Success stories of marketplace lending in consumer credit markets are plentiful. They provide models of success for lenders seeking to leverage technology to reach underserved markets, but along with the successes, there is a significant legal issue that has impacted marketplace lending of which student loan lenders and investors should be aware.
We've written about Madden v. Midland Funding (Madden) risks in prior blogs and articles in connection with marketplace lending. A recent settlement involving National Collegiate Student Loan Trusts in the class action of Eul v. Transworld Systems Inc. (Eul) serves as a reminder that Madden is not just a marketplace lending problem.
In Eul, the borrower-plaintiffs sued in part over usurious interest rates charged on student loans. Although the loans were originated by a national bank (Chase) the plaintiffs alleged the "true lender" was First Marblehead, a non-bank entity which then assigned these loans to National Collegiate and Transworld Systems. Defendants argued that the state usury laws at issue were preempted by the federal National Bank Act and the interest charged was permissible under federal law.
When the Illinois court ruled on the motion to dismiss on this question of preemption in 2017, the court looked to the Second Circuit's decision in Madden for guidance. In that case, non-bank debt buyers were seeking protection under the National Bank Act for credit card debt that had been originated by a national bank and then assigned to the debt buyers. The Madden court concluded that federal preemption did not apply and the state usury claims could proceed. The Eul court followed Madden.
Although there was a court approved settlement with the Eul parties in 2018, outstanding disputes with certain class members were only recently resolved. Now that this settlement is complete, the terms should give investors and issuers pause, as they highlight the financial risks from "true lender" scenarios in the student loan context. The terms include, depending on certain timing considerations of the last payment or delinquency, suppressing all interest charges for 24 or 48 months, implementing a cap on interest rates to conform to the lesser of the contract rate and applicable usury rates, and permitting certain borrowers who make timely payments to satisfy their debt by paying 62.5% or 75% of the total debt. A small percentage (1.1%) of the class, who presumably believe they have strong defenses to payment, opted out of the settlement, but the majority did not object.
The bottom line is that with class members totaling approximately 10,000, cash flows will not be close to expectations and the value of the subject loans will be significantly reduced.
As Lynn Anderson once sang, "along with the sunshine there's gotta be a little rain sometimes." Marketplace lending has provided many positive lessons for traditional and online lenders, but the legal issues facing marketplace lenders, especially those using the bank partnership model, must also be heeded. As in Eul, at a minimum, expected cash flows could be severely curtailed and values substantially impaired, but, as we've seen in other contexts, there may also be fines for violations of consumer protection laws if the hard lessons aren't learned.
Massimo Giugliano, Counsel, and Nicole Serratore, an Attorney, in the Insolvency, Creditors' Rights & Financial Products Practice Group of Davis & Gilbert, contributed to this post.
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