Who bears the risk? Federal Court holds that a purchaser of unsecured consumer loans is the “true lender”

By Irene C. Freidel and David D. Christensen

A California federal court has held that the purchaser of consumer loans is the “true lender” and thus subject to state usury laws, even though a separate entity funded and closed the loans in its own name. The recent decision, however, is another reminder that US state and federal regulators, as well as plaintiffs’ attorneys, may be able to pierce these partnerships where the financial institution funding and closing the loan does not bear substantial risk on those loans.

The court’s holding, which renders the loans unenforceable, challenges the business model used by many marketplace lending platforms. Generally speaking, marketplace platforms partner with financial institutions to protect themselves from the substantial licensing and compliance burden of state laws, including usury limits.

In the California case,[1] the Consumer Financial Protection Bureau (CFPB) alleged that CashCall engaged in unfair, deceptive, and abusive acts and practices under the Consumer Financial Protection Act of 2010, 12 U.S.C. § 5536(a)(1)(B) (CFPA), “by servicing and collecting full payment on loans that state-licensing and usury laws had rendered wholly or partially void or uncollectable.”   The CFPB’s theory of liability hinged on showing that CashCall, and not the tribal entity that funded and closed the loans, was the “true lender.”  As in similar cases,[2] the court held that the determining factor for such an inquiry is whether the partner financial institution (here, the tribal entity) bore a sufficient monetary burden on the loans.  In CashCall, the court held that it did not.

For example, the court found that (1) CashCall purchased all of the tribal entity’s loans and paid more than the funded amount for each loan; (2) CashCall purchased each loan before any payments were due and assumed all default risk upon assignment; and (3) CashCall agreed to indemnify the tribal entity with respect to any civil, criminal, or administrative actions that arose from the lending program. In short, the court held that “the entire monetary burden and risk of the loan program was placed on CashCall.”

Rejecting the loan agreements’ choice-of-law provision, the court held that the loans at issue were void or uncollectable under the usury and consumer protection laws of most of the borrowers’ home states. The court concluded that, because CashCall was collecting on unenforceable loans and did not notify borrowers that their loans were void, CashCall had engaged in deceptive conduct in violation of the CFPA.

Even if the lending arrangement involved in the CashCall case is not typical of marketplace lending platforms’ bank partnerships, the case is nevertheless a stark reminder that platforms face scrutiny from regulators and plaintiffs’ counsel.  Participants in these arrangements may need to reassess their terms to ensure that the funding institution maintains a sufficient level of risk on the subject loans.  We will continue to monitor and report on further developments in this area.

[1] See Consumer Financial Protection Bureau v. CashCall, Inc., No. 15-cv-7522 (C.D. Cal. Aug. 31, 2016).

[2] See, e.g., Commonwealth v. Think Finance, Inc., 2016 WL 183289 (E.D. Pa. Jan. 14, 2016); CashCall, Inc. v. Morrisey, 2014 W. Va. Lexis 587 (May 30, 2014).