On September 20, the U.S. District Court for the Central District of California dismissed a class action suit alleging illegally charged usurious interest rates on private student loans in violation of California law. Beechum v. Navient Solutions, Inc., No. 2:15-cv-08239-JGB-KK (C.D. Cal. Sept. 20, 2016). In doing so, the court rejected the plaintiff’s arguments that the defendants were the de facto “true lenders” of loans made by a national bank under a bank partnership with a non-bank partner. Consistent with the controlling judicial authority for challenges to the applicability of statutory or constitutional exemptions to California’s usury prohibition, the court determined that “it must look solely to the face of the transaction” in determining whether an exemption applies. This case uses a straightforward, objective standard for determining whether a loan was indeed made by a bank and expressly rejects the position that a subjective inquiry into the intent of the parties making the loan promotes public policy.

Case Overview

The plaintiffs in this case obtained private student loans using loan applications that identified Stillwater National Bank and Trust Company, a national bank, as the “lender.” The plaintiffs alleged that the “actual lenders” of the loans were the Student Loan Marketing Association (SLMA) or subsidiaries of the SML Corporation. The plaintiffs alleged that SMLA and the SLM Corp. subsidiaries originated, underwrote, funded and bore the risk of loss as to the loans under an agreement between SLMA and Stillwater. The agreement provided that Stillwater was required to sell the loans to SLMA at cost within 90 days of being funded. The loans were serviced by SLMA or an SLM Corp. subsidiary or Navient Solutions. The allegations include that Navient Solutions has been charging and collecting interest from the loans at a rate higher than 10 percent, which is in violation of the California Constitution and usury law of California.

Under the agreement, SLMA would originate, underwrite, market and fund loans on which Stillwater would be identified as the lender and which SLMA would then purchase from Stillwater. Included in the agreement was a commitment by SLMA to purchase a specific dollar volume of loans within a set period of time. Stillwater sold, and SLMA purchased, 100 percent of the eligible private loans within 90 days of disbursement. The agreement stipulated that loans were to be sold to SLMA for principal, plus accrued interest, and less the amount paid or payable to insure the loans.

The plaintiffs asserted a number of claims, including usury in violation of Article XV, Section 1, of the California Constitution, which sets a maximum annual interest rate on loans under written contract up to 10 percent. The usury prohibition is subject to numerous exemptions. In particular, the California Constitution exempts from the usury prohibition loans made by “any bank created and operating under and pursuant to any laws of this State or of the United States of America.” Cal. Const. art. XV, § 1.

The district court rejected the “true lender” legal analysis advocated by the plaintiffs and found that the controlling case law required it to “loo[k] only to the face of the transaction at issue when assessing whether plaintiffs’ loans are exempted from the usury prohibition.” Because the plaintiffs alleged in their complaint that the loans were made by Stillwater, the court found the loans to be exempt. In a footnote at the conclusion of its opinion, the court noted that “this result is in accord with public policy considerations” based on the rationale that finding entities that purchase loans from banks to be nonexempt would interfere with the ability of banks to assign or sell loans in the secondary market. The court did not address the question of whether the claims were preempted by the National Bank Act.

Court’s Reasoning

The court relied on two California appellate decisions in holding that courts “must look only at the face of a transaction when assessing whether it falls under a statutory exemption from the usury prohibition and not look to the intent of the parties.” See Jones v. Wells Fargo Bank, 112 Cal. App. 4th 1527, 1527-38 (Cal. Ct. App. 2003) (noting that “Defendants’ intent [wa]s irrelevant” where “agreement fit within a legally authorized exception to the general usury law.”); WRI Opportunity Loans II LLC v. Cooper, 154 Cal. App. 4th 525, 536 (Cal. Ct. App. 2007) (noting that “when a loan meets the requirements for a statutory exemption to the usury law, courts will not look beyond those requirements”).

Additionally, as noted above, the court analyzed possible public policy considerations. Unlike other federal and state courts that have recently decided true lender cases, including the Second Circuit in Madden v. Midland Funding, 786 F.3d 246 (2nd Cir. 2015), the court explicitly acknowledged that making it difficult for banks to assign or sell their commercial property to the secondary market impedes, versus promotes, good public policy.

Pepper Points

• The court’s public policy analysis helps to bolster the effect of this decision because it does not rely strictly on legal technicalities of a single state law usury exemption. The larger view of the court in this case expresses an understanding of the broader economic consequences for holding that non-bank partners are “true lenders” when engaged in bank partnerships where loans are originated by federally insured banks.

• In looking “solely to the face of a transaction” in determining whether the subject loans were exempt from California’s usury prohibition, the court applied an objective standard that, unlike the highly subjective and fact-sensitive “true lender” line of reasoning, would result in consistent outcomes from one case to the next.

• While this recent decision does not address the question of whether the claims were preempted by the National Bank Act, the case represents the latest “true lender” case, with a reasoned and measured approach to bank partnerships. In dismissing this case, the court rejected the idea of looking beyond the face of the transaction and into the intentions of the parties.

• The Central District of California is the same court that, just three weeks prior, provided the decision in Consumer Financial Protection Bureau v. CashCall, Inc. Unlike the CashCall decision, the court did not use the “predominant economic interest” test for determining “true lender” status and acknowledged the negative effect on the secondary market of looking to the intentions of the parties instead of the transaction on its face.