The recent opinion of Consumer Financial Protection Bureau v. CashCall, Inc., et al., issued by the U.S. District Court for the Central District of California, posed a challenge to internet-based lenders seeking to obtain preemption by making loans through a third-party. The case puts into question the validity of a true lender in loans involving more than one financing party. It also provides insight as to what factors the court considers when ruling that a non-bank, conducting transactions with a bank, should be judged as a true lender.
The Consumer Financial Protection Bureau (CFPB) filed suit challenging CashCall’s latest business model where the documents associated with the advertising, processing, and issuing of loans were originated by Western Sky Financial—an organization affiliated with the Cheyenne River Sioux Tribe, with the loans serviced and collected by CashCall. According to the suit, CashCall intended to use this approach to exploit the benefits of Tribal statutes on a national basis, thereby avoiding state licensing regulations and lending limitations to offer higher interest rate loans.
The District Court found that although the documents in question listed Western Sky as the lender of record, based on the “totality” of the circumstances, CashCall was, in fact, the true lender. In doing so, the court concentrated their analysis not on which entity was indicated as the lender in the documents, but what took place behind the scenes of the transaction and who actually issued the credit.
CashCall’s operational framework mirrors a widely used model within the online lending industry. It involves using an internet software provider cooperating with a government-endorsed insured depository entity that is subsequently listed as the primary creditor on the loan documents. The set-up enables a non-banking organization, lacking the necessary state lending licensing, to engage clients nationwide for loans extended behind the scenes by the partnering creditor. These loans carried interest rates that were based on where the non-banking organization was incorporated, allowing the true-lender to bypass state lending guidelines.
The court determined that the relationship between CashCall and Western Sky resulted in a situation in which the entire financial burden and risk of the loan structure was shouldered by CashCall—meaning it, not Western Sky, possessed the overriding economic interest. Ignoring that Western Sky would have been potentially liable had CashCall breached its contractual obligations, the court instead pointed out that CashCall pre-paid loans for two days on behalf of Western Sky; bought all originating loans following a minimum three-day window after the loan’s closing; guaranteed a minimum price point; and consented to fully indemnify Western Sky in the event of any legal liability related to its loans.
Furthermore, the court ruled that the relationship between CashCall’s customers and the Cheyenne River Sioux Tribe did not constitute a substantial relationship to the extent that Tribal laws should preempt applicable state laws as a matter of public policy. Accordingly, the court invalidated the Tribal choice of law stipulations and mandated that the usury and licensing regulations of the customers’ residence State should apply to the loan agreements.
The ruling indicates that several loans originating from the partnership of CashCall with Western Sky were voided as a result of violating state law and therefore non-collectible. The court additionally accepted the CFPB’s position that CashCall’s processing of loans rendered uncollectible constituted a deceptive practice that violated the Dodd-Frank Act’s restriction on unfair, deceptive, and abusive practices. The CFPB argued that CashCall fabricated the impression to customers that the loans were valid and collectible.
While it is common for contracts within the online lending industry to designate counter-party risk, guarantee minimum price points, stipulate receivable financing, and require some level of pre-payment penalty, the CashCall opinion provides some guidance as to when courts will determine the non-bank entity is, in fact, the true lender. Additionally, the CFPB petitioned the court to hold CashCall’s managers and executive officers personally liable for the entity’s unlawful actions.
The court subsequently held CashCall’s CEO, and sole shareholder, liable for the deceptive practices violation after finding he either knew of the practice, or was recklessly indifferent regarding the consumer misrepresentations. If future courts were to rule that non-banks regularly function as genuine lenders in similar partnerships, the effect on these holdings will be a significant increase in the degree of risk for internet-based lenders and a corresponding rise in costs and exposure to litigation.
The CashCall decision accentuates how vital it is for lenders to routinely monitor the regulatory risks associated with significant changes in their business structure. Non-banking entities entering into contracts with depository organizations should stipulate the amount of risk that is shared between, on top of any contractual requirements.
In situations where the non-lending party purchases loans originated by the face lender, an extended retention window is preferable, helping to clarify how the lending party shares in the credit risks. Internet lenders should be aware that the CFPB is coordinating with State Attorney Generals to enforce consumer protection compliance, as a growing trend, and appropriate actions should be taken to avoid future potential litigation and penalties.
