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Madden v. Marine Midland Funding

posted by Adam Levitin

In a recent case called Madden v. Marine Midland Funding, the Second Circuit ruled that a loan owned by a debt collector violated New York's usury statute.  The loan had been originally made by a national bank and was subsequently sold to the debt collector when it was in default.  There's no question that the state usury law was preempted when the loan was held by the national bank.  The Supreme Court's (awful) Marquette National Bank v. First of Omaha Service Corp. decision from 1978 makes that very clear.  (The Court suddenly discovered in 1978 that over a century of legal understanding of the 1864 National Bank Act was somehow wrong and that banks had been leaving lots of money on the table.)  

The debt collector argued that because the loan had been made by a national bank, it carried preemption of state usury laws with it as a permanent, indelible feature.  "Applesauce!" proclaimed the Second Circuit:  National Bank Act preemption of state usury laws extends no further than National Bank Act regulation.  Preemption is part of a package with regulation, but once the loan passes beyond the hands of a National Bank, it loses its preemption protection and becomes subject to state usury laws.  (Some of you might recognize that this is an argument I made several years ago. Plaintiff's counsel sent me a very nice email to this effect.  You owe me a citation, 2d Circuit!).  

The financial services industry is pretty upset by the Madden decision.  While Madden addresses this issue in the context of a debt collector (a small corner of the financial services world), the problem of transferable preemption is an issue that also arises in securitization markets.  In other words, all that securitized mortgage and credit card and auto loan and student loan debt might not be fully enforceable, because it might be usurious. (The effect of a loan be usurious varies by state, but typically the excess interest is unenforceable.) Indeed, there might well be claims for unjust enrichment for loans that have already been paid. (Even if the securitization trusts have no hard assets left, they do have representations and warranties that might be valuable to plaintiffs.) 

The fear over secondary market liability for securitization markets is what's brought some heavy hitters to the table as amici, represented by none other than Rodgin Cohen, urging rehearing and reversal.  

The amici are quick to point out the securitization issue, but they fail to note that representations and warranties in mortgage securitization transactions, at least, frequently represent and warrant that the loans comply with state usury laws.  In other words, the market is already addressing the problem.  There are also other market-based solutions, such as insurance, that amici don't mention. They also don't mention that illegality that renders an obligation void—as usury laws typically do in part--is a "real" defense that isn't protected by negotiability rules. A holder-in-due-course is still subject to usury laws. That signals an important policy choice that states could easily change if they wanted.   

The amici urging reversal are simply wrong. They make a legal argument and a policy argument. The legal argument is that it's long established that a loan's usurious status is determined at origination. That's correct, but misapplied.  All of the cases the amici cite for the principle that a loan's usurious status is determined at the time of origination are irrelevant. They are all pre-National Bank Act cases. The National Bank Act preempts state usury laws. It does not mean that the loans are not usurious, only that the state law is not enforceable against the national bank.  

Second, the amici's policy argument is bad. Their policy argument has two parts. First is a standard claim that poor people won't be able to get credit. Perhaps. But it means they won't be able to get usurious credit, and Congress has never acted to limit states' power to pass usury laws, for better or worse.  Second, amici argue that compliance with usury laws will gum up secondary markets. That's hogwash. Usury law compliance is already represented and warranted in many deals and to the extent that those R&W aren't seen as valuable, nothing prevents 3d party insurance from filling the void. Markets will adapt to law.  

In any case, if compliance with usury laws remains an inconvenience for secondary markets, that's a problem amici should ask Congress to fix.  State usury laws were not viscerated by the Supreme Court in Marquette National Bank not on a principle of market convenience or even a ruling on the wisdom of usury laws (sure, there's a Posner opinion out there--isn't there one on everything?--with an economic rationale, but that's not how law is supposed to be done, and it's a debatable rationale).  Instead, Marquette was premised on a reading of the language of the 1864 National Bank Act as creating conflict preemption.  (The National Bank Act actually contains its own weird usury cap, see here and here:  fwiw, I think this section probably means that there is a 7% usury cap on national banks based in Delaware, but that's another issue.)  

Marquette was a conflict preemption ruling plain and simple. That principle of decision should still be what applies to the secondary market, where there's no field preemption argument to be made because there's no pervasive regulation of the secondary market. Like national banks, secondary market players should get whatever preemption benefits are provided by federal statute, and nothing more. National banks shouldn't be in the business of laundering usurious debts via their preemption status. Yet that is exactly what The Clearing House and friends are urging. Hopefully the Second Circuit stands its ground (and gives me a citation!).   


Is the capacity of the trustee relevant to whether usurious rates can be charged? For example, if Bank of America, N.A. was the originator and still owns the loan then obviously federal law pre-empts state law on the usury issue. However, if Bank of America, N.A. sold the loan to the Scratched and Dented Sponsor who then sold the loan to the Scratched and Dented Depositor which then sold the loan to "Trustee" as trustee for the 2015-U Usurious Loan Trust, then is the identity of the trustee relevant as to whether it can enforce usurious interest rates? Certainly a non-national association Trustee would be subject to state law. Would a national association bank operating solely as a trustee for the usurious trust be subject to state usury laws?

That's a really interesting question. The answer is "I don't think so," but I don't know of an obvious prooftext that answers the question. The section of the national bank act that deals with the trust powers of national banks doesn't seem to provide answer.

It's also possible that the answer depends on the particular entity used for a securitization vehicle. If it's a Delaware statutory trust (which is a juridical entity, as opposed to a common law trust), perhaps there is a different analysis. (If the SPE is a corporation or LLC, as is common in commercial real estate deals and CDOs, then the trustee issue doesn't come up at all.)

As a policy matter it seems that allowing banks to rent out preemption via trust powers would be nothing more than the latest version of rent-a-BIN. It certainly doesn't look good, but bottom line is I'm not sure.


I've done what I could to give you some credit here:



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