Madden v. Midland Funding LLC – Implications And Potential Responses

This client alert focuses on the implications of the Second Circuit's decision in Madden v. Midland Funding, LLC1 ("Madden") and considers strategies for secondary market loan transactions that may mitigate its effects.

BACKGROUND AND MARKET RESPONSE

Under the National Bank Act ("NBA"), national banks may be sued for usury only if they charge an interest rate higher than that allowed by their home state.2 All other usury claims against national banks are preempted by the NBA. On May 22, 2015, the United States Court of Appeals for the Second Circuit held in Madden that a non-national bank assignee of debt originated by a national bank could not rely on the NBA for preemption of state usury laws.

Citing the relevant preemption standard set forth by the Supreme Court in Barnett Bank of Marion County, N.A. v. Nelson3, the Second Circuit wrote that "[t]o apply NBA preemption to an action taken by a non-national bank entity, application of state law to that action must significantly interfere with a national bank's ability to exercise its power under the NBA."4 The Court then held that no such "significant interference" would occur if assignees of debt originated by national banks were prevented from relying on NBA preemption of state usury laws:

[S]tate usury laws would not prevent consumer debt sales by national banks to third parties. Although it is possible that usury laws might decrease the amount a national bank could charge for its consumer debt in certain states (i.e., those with firm usury limits, like New York), such an effect would not "significantly interfere" with the exercise of a national bank power.5

The Court reached this conclusion apparently without considering any empirical data that may have shed light on the likely effects of this holding on the business of national banks.

In reaching its decision, the Second Circuit also did not address at all an independent basis for finding that the interest charged by Defendants was valid: The longstanding and widely relied-upon common law principle that "[t]he non-usurious character of a note should not change when the note changes hands"—the so-called Valid-When-Made Doctrine.6

Defendants requested rehearing of the Second Circuit's decision, seeking to focus the Second Circuit on the Valid-When-Made issue and encourage the Court to reconsider whether its ruling would substantially interfere with national banks' ability to exercise their authority under the NBA, but the Second Circuit denied their petition for rehearing on August 12, 2015. Defendants are expected to file a petition for writ of certiorari to the Supreme Court prior to the November 19, 2015 deadline. At least for now, however, the Second Circuit's decision in Madden is binding on federal courts in New York, Connecticut and Vermont.

As it stands, Madden is causing substantial uncertainty in the lending industry as a whole and especially in secondary loan markets. Secondary loan markets have historically been liquid in part because the Valid-When-Made Doctrine provided financial institutions comfort that loans originated by federal or state-chartered depositary institutions would remain non-usurious after assignment. Unless it is overturned or qualified, Madden has important implications for the lending market.

MADDEN'S SCOPE

Analyzing Madden's substantive and jurisdictional scope is crucial to understanding the likely implications of the decision.

Madden does not explicitly address the Valid-When-Made Doctrine.

The Second Circuit did not mention the Valid-When-Made Doctrine when deciding Madden. This leaves room to argueeven in the...