State Usury Law May Apply to Later-Transferred National Bank Loans

Under the National Bank Act, national banks are subject only to the usury laws of the state in which they are headquartered, even when they are making loans to customers located in another state. Thus, national banks can effectively avoid stricter usury laws of some states by setting up their headquarters in a state with friendlier usury laws (for example, Delaware or South Dakota). State banks and nonbank entities, however, must comply with the local usury laws of the states where they make loans. But what happens when a state bank or nonbank entity acquires a loan that was originated by a national bank? Recent court rulings suggest that state banks and nonbank entities are not protected by the National Bank Act even when they acquire loans from national banks.

It is common practice for lenders to originate a loan and then sell it to a different bank or finance company. Banks may also sell uncollectible loans to companies that specialize in collecting bad debts. Typically, the terms of a loan remain the same when the loan is transferred from one bank to another. This common practice played out when a nonbank entity called Midland Funding LLC acquired credit card accounts that had originally been issued by Bank of America. One of the credit card customers, Saliha Madden, sued Midland Funding, arguing that the 27% interest rate on the debt violated the state usury laws of New York. Midland Funding responded that it was not subject to New York usury law because the loan had been originated by a national bank in a state where the 27% rate was legal, making the rate permissible under the National Bank Act. Midland Funding argued that it enjoyed the protections of the National Bank Act, even though it is not a national bank, under the long-established principle that a loan that is valid when issued cannot later become usurious based on later events such as the sale of the loan.

After Midland Funding won its argument in the district court, Madden appealed to the court of appeals. The court of appeals sided with Madden and ruled that Midland Funding could not invoke the protections of the National Bank Act:

We hold that non-national bank entities are not entitled to protection under the National Bank Act from state‐law usury claims merely because they are assignees of a national bank. . . . Furthermore, extension of NBA preemption to third‐party debt collectors such as the defendants would be an overly broad application of the NBA. Although national banks’ agents and subsidiaries exercise national banks’ powers and receive protection under the NBA when doing so, extending those protections to third parties would create an end‐run around usury laws for non‐national bank entities that are not acting on behalf of a national bank.

Midland Funding petitioned the Supreme Court to review the decision of the court of appeals. The petition received support from banks and financial industry trade groups, including the American Bankers Association, which argued that the court of appeals’ decision “will disrupt the secondary market for loans, upon which the primary market for lending depends; as a result it will chill the primary market for making loans and thereby increase the costs borrowers face.” Even the federal government and the OCC agreed that the court of appeals’ decision misinterpreted the National Bank Act, although they argued that the case was not ripe for Supreme Court review for other reasons. Today, the Supreme Court refused to review the court of appeals’ decision, leaving the decision in place.

This case has the potential to impact state-chartered banks involved in the acquisition of credit card accounts and other loans with high interest rates. As a best practice, these banks should consider modifying high-rate loans acquired from national banks to comply with the usury laws of the state where such loans are originated. In addition, national banks could feel the impact of this case by seeing added diligence and compliance costs in the secondary loan market. Banks in New York (where the case originated) should be particularly aware of the case, but until the Supreme Court resolves this issue, the case has the potential to impact banks across the country.