California v. FDIC

Preliminary Statement

For over 200 years, the U.S. credit markets have relied on the cardinal rule that, if a loanis valid and not usurious in its inception, it cannot be rendered usurious subsequently, including by beingsold or transferred to a third party. Bank of Georgetown, 26 U.S.37, 43 (1828); , 32 U.S. at 109. That rule, often called the “valid-when-made” doctrine, is vitalto the correct operation of 12 U.S.C. § 1831d (also referred to as Section 27 of the FDIA), which since1980 has authorized FDIC Banks to make loans charging interest at the rate permitted by the state wherethe bank is located, or at one percent in excess of the 90-day commercial paper rate, whichever is greater.Section 1831d is modeled after the earlier-enacted 12 U.S.C. § 85, which provides the same power fornational banks. See Greenwood Tr. Co. v. Massachusetts, 971 F.2d 818, 826–27 (1st Cir. 1992). Congresspatterned Section 1831d after 12 U.S.C. § 85 in order to achieve “parity” and “competitive equality”between state and national banks in the interest-rate area. Id. (citations omitted).

Without the valid-when-made doctrine, FDIC Banks making loans in reliance on theinterest rates authorized by the FDIA would have a severely limited ability to sell or assign loans to thirdparties, who would fear that different states’ patchwork of contradictory usury laws might thereuponapply. This fear would, in turn, restrict the operation of the credit markets and increase the cost of creditto American households and small businesses.

In, LLC, the Second Circuit broke from—by ignoring—a longline of decisions by the U.S. Supreme Court and federal Courts of Appeals that universally endorsed thevalid-when-made doctrine. Madden did so in the context of NBA preemption, holding that application ofstates’ usury laws to a bank’s loans after they are assigned to a non-bank third party does not interferewith the bank’s powers under the NBA. 786 F.3d 246, 250 (2d Cir. 2015). In other words, the SecondCircuit held that a loan validly originated by a national bank that was not usurious at origination couldbecome usurious upon transfer to a non-bank. Although Madden concerned the assignment of a loan bya national bank, because Section 1831d is substantially similar to, and interpreted in the same way as, the relevant provision of the NBA, Madden also had direct implications for Section 1831d, highlighting theneed for the FDIC to avoid misapplications of the FDIA interest rate provisions.

Not only did Madden fatally err by failing even to consider the valid-when-made doctrine,but, as the Ninth Circuit recently recognized, has had negative effects on the credit markets bycausing restrictions in the extension of credit to borrowers in the Second Circuit, particularly forunderserved borrowers such as lower-income Americans and small businesses. See McShannock, 976F.3d at 892.

The FDIC’s recent regulation reaffirming the cardinal rule and making clear that theFDIA’s provisions apply to loans originated by an FDIC Bank, even after the transfer of such loans, iscrucial to fixing the legal fallacy and economic damage that Madden has created. See Federal InterestRate Authority, 85 Fed. Reg. 44,146 (Aug. 21, 2020) (codified as part of 12 C.F.R. § 331.4(e)) (“FDICRule”). This Court should grant the FDIC’s motion for summary judgment and reject Plaintiffs’ erroneouslegal and economic argument for two reasons.

First, Plaintiffs wrongly contend that the foundational U.S. cases recognizing the validwhen-made doctrine are distinguishable from the current context because those courts could not havecontemplated, prior to the passage of the NBA and FDIA, that the usurious nature of a loan could turn onwhether the loan’s assignee was subject to a different interest rate cap than was the originator.Thiscontention is demonstrably false: even before the NBA and FDIA, there was substantial variation in theusury laws among states—and even within a state—such that different entities would be subject todifferent interest rate caps. The valid-when-made doctrine was thus necessary to ensure that a validlyoriginated loan did not become usurious merely by reason of its assignment. Moreover, Plaintiffs (and their amici) tellingly have not identified a single pre-Madden case in the history of American law—including in the 150 years between the enactment of the NBA in 1864 and Madden in 2015—holding thata validly originated loan became usurious as a result of an assignment or sale. The reason for this completelack of caselaw is obvious: prior to Madden, there was no doubt about the valid-when-made doctrine’sapplicability to loans validly originated by banks and sold to non-banks, or, for that matter, a loan validlyoriginated by any lender and subsequently sold to another party. Indeed, before Madden, several federalcourts of appeals explicitly endorsed valid-when-made in the context of Section 1831d and its nationalbank analog. See Olvera v. Blitt & Gaines, P.C., 431 F.3d 285, 289 (7th Cir. 2005) (Posner, J.); Krispinv. May Dep’t Stores Co., 218 F.3d 919, 924 (8th Cir. 2000); FDIC v. Lattimore Land Corp., 656 F.2d139, 148–49, 149 n.17 (5th Cir. 1981). This history, among other factors, led the U.S. Solicitor Generalto assert in 2016 that the “court of appeals’ decision [in Madden] is incorrect.” Brief for the United Statesas Amicus Curiae, Midland Funding, LLC v. Madden, No. 15-610, 2016 WL 2997343, at 6 (U.S. May 24,2016) (“OCC/SG Brief”).

Second, as the Ninth Circuit realized in McShannock, and as shown by many legal andfinance scholars, Madden’s deviation from the valid-when-made doctrine has caused significant harm tothe credit markets. Specifically, the decision caused lenders to “extend[] ‘relatively less credit toborrowers’ and [to] ‘discount[] notes backed by above-usury loans to borrowers in Connecticut and NewYork.’” McShannock, 976 F.3d at 892 (quoting Colleen Honigsberg et al., How Does Legal EnforceabilityAffect Consumer Lending? Evidence from a Natural Experiment, 60 J.L. & ECON. 673, 675, 691 (2017)).Indeed, some lenders even “‘declined to issue loans to the higher-risk borrowers most likely to borrowabove usury rates’” altogether. Id. (quoting Honigsberg, supra, at 675). Thus, Madden restricted accessto credit for the small businesses and individuals who are most in need of access to liquidity.

The FDIC Rule was developed to eliminate the uncertainty, reduced access to credit, andincreased costs brought on by the erroneous Madden decision. Striking down the FDIC Rule wouldreintroduce those harms and allow them to spread, reducing the availability of credit and thereby harmingthe U.S. financial system and economy. Those harms will only grow when this country returns tohistorically normal interest rates, and allegations of usury become more common as a result. Accordingly in ruling on the pending Motions for Summary Judgment, the Court should uphold the FDIC’s recognitionof the cardinal rule and reject any reliance on the erroneous decision.

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