The U.S. Court of Appeals for the Second Circuit ruled last week that a purchaser of charged-off debts from a national bank was not entitled to assert the preemption of state usury laws available to national banks under Section 85 of the National Bank Act (NBA).

The case has significant implications not only for purchasers of charged-off debt from national banks but also for a wide variety of other lending programs and arrangements that rely on the originating bank’s preemptive authority under federal law to charge interest rates and fees greater than those permitted under otherwise applicable state law. It is also significant that the Second Circuit held on appeal, without seeking any additional fact-finding by the district court, that application of state usury laws to the loans in question would not “significantly interfere” with the bank’s exercise of its powers under the NBA, including the right to “take, receive, reserve, and charge” interest under Section 85 and the right to make and sell loans under Section 24 (Seventh).

In Madden v. Midland Funding, LLC, the plaintiff filed a putative class action complaint alleging that the debt buyer, which had purchased her charged-off credit card debt from a national bank, and the buyer’s affiliated servicer, violated the Fair Debt Collection Practices Act (FDCPA) by falsely representing in a collection letter the amount of interest they were legally entitled to collect. The plaintiff claimed that the interest charged by the defendants after the sale of her account was usurious under the law of the state in which she resided. The district court entered judgment in favor of the defendants, holding that the defendants were entitled to assert the preemption of state usury laws available to the national bank under 12 U.S.C. §85.

Applying the rule enunciated by the U.S. Supreme Court in Barnett Bank of Marion Cty., N.A. v. Nelson, which Congress adopted in the Dodd-Frank Act as the appropriate standard for NBA preemption determinations, the Second Circuit analyzed whether the state usury law in question operated to materially impair the national bank’s exercise of its federally created powers. The court found that it would not significantly interfere with the national bank’s rights under the NBA. The Court did not address whether the rates charged by the debt buyer were permissible as a matter of the state common law of assignment, which typically provides that an assignee steps into the shoes of its assignor, with the same rights and obligations as the assignor.

Notably, and despite the Second Circuit’s attempt to argue otherwise, Madden conflicts with the Eighth Circuit’s decision in Krispin v. May Dep't Stores, 218 F.3d 919 (8th Cir. 2000). In Krispin, the Court held that 12 U.S.C. §85, and not state law, applied to charges imposed by a non-bank after it acquired credit card receivables from its affiliated national bank.

The Second Circuit’s ruling that interest charges are governed by federal law only while consumer debts are held by a national bank, and not after their sale to a non-bank, creates increased usury and other risks for any program involving asset sales by a bank to a third party. The ruling also means that, like the defendants in Madden, debt buyers face the specter of FDCPA claims challenging the legality of interest and fees charged on debts that were originated by banks entitled to rely on federal preemption and purchased by a non-bank.