[co-author: Ned Hirschfeld]
On December 22, 2016, the California Supreme Court issued People ex rel. Owen v. Miami Nation Enterprises. The decision found that certain tribal business entities that provided loans in California are not "arms of the tribe" entitled to immunity from California state law regulating payday loans.
In 2005, two federally recognized tribes, the Miami Tribe of Oklahoma and the Santee Sioux Nation, created business entities under tribal law for the purpose of offering online payday loans throughout the country. These tribal entities hired a series of management companies to operate their payday lending businesses. Although the tribal entities retained authority to set lending parameters and approve or disapprove any loan, they received only a small portion of lending-related income; under the agreements with one management company, for example, they were entitled to either 1% of gross revenue or a small guaranteed monthly payment.
In 2007, the State of California sued the tribal entities for violating state law by providing payday loans without a license and exceeding statutory limits on the size of the loans and related fees. The entities claimed that they were immune from suit under state law as arms of the Miami Tribe and Sioux Nation, both of which possess tribal sovereign immunity. A state Court of Appeal sided with the tribal entities, concluding that they shared the tribes' immunity because of several formal ties. In particular, the entities had been formed under tribal law for the purpose of tribal economic development, and their leadership—which nominally retained final authority over lending decisions—was put in place by the tribes.
The California Supreme Court reversed. The court first announced a five-factor test for determining whether a tribal business entity is entitled to sovereign immunity as an "arm of the tribe." California courts must consider "(1) the entity's method of creation, (2) whether the tribe intended the entity to share in its immunity, (3) the entity's purpose, (4) the tribe's control over the entity, and (5) the financial relationship between the tribe and the entity." Contrasting its approach with that of other states, the court explained that "this test takes into account both formal and functional considerations—in other words, not only the legal or organizational relationship between the tribe and the entity, but also the practical operation of the entity in relation to the tribe."
After weighing the relevant factors, the court concluded that the tribal entities do not qualify as arms of the tribes. The court acknowledged that they nominally served to further tribal economic development by conducting payday lending operations, over which they technically retained final authority. "Notwithstanding these formal arrangements," however, the tribal entities actually provided minimal economic benefits to the tribes and exercised scant control over the lending operations of the management companies. The court found significant that the tribal entities received only a sliver of gross revenue from the management companies, failed to supervise loan decisions, and allowed one of the management companies to spend business funds at its discretion. Moreover, although the tribal entities were formed under tribal law, their initial capital and intellectual property came from non-tribal corporations. In light of those functional considerations, the five-factor test cut decisively against a finding of tribal immunity.
The California Supreme Court's decision is notable for its potential impact on the marketplace lending industry and the body of law that governs the applicability of state usury and consumer protection law to marketplace lending models.
Orrick will continue to monitor developments related to the application of state lending regulations and provide updates as appropriate.