In a clash of competing sovereigns’ interests, the Second Circuit recently upheld, for now, the authority of the New York Department of Financial Services (DFS) to regulate online payday loans made by Indian tribal lenders to New York borrowers. The Second Circuit’s decision in Otoe-Missouria Tribe of Indians v. New York State Dep’t of Financial Services affirmed the lower court’s denial of a preliminary injunction sought by the tribal lenders to prevent the DFS from interfering with the tribes’ consumer lending business by barring these loans and pressuring banks and NACHA to cease doing business with the tribes.

The case arose from DFS actions in the summer of 2013 to regulate out-of-state payday lenders. The DFS sent cease-and-desist letters to a number of online payday lenders identified as having made loans to New York residents, accusing them of using the Internet to make high-interest loans in violation of the state’s usury laws. The tribal lenders received the letter. The DFS also wrote to financial services industry participants who were involved in the lenders’ financing processes, such as banks and NACHA, the operator of the Automated Clearing House (ACH) payment system. The agency’s letters urged these participants to take actions to assure that they not provide a pipeline for the supposedly illegal loans.

The tribal lenders contended that the DFS’s actions “had immediate and devastating effects” on them, causing the banks and NACHA to end their relationships with the lenders. This, in turn, shut down the lenders’ transactions “not just with New York borrowers, but with consumers in every other state in the union.” The Second Circuit noted the competing views of the DFS’s actions: the tribal lenders described the actions “as a ‘market-based campaign explicitly designed to destroy Tribal enterprises,’ and New York... defend[ed] [its actions] as a ‘comprehensive effort to determine how best to protect New Yorkers from the harmful effects of usurious online payday loans.’”

In seeking a preliminary injunction, the tribal lenders invoked the Indian Commerce Clause of the U.S. Constitution, which generally protects Native Americans’ tribal sovereignty. Their contention was that New York had improperly “projected its regulations over the [I]nternet and onto reservations.” Consequently, “both the tribes and New York believed that the high-interest loans fell within their domain, both geographic and regulatory....” As the Second Circuit put it, their interests “collided.” The main issue was “where they collided—in New York or on a Native American reservation.”

The lenders asserted that the transactions occurred on reservations for the following reasons:

• The loan application process took place via a website owned and controlled by the tribes.
• The loans were reviewed and assessed by the tribal loan underwriting process.
• The loans complied with rules of the tribal authorities.
• The loans were funded out of tribal bank accounts.
• The loan applications informed the borrowers that tribal law principally governed.

In essence, the tribal lenders argued that “through technological aids and underwriting software, loans are approved through processes that occur on the Reservation in various forms.”

On the other hand, the loans had substantial New York connections. While approved on reservations, the loans flowed across borders to consumers in New York. New York borrowers never went to tribal lands but instead signed loan contracts electronically. Borrowers listed New York addresses on applications and provided information on their bank accounts in New York. The lenders reached into New York to collect payments from the borrowers’ New York accounts. And the alleged “harm inflicted by these high-interest loans fell upon customers in New York,” resulting in complaints to the DFS.

The court held that the tribal lenders were not entitled to a preliminary injunction because they had not shown likelihood of success on the merits. The tribes claimed that their sovereignty was infringed on the grounds that New York “had no authority to order tribes to stop issuing loans originated on Native American reservations” and “regulated activity far outside its borders when it launched a ‘market-based campaign’ to shut down tribal lending in every state in the Union.” The court explained that to make this merits showing, the tribes needed to prove that the transactions occurred “somewhere other than New York, and, if they occurred on reservations, that the tribes had a substantial interest in the lending businesses.”

The Second Circuit held that the district court reasonably concluded that the plaintiffs failed to make their case. At bottom, the court found that the factual record was too uncertain—producing ambiguity about the place of Internet lending and the nature of the DFS’s regulatory campaign—to support preliminary injunctive relief.

Of possibly broader significance for regulatory actions generally, the court highlighted the ambiguous—and unresolved—nature of loans made over the Internet: “Neither our court nor the Supreme Court has confronted a hybrid transaction like the loans at issue here, e-commerce that straddles borders and connects parties separated by hundreds of miles.” The court also observed, by way of a footnote that should not be overlooked, that tribal lenders “are not the only entities who have sought to enter this [lending] market and take advantage of [I]nternet-based technology to make loans to New York residents from remote locations. Companies located abroad or in non-reservation locations... have adopted similar business models.” Ultimately, this lawsuit may provide additional guidance on the permitted scope of state regulation of interstate loans (and other transactions) over the Internet.