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Usury Law: Not Too far From the Madden Crowd

NewYorkA recent decision by a three-judge panel of the 2nd Circuit Appeals Court, one that arose out of an application of New York State’s usury laws, may have important consequences for the securitization market. Accordingly, some of the big names of the Wall Street bar have entered the appellate picture representing “friends of the court” such as The Clearing House Association LLC and the Financial Services Roundtable. They want the same court to grant a rehearing, either by the panel or en banc.

The contention of the amici is that the decision threatens “the long-standing and settled expectations of the credit markets” and threatens in the process “to cause significant harm to those markets, the banking industry, and the millions of families and businesses they serve.”

The case is Madden v. Midland Funding LLC : To begin at the beginning: in 2005 a New York resident, Saliha Madden, opened a credit- card account with Bank of America. Bank of America later transferred this account to FIA Card Services, and by 2008, at a point at which Madden owed $5,000, FIA gave up on collection, and sold the rights to pursue the matter to defendant Midland.

Usury and Preemption

Madden sued Midland alleging that the interest rate charged on the debt is usurious under state law. The district court held that since Bank of America and FIA Card Services are regulated at the federal level, such state laws are preempted. The plaintiff appealed that to the 2d Circuit, which on the contrary decided on May 22, 2015 that preemption is not passed from one collector to another in an endless magnetic chain. Rather, federal preemption is part of the package involving the whole federal regulatory system, and , this collector, Midland, is neither a national bank nor a subsidiary or agent of a national bank. The district court was wrong, then, to dismiss Madden’s lawsuit on the usury issue.

That is the ruling that has piqued the interest of the credit markets. Not that debt collection itself is all that big a fish. But the issue of transferrable preemption pops up throughout the financial pond. Credit cards, like mortgages, student loans, etc., get securitized, and have been getting securitized without any concern about applicable usury laws so long as they have been lawful at origination (when, as in this case, they are generally protected by preemption).

Shout Out to Levitin

The defendant and the court’s various friends will try to change the result. But in the meantime, some credit has to go to Adam J. Levitin, of the Georgetown University Law Center, for creative lawyering. The appeals panel has now adopted a theory that Levitin first advanced back in 2009. In an article published in the Yale Journal on Regulation, Levitin wrote of the “recent changes in financial markets” that had “placed the majority of consumer debt in the hands of secondary market entities … which are not protected by federal regulation.” This gave the states what Levitin called the ability to “channel the hydraulic force of the markets.” He thereby created the argument that the plaintiffs are now using, thus far with success.

The legal argument that defendants are using on the other side, against the 2d Circuit’s holding, relies on a precedent almost two centuries old, the U.S. Supreme Court decision in Gaither v. Farmers & Mechanics (1828). The high court said then that “the rule cannot be doubted, that is a note [is] free from usury, in its origin, no subsequent usurious transactions respecting it, can affect it with the taint of usury.” Gaither doesn’t seem to have had anything to do with federal/state issues. Indeed, the notion of federal preemption of state regulatory authority was itself only slowly developing in those years, in a string of cases in which Gaither plays no part.

There was no plausible argument for federal preemption of any of the consequences of state usury laws until the passage of the National Bank Act thirty five years after Gaither, so it isn’t immediately obvious how the appeals court en banc, or the Supreme Court should the issue get that far, is going to judge the relevance of Gaither to these facts.