The Office of the Comptroller of the Currency (OCC) issued a proposed rule on July 20 that would determine when a national bank or federal savings association (bank) makes a loan and is the “true lender” in the context of a partnership between a bank and a third party, such as a marketplace lender. This is a significant regulatory development that warrants the close attention of the national banking community, and those who do business with national banks and federal savings associations.
Banks’ lending relationships with third parties have been subject to increasing litigation about the legal framework that applies to loans made as part of these relationships, which may discourage banks and third parties from entering into such relationships. Federal law authorizes banks to enter into contracts, to make loans, and to subsequently transfer these loans and assign loan contracts. But these statutes do not articulate standards to determine which entity should be treated as “making” the loan (or, as commonly described in case law, which entity is the “true lender”) and, therefore, what legal framework applies when the loan is originated as part of a lending relationship between a bank and a third party. The consequences are significant: the laws applicable to banks versus unlicensed fintechs, for example, permit very different interest rates and fees and can trigger a complex array of state licensing and legal considerations.
The OCC also has not previously taken regulatory action to resolve this ambiguity. In the absence of regulatory action, courts are left to determine when, in a lending partnership, a bank is making the loan and when its partner makes the loan, generally on the basis of varying state-law doctrines.
As a result, a growing body of case law has introduced divergent and sometimes inconsistent standards for resolving this issue. In some cases, courts have concluded that the form of the transaction alone resolves this issue. Under this analysis, the lender is the entity named in the loan agreement. In other cases, the courts have applied fact-intensive balancing tests, in which they have considered a multitude of factors, including: (1) how long the entity named as the lender holds the loan before selling it to the third party; (2) whether the third party advances money that the named lender draws on to make loans; (3) whether the third party guarantees minimum payments or fees to the named lender; (4) whether the third party agrees to indemnify the named lender; and (5) how loans are treated for financial reporting purposes. However, no factor is dispositive, and there is no predictable, bright-line standard.
Other courts have applied a “predominant economic interest” test in conducting this analysis, but have not necessarily considered all of the same factors or given each factor the same weight. The OCC succinctly summarized the practical commercial consequences of these fact-specific modes of analysis as “unnecessarily complex and unpredictable.”
In jurisdictions where courts have applied balancing tests to determine the true lender—or where there is no case law—knowing which legal framework sets the parameters of usury, fees, and licensing as of the date of loan origination can be difficult. For example, federal law establishes the interest a bank may charge on any loan it makes and authorizes the bank to export that rate from the state in which it is located to borrowers in other states. While the OCC recently clarified that the permissibility of interest charged on a loan made by a bank is not affected by the subsequent sale, assignment, or other transfer of the loan (which we previously reported on), there is no uniform standard to determine if a loan is, in fact, made by a bank as opposed to by its non-bank partner.
The proposed rule adopts a simple, straightforward, and easy-to-apply test to determine when a bank makes a loan: a bank makes a loan and is the “true lender” if, as of the date of origination, it (1) is named as the lender in the loan agreement, or (2) funds the loan.
If a bank is named in the loan agreement as the lender as of the date of origination, the OCC views this imprimatur as conclusive evidence that the bank is exercising its authority to make loans pursuant to the lending authority granted to it under federal law, and has elected to subject itself to all applicable federal laws and regulations (including consumer protection laws) governing lending by banks. The OCC’s proposal emphasizes that the agency intends to continue examining banks’ lending through partner channels under this standard as well—a reminder that the implications of the rule may require more active involvement by bank partners in their lending relationships.
In addition, in the OCC’s view, there are circumstances in which a bank is not named as the lender in the loan agreement but is still making the loan. To ensure that the OCC’s rule would capture these circumstances, the agency is proposing a second standard based on which party funded the loan. Under this standard, if a bank funds a loan as of the date of origination, the OCC concludes that it has a predominant economic interest in the loan and, therefore, has made the loan—regardless of whether it is the named lender in the loan agreement as of the date of origination.
Under the OCC’s proposal, the determination of which entity made the loan under the above standards would be complete as of the date the loan is originated and would not change, even if the bank were to subsequently transfer the loan. As the OCC recognizes, certainty is one of the key advantages of this proposed approach.
Comments on the proposed rule must be submitted by September 3, 2020. The OCC invites comments on all aspects of the proposed rule, including whether there are additional lending arrangements that should be captured by the OCC’s standards for determining when a bank makes a loan and whether the proposed standards would capture lending arrangements that should be excluded.
- The proposed rule, if adopted and upheld in the courts, has the potential to provide material clarity to the legal landscape for national bank and federal savings association lenders, which have faced divergent and inconsistent results in the courts resulting in substantial legal uncertainty for banks and those doing business with banks.
- The proposed rule would operate together with the OCC’s recently finalized Madden-fix rule to provide greater clarity to banks regarding their lending activities. Legal certainty about whether a loan is made by a bank, and what rules apply as a result, should encourage banks to engage in new lending relationships or to expand their existing lending relationships.
- The OCC’s proposed rule applies only to national banks and federal savings associations. Partnerships with state-chartered banks will not be affected until (and if) the FDIC issues a comparable proposal. At this time, the FDIC has not taken corresponding action to propose an equivalent rule for state-chartered insured banks, although there is the possibility that the FDIC may do so; in this regard, Acting Comptroller of the Currency Brian Brooks—who is also a member of the FDIC Board of Directors—has previously indicated that the FDIC would partner with the OCC in formulating this proposal. In addition, the Board of Governors of the Federal Reserve System (Federal Reserve) may also have a role with respect to state-chartered insured banks that are members of the Federal Reserve System.
- The likelihood of a court challenge to the OCC’s authority from one or more of several sources to adopt such a rule would appear to be significant. In turn, the level of deference that courts may afford to this agency rulemaking remains to be seen and involves core questions of administrative law.
- Although the OCC may be able to issue a final rule before the November election, it is not clear whether a new administration would be similarly supportive of such regulatory changes, and there may also be opposition by state regulatory authorities and in Congress. Banks, as well as fintech firms and nonbank lenders and servicers, operating under a bank partnership model therefore should continue to exercise diligence as they structure their programs, and nonbank lenders should stay abreast of related state law requirements, including loan brokering and debt collector licensing requirements.
- OCC-regulated banks that partner with nonbanks to originate loans under this framework should pay close attention to the OCC’s expectations about their level of involvement in the lending process. The consequence of a clear-cut rule that the loans are “the bank’s loans” is that the OCC expects banks to be fully responsible for consumer compliance, underwriting, and fair lending in connection with those loans in addition to adhering to the OCC’s third-party relationship management standards.
- By the same token, the OCC makes clear that the proposal, if adopted, would not relieve OCC-regulated banks of their legal and risk management responsibilities in their relationships with bank partners, including those responsibilities detailed under the OCC's supervisory guidance on bank relationships with third-party lenders and service providers. Similarly, bank partners need to remain mindful of these requirements in their dealings with OCC-regulated banks on lending-related activities and programs.