couple of interesting things. One is that it tied the rate calculation to the Federal Military Lending Act’s Military Annual Percentage Rate Calculation, different from Truth in Lending and the Annual Percentage Rate (APR) that most people think about. What it did is it looked to attack companies that partnered with depository institutions and set out a number of factors about when they would be viewed as the de facto lender or the true lender, including things like predominant economic interest tests, people taking the applications on the front end while also having the right or an obligation to purchase the loans.

Also included is a totality of the circumstances test. What it sought to do is say, if you’re going to stay below our 36% cap as we have defined it, we’ll leave you alone. There are no material requirements, and we’ll let you go about your day. And if you exceed that rate limit, we will deem you the true lender and seek to void the loans. So it attempted to draw a line in the sand that said, hey, we see how these partnerships are being structured. These are the ones that we’re concerned about. This is the test, and this is the line in the sand in terms of what we think is acceptable and is not acceptable. In the three years or so since that law took effect, you’ve seen several other copycat states where the states have come in and done some variation of that.

In Illinois, it was tied to a 36% rate tied to a federal rate calculation that was at least acknowledged. In law, some other states have done this with varying interest rate limits. Maine adopted one with some lower interest rate limitations. New Mexico adopted one that was at a 36% threshold. Some states have also paired a licensing element to it, whereas Illinois focused on substantive product.

Some of these other laws have paired a licensing component where you are the lender for more purposes than just the rate caps. And so you can actually run afoul of state licensing laws, not solely because you’re processing a loan application or you know you’re a loan servicer, but also because of the substantive contractual arrangement between you and the depository institution.

Over the last few years, we’ve seen that the states have continued to propose legislation already in 2024. We have seen a number of proposals from states ranging from Florida to Maryland to Washington to Alaska.

Although, to date, the only one that has been passed to my knowledge is Washington, which takes effect on June 6th but adopted a similar but different test in terms of licensure. But it tied the substantive obligations in general to exceeding the rates otherwise permitted by law in a way that is in some ways similar to the Illinois PLPA. So when you think about what’s going on at the state level, that’s how true lender has evolved.

Now, the other huge development for bank programs that are in the credit space is the law that grants state charter depository institutions that are insured by the FDIC the ability to apply a uniform and consistent program and with respect to interest rates and fees across state lines, was created by a federal law in 1980, Depository Institutions Deregulation and Monetary Control Act (DIDMCA).

Aaron Kouhoupt: So what I’m hearing, Robert, is that the states are going in a few different directions, and part of the reasons that these FinTech partnerships exist are that banks have certain rights, national banks under the National Bank Act and state-chartered banks have similar expectation and some preemption rights that were meant to bring uniformity in particular to the credit market and to bring both consumers and businesses the ability to have a standard set of understandings on how to deal with things that were at least related to the loan that the financial institution was making. Right. I think we all recognize that preemption and exportation weren’t for everything. Still, for certain things that are very important to the consumer and for the entity, there was some uniformity there.

And is this proliferation of state laws that are looking to go, not at the banks necessarily, but at the bank programs by looking to the bank’s partners is that of concern that you’re now sort of chipping away at those national and state bank rights to offer uniform programs across the country?

Robert Savoie: Yeah, absolutely. If you think about the classic bargain and the purpose of the National Bank Act in the first place, right? There was recognition early on in the Republic that it was not a great outcome to have banks differ in their activities and material key ways, as you said, across state lines. That was the reason for the creation of the National Bank Act, which was to provide uniformity and consistency. And that’s why, in 1980, they extended those rights on matters material to determining the interest rate to state-chartered Federal Deposit Insurance Corporation (FDIC)-insured depository institutions. And that was in a landslide, right? It was 75, 80% of Congress voted in favor of it. It was certainly not a squeaker, the way everything is in terms of politics on a partisan basis today. And so you think about that, what was the point?

The point was that banks trade the ability to have uniformity and consistency for an enormous regulatory burden. The sheer scale of the compliance expectations and the regulatory apparatus that applies to depository institutions is just orders of magnitude above a non-depository entity. The premise was to take highly regulated, very carefully supervised depository institutions and give them uniformity and consistency because they face a heightened scrutiny on all levels.

The approach in terms of the restriction of those depository institutions’ activities through the actions of their vendors chips away at that bargain because it restricts the ability of depository institutions that need to rely on third-party vendors and tech providers to compete and it restricts their ability to use them in a way that it does not for larger, more well-capitalized financial institutions. It also creates an interesting question of how enforceable these laws are in the first place.

There are really interesting questions about whether a true lender law is a violation, whether it is preempted under the Federal Deposit Insurance Act (FDIA), or certainly the National Bank Act in terms of those laws not allowing states to interfere with their rights. Now you put a pin in that because it’s a really interesting concept and because separately from true lender laws or, in some cases, in conjunction with true lender laws, we’ve seen a resurgence of interest in opting out of these federal rights with respect to state-chartered depository institutions.

To understand how to think about it the National Bank Act gives broad preemption to nationally chartered banks, and states are not able to disagree with it or opt out. Those state laws are preempted. It’s not the same with state-chartered depository institutions where they get their right to export their home or host state interest rate under that federal law DIDMCA, and DIDMCA granted an opt-out right when it was adopted under state law that a state could opt out very clearly from those laws. Iowa did that a number of years ago; a few other states did, although they rescinded their opt-outs. So, it probably does make sense to just talk about the state of that law and the optics.

Aaron Kouhoupt: Yeah, I think that’s all going to be very interesting to see how it plays out because you not only are interfering with that uniformity, you’re also putting national banks and state banks on different playing fields, which is what they were trying not to do when they passed this law, what, over 30 years ago. And so you’re sort of going back to a problem that existed a long time ago by creating this patchwork and putting them on different levels.

Joe, legislatures are obviously very busy. It’ll be interesting to see how that plays out either to the courts or where some of these litigations have already been filed in Colorado, for example. On top of that, what are you seeing on the litigation side of things?

Joe Apatov: So, the litigation has been relatively quiet on this front; there are obviously some attorneys general who have pursued various attacks, but from the private litigation side, it’s very limited. I think there are a few reasons for that. One is that generally, a plaintiff’s firm is going to need an incentive to pursue the claim, and these do not really lend well to that. And the reason there is, in part, that this theory does not really play well into the consumer protection statutes, for example. And that would be one place where you get the incentive because there are generally attorney provisions, attorney’s fee provisions there.

But if you look at the Fair Debt Collection Practices Act (FDCPA), you’re not dealing with debt collectors. If you’re looking at the Fair Credit Reporting Act (FCRA), if you’re challenging the interest rate, that’s going to be a legal challenge that most courts have generally been kind of hesitant to allow to be challenged through a FCRA claim.

The other path is really going to be class actions, and on top of finding the proper vehicle, because those consumer protection statutes have issues, you have the second issue, which is that, generally speaking, you’re going to find FinTechs have strong arbitration provisions with class action waivers. And where we have seen class actions brought that are attempting to make a true lender challenge, whether it’s in Pennsylvania under the LIPL saying that the interest rate is too high or wherever it is, they get met with a motion to compel arbitration. And generally, those have been successful.

I saw one out in California that was pending for a couple of years. The court denied a motion to compel arbitration and went to appeal to the Ninth Circuit. And about a month ago, in April, the Ninth Circuit reversed, and arbitration was compelled. So generally, there’s going to be that strong bar to pursuing a claim as a class action. Without the class action or the attorney’s fee provision, there’s not a lot of incentive for the plaintiffs to bring these claims because there’s generally not a lot at issue as far as damages are concerned and anything of that nature.

So where you’ll see this challenge more, I think, is in defensive litigation. If there’s an attempt to collect on a debt, collect a deficiency, whatever it is, then there’s the challenge to say, no, you can’t collect this because it was usurious because true lender and the bank was not the true lender. So it gets kind of pigeonholed into, I think, a much more limited group. It’s also not completely novel because debt collectors have dealt with this as well.

There was the Madden case out of the Second Circuit seven, eight years ago, where a debt collector attempted to collect on a debt. The Second Circuit said this was usurious, and you can’t get the protections of preemption because you are not the bank. That has generally been retreated from everywhere I’ve seen, but it wasn’t a novel theory; it was just being transformed from debt collector to FinTech here.

So I think the biggest thing we see when you’re dealing with this litigation is just the motioning compel arbitration is kind of the forefront attack that protects the FinTech from this litigation. From there, whether it’s being litigated in arbitration, there’s not a lot at issue, however it plays out. It’s complex litigation that requires an investment from counsel. And unless there’s incentive to put that investment out there in an individual claim or a claim without attorney’s fees, it doesn’t really get you there. Trying to raise a novel theory really requires an in-depth analysis of a bank partnership program and discovery that requires unwinding what’s going on there. This involves finding out a lot about what’s going on there, things that are not going to be in their possession or they’re going to be aware of until they start litigating. They’re going in blind, hoping to find something that could potentially open the door if they can get past these other hurdles. So it’s just not very enticing as litigation is concerned.

Robert Savoie: It’s interesting, maybe that’s one of those things that led to the legislation, right, which was there were these actions and some high profile actions, and people thought, oh, there’s going to be more of these, and all of this. But the companies ended up winning a number of those because client attorneys couldn’t prove their claim, which I guess lends itself to your point, although maybe that’s why it’s pivoting back towards legislation as opposed to litigation.

Joe Apatov: And that’s where it makes sense. The regulators, the attorneys general, are better equipped to pursue these things rather than individuals trying to raise this kind of novel challenge. And there’s more information there. There’s more of a public policy concern. I think the big thing is just staying abreast of these changes of the law and law, staying abreast of licensing requirements, all things of that nature where there can be a quicker challenge. As long as you stay abreast of what’s developing in the law, you can protect yourself a lot. And I know that’s why you guys are always digging around the legislatures, asking them everything that’s going on and finding out what’s happening.

Aaron Kouhoupt: So I mean, look, it suffices to say there’s not any lack of excitement in this space. It’s not slowing down. It’s ratcheting it up and maybe finding new problems created by some of this legislation. Both Joe and Robert’s point is that it’s very important, especially if you’re operating on a 50-state basis or even on a regional basis, to be aware of the states and how the various states are dealing with these issues.

We raised a lot  during this first session of the Deep Dive into Bank Partnerships, and we’re going to dig into some of these things in some future episodes

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