On June 2, 2020, the Office of the Comptroller of the Currency (“OCC”) issued a final rule (“Rule”) to quell the uncertainty created by the Second Circuit decision in Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015) for national banks and federal savings associations (“banks”) engaged in the sell, assignment or otherwise transfer (“transfer”) of loans they made. The Rule clarifies that when a bank makes a loan with permissible interest, such interest remains and continues to be permissible after the bank transfers the loan. The Rule will be effective August 3, 2020.
As mentioned above, the Rule is in response to the Madden decision, which created uncertainty not only for banks, but also to bank regulators and bank receivers, such as the FDIC, and participants in the lending market. In general, banks may charge interest on loans at the maximum rate permitted to any state-chartered or licensed lending institution in the state where the bank is located. Also, banks are generally authorized to transfer loans and to assign loan agreements.
In Madden, the Second Circuit held that a purchaser of a loan originated by a bank could not charge the interest rate on the loan, which was permissible for the bank, if that rate would be impermissible under the lower usury cap applicable to the purchaser. The Madden decision upended more than a century and a half old common law doctrine known as “valid when made”. The “valid when made” rule provides that if the loan when made did not violate any usury laws, it can never be invalidated on the ground of usury. See, Gaither v. Farmers’ & Mechanics’ Bank of Georgetown, 26 U.S. 37, 43, 7 L. Ed. 43 (1828); Nichols v. Fearson, 32 U.S. 103, 105, 8 L. Ed. 623 (1833). The “valid when made rule” served as a bedrock of certainty for the financial system. It allows for a loan to be valued based on its terms and irrespective of who the subsequent purchaser of the loan may be or any subsequent changes in the law. This in turn allowed loans to be securitized in secondary market and ensures a valid loan’s liquidity as an asset.
The OCC action came after the U.S. Supreme Court denied certiorari in Madden. The OCC Rule does not rely on the “valid when made” for its authority. Rather, it relies its authority to interpret the statutory scheme that allows banks to charge interest and transfer loans, including the interest rate provisions applicable to banks under section 12 U.S.C. § 85 of the National Bank Act and section 12 U.S.C. § 1463 of the Home Owners’ Loan Act. Nevertheless, the end effect of the Rule is consistent with the “valid when made” doctrine.
The FDIC took a similar step to counteract Madden by proposing a rule similar to the OCC, on December 6, 2019. See, 84 FR 66845. The comment period on the FDIC proposal has ended and it is expected that the FDIC would issue its final rule within a short time and that such rule would be consistent with the OCC Rule.
The OCC Rule would provide certainty for banks and their counterparties with respect to loans transferred by banks. It would ensure that banks’ loans maintain their value and liquidity. Given the structure of the Rule and its effective date a question arise whether courts apply the rule retroactively to loans made by banks prior to the effective date?
While the Rule counteracts the Madden decision, it applies only to banks. Even similar rules by the FDIC, and probably (eventually) by the NCUA, would mean that only banks and federally insured depositories would enjoy a regulatory “valid when made” rule.
However, the “valid when made” doctrine is an important foundational concept for the entire lending industry. One can only hope that the actions of federal regulators, such as the OCC’s Rule, would eventually cause other circuit courts to disagree with the Madden decision and that such action would pave the way for abrogation of Madden by the Supreme Court and with it certainty and a level playing field for all lenders.
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