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Colorado raises the stakes in lawsuit against marketplace lenders

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While Congress drags its feet on a legislative “fix” for Madden v. Midland, the judicial precedent that marketplace lenders rely on to charge interest rates above state limits is under fresh attack in two other lawsuits.

This time, it’s not just the ability of the online platforms to purchase loans from banks that is being challenged, but their access to funding through the capital markets.

In 2017, the state of Colorado initiated a pair of lawsuits against Avant and Marlette, alleging that they had violated the state’s Uniform Consumer Credit Code by charging interest and some fees in excess of those allowed under Colorado law. These loans were made by out-of-state banks, which are allowed to “export” higher interest rate caps in their home states. Nevertheless, Colorado claimed that the online platforms were the “true lenders” because they held the predominant economic interest in the loans – the doctrine enumerated by the Second Circuit Court of Appeals a year earlier in Madden v. Midland.

These suits, Mead v. Avant of Colorado and Mead v. Marlette Funding d/b/a Best Egg in Colorado, were tied up for a year in procedural machinations; the marketplace lenders removed the cases from state court to federal court. Then in early 2018, the federal court remanded the cases to state court.

In November, Colorado Attorney General Cynthia Coffman filed amended complaints in state court that challenge the marketplace lenders’ ability to fund lending by bundling loans into collateral for bonds. The suits now allege that securitization trusts that have taken assignment of payments under the loans, as well as their trustees, are also charging and collecting amounts in excess of what is allowed under the Colorado UCCC.

Colorado is seeking a permanent injunction against the platforms and the securitization trusts from violating the UCCC, refunds to consumers and civil penalties.

“This latest effort by Colorado to expand the suit to national trust banks is a lose-lose proposition that creates risk for our financial system,” Nathaniel Hoopes, director of the Marketplace Lenders Association, said in an email. “Colorado consumers and small businesses will lose out on simple, more transparent and more affordable credit options.”

Avant and Marlette are already excluding Colorado loans from new securitizations. Avant’s most recent transaction, Avant Loans Funding 2018-B, does not contain a single loan to a borrower in the state, according to Kroll Bond Rating Agency. The deal also excludes certain loans made to borrowers in New York, Vermont and Connecticut, where the Second Circuit Court’s decision in Madden v. Midland is binding. The deal only includes loans to borrowers in New York and Vermont with interest rates below the 16%/12% usury caps in those states; however, a small percentage of loans to borrowers in Connecticut are above that state’s 12% usury cap.

Similarly, Marlette’s latest securitization, Marlette Funding 2018-4, does not contain a single loan to a borrower in Colorado, and all loans originated to borrowers in New York, Connecticut and Vermont are limited to the usury caps in those states.

Both transactions were completed before Colorado expanded the suits to include securitization trusts that hold loans made in the state.

Hoopes said that if Colorado’s cases succeed, the precedent will make banks less safe. “Banks lose the ability de-risk by selling the full range of loans into the credit market,” he said. “Although this is just one state’s court, the effort is certainly misguided and potentially very harmful.”

The ultimate determination of the theories involved in these two cases could impact the ability of marketplace lenders to lend in other states as well. “All participants in the online lending space should carefully watch these cases and also be careful in structuring loan programs in conjunction with funding banks,” the law firm Chapman and Cutler warned in a Dec. 11 client alert. “In particular, as a number of states beyond Colorado have enacted a version of the UCCC, the decisions ultimately rendered in these cases could have implications for online lending in multiple jurisdictions.”

In June, a group of 21 state attorneys general called on Congress to vote against two House-passed bills that would codify the “valid when made” doctrine, which they said would undermine states’ ability to enforce consumer protection laws.

In a letter to the Senate leadership, the state attorneys general said they oppose legislation that would allow debt buyers, including fintech firms, to bypass state interest rate caps, as well as a bill that would say that a bank is the “true lender” in any loan assignment arrangement with a third-party service provider.

“If passed, these bills would allow nonbank lenders to sidestep state usury laws and charge excessive interest rates that would otherwise be illegal under state law,” wrote the state attorneys general, led by Coffman and Massachusetts Attorney General Maura Healey.

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Midland Funding v Madden Marketplace lending