California District Court Upholds “Valid When Made” Rule

A federal court in California recently upheld the age-old common law “valid when made” doctrine, seeking to reinforce the rule that when a national bank sells or assigns a loan, the interest rate charged on the loan remains valid after the transfer or assignment.

Ever since the 2nd Circuit’s decision in Madden v. Midland Funding, LLC in 2015, banks and fintech lenders, including those active in securitization markets, have grappled with uncertainty when selling or assigning funded loans across state lines. In Madden, the court held that a non-bank assignee of a loan originated by a national bank had to look to the usury laws of its home state to determine the validity of the loan. The court based its decision on an argument that state usury laws were not pre-empted by the National Bank Act. Although the court did not directly address the application of the “valid when made” doctrine to the facts of the case, its holding nonetheless introduced uncertainty in this area, where there had been none before. Madden spawned litigation in other courts, as well, with the various circuit courts often reaching different conclusions. Some courts ruled in line with Madden, while others held that validly made loans were not rendered invalid by subsequent assignment, and still others allowed usury claims to go forward when the non-bank lender was deemed to be the “true lender” rather than the bank.

In 2020, as a direct response to Madden and its progeny, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) promulgated rules that sought to undo the Madden decision and establish bright-line rules with respect to the “valid when made” doctrine and, solely in the case of the OCC, to determine when a bank is the “true lender.” Challenges to these rules followed, with several attorneys general joining in each, including two cases challenging the “valid when made” rules in the Northern District of California—California v. OCC, No. 4:20-cv-05200 (N.D. Cal. Feb. 8, 2022) and California v. FDIC, No. 4:20-cv-05860 (N.D. Cal. Feb. 8, 2022). (In June 2021, Congress repealed the OCC’s “true lender” rule pursuant to its power under the Congressional Review Act, rendering the suits related to that rule moot.)

In a significant victory for the OCC and FDIC, on February 8, 2022, United States District Court Judge Joseph White granted summary judgment in favor of the agencies in both of the lawsuits brought by the states. The court found that the agencies did not exceed their statutory authority in promulgating the rules, nor were the rules arbitrary and capricious. The court observed, “it was not unreasonable” for banking regulators “to determine greater certainty regarding the transfer of interest rates, and a large market for transfers, would serve to promote the safety and soundness of the national banking system.”

Despite the win, uncertainties remain. The states have until April 11 to appeal the Northern District of California’s rulings to the 9th Circuit. An appeal has not yet been filed, but is thought to be likely. Moreover, even if the decision is not appealed or withstands challenge on appeal, interested loan market participants, including banks, fintech lenders, securitization sponsors and investors will remain focused on mitigating their exposure to challenges concerning the “true lender” of their loans, where additional case-by-case analysis may be required.