The ongoing battle over the interest rates that online lenders can charge has moved to Colorado, which is taking aggressive steps to enforce its 12% rate cap for consumer loans.
The state’s hard-nosed posture is setting off alarm bells in the marketplace lending industry, where lending websites frequently partner with banks in arrangements that are designed to work around state-by-state interest rate caps.
The Rocky Mountain skirmish follows a 2015 court ruling that curtailed the industry’s growth in New York, Connecticut and Vermont. Industry lawyers are predicting future fights in additional states that have strict interest rate caps.
“I think that different states are going to try to test this doctrine more and more,” said Brian Korn, a partner at Manatt, Phelps & Phillips who represents one of the banks involved in the Colorado dispute.
So far, the fight in Colorado involves two online consumer lenders, Chicago-based Avant and Wilimington, Del.-based Marlette Funding. Avant advertises personal loans with annual percentage rates of up to 35.99% in many states. Marlette, which markets its loans under the Best Egg brand, charges APRs of up to 29.99%.
Colorado officials sued both firms early this year, asserting that they must comply with the state’s interest rate cap, and arguing that their relationships with banks that originate loans on their behalf do not get them off the hook.
In response, the banks that work with Avant and Marlette filed separate lawsuits against the state of Colorado, arguing that the state is trying to undermine privileges they are granted under federal law. State-chartered banks are allowed to charge the interest rates of their home states to borrowers across the entire country.
“This is yet another example of the marketplace lending platform model being under attack, whether it’s under attack by the courts, or whether it’s under attack by the states,” said Arlen Gelbard, general counsel at Cross River Bank, which partners with Marlette Funding.
Under its agreements with Marlette, Cross River Bank makes the loans. But the Teaneck, N.J.-based bank sells about 90% of the loans to Marlette or other buyers within two business days, according to the state of Colorado’s lawsuit. With respect to the loans that Cross River sells, the lawsuit argues that the bank is not the true lender.
Cross River takes issue with that legal analysis, and argues that Colorado authorities are seeking to undermine a business model that is kosher under federal law. It is seeking a court order that would bar the state from continuing its pursuit of Marlette.
“Without the ability to sell or transfer the loans on their original terms as authorized by federal law, Cross River’s business and the valuable service it provides to individuals and small businesses would be severely constrained,” said the New Jersey bank’s complaint, which was filed Monday in federal court.
WebBank, based in Salt Lake City, filed a similar suit against the state of Colorado in late March. WebBank’s online lending partners include some of the largest firms in the industry, such as Avant, Lending Club and Prosper Marketplace.
A spokeswoman for the Colorado attorney general’s office declined to comment on ongoing litigation.
The recent actions against Marlette and Avant are already having ripple effects throughout the online lending sector, according to an industry lawyer who spoke on condition of anonymity.
“I don’t think there’s any reason to believe that these are the only two companies that will be targeted,” this source said. “Companies are going to stop lending in Colorado. Some of them have already stopped.”
Something similar happened in New York, Connecticut and Vermont in the wake of the 2015 federal appeals court ruling, which rattled investors in the fast-growing sector.
The uncertainty at the state level could help to prompt action in Washington. Rep. Patrick McHenry, R-N.C., has introduced legislation that aims to resolve the issue. In addition, the Office of the Comptroller of the Currency has proposed a national fintech charter that would enable online lenders to avoid state-by-state licensing requirements.
“Regardless of whether these cases move forward,” lawyers at Pepper Hamilton wrote in a recent alert to clients regarding Colorado’s actions, “they highlight the unsettled state of the law and are likely to spur increased interest among fintech lenders about the possibility of obtaining a special-purpose national bank charter.”