Marketplace lenders would benefit most from an overturn of the Madden vs. Midland decision

The Supreme Court might hear a case that’s pivotal for marketplace lenders.

On Nov. 10, defendants in the high-profile Madden vs. Midland Funding case petitioned the country’s highest court to review a ruling that has put online marketplace lenders in danger of violating usury laws in some states.

But they’re taking a risk.

Moody’s Investors Service said the worst possible outcome for marketplace lenders would be that the Supreme Court hears and affirms the decision.

This would broaden the scope of the decision from New York, Connecticut and Vermont currently to the entire U.S., potentially forcing marketplace lenders to lower rates on loans across the country.

Naturally, the best scenario for marketplace lenders would be an overturn of the original ruling.

Commenting on case in a report today, Moody’s said the litigation presents risks for bonds backed by marketplace loans. Some of these loans bear interest rates that might have to be reset lower, reducing the flows available to pay bondholders.

The marketplace lenders most vulnerable to the litigation are those that fall under the rubric of “purchasing platforms.” They broker loans originated by third-party banks. Lenders that do this, such as Lending Club and Prosper, tend to skirt usury laws that would typically apply to nonbank lenders.

“Further court decisions, including the possible Supreme Court review, should provide more clarity over the next two years about the likelihood of losses on loans from marketplace lenders resulting from their use of the partner-bank origination model,” the rating agency said.

Moody’s pointed out that some lenders are already cutting back on loans bearing rates that breach caps in the three states under the jurisdiction of the Second Circuit US Court of Appeals, which passed down the decision.

By using third-party banks, lenders can take advantage of “rate exportation” laws that allow banks to provide loans that breach state-by-state usury limits.

But a nonbank availing itself of those laws was legally challenged last May in the case Midland vs. Madden. The ruling said that Midland, a unit of Encore Capital Group, could not charge the same interest rate as a bank, on bad credit card debt that it acquired. Basically court ruled that the debt collector was not entitled to the usury law carve out enjoyed by banks.

Many observers believe this would apply to marketplace lenders as well.

At any rate, the litigation may take a while though. Moody’s points out that the Supreme Court could “possibly rule” on the case by June 2016.

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