Increased Risk for Buyers of Credit Card Loans

Third party debt buyers may face increased threat of state-law class action lawsuits after a recent Second Circuit ruling prohibiting such debt buyers from invoking federal preemption defenses under the National Bank Act to defeat state-law usury claims.

In Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015), the Second Circuit rejected the preemption arguments of two debt buyers who purchased charged-off consumer credit card debt from Bank of America and FIA Card Services, N.A.  In taking assignment of the card accounts, the debt buyers contended they assumed the same preemption defenses available to BoA and FIA as national banks under the National Bank Act.

The plaintiff in the case, who owed $5,000 on her credit card in 2008 when the account was charged off and debt sold, brought a class-action lawsuit alleging that the debt buyer violated New York usury laws when it began charging her a 27 percent annual interest rate on her debt.

The National Bank Act preempts state-law usury claims against national banks and allows a national bank to charge interest at maximum rates permitted where the bank is located, even if those rates would violate state usury laws elsewhere.  Such a preemption defense would have been available to BoA or FIA, and the district court ruled that a national bank’s assignees are entitled to the same protections of the National Bank Act as the originating bank.

But the Second Circuit reversed, holding that third party debt buyers are not entitled to the same preemption defenses, even if they take assignment of a national bank’s accounts. The Court emphasized that a third party debt buyer “is [not] a national bank, nor a subsidiary or agent of a national bank, or is otherwise acting on behalf of a national bank.”  Id. at 249.

The Court’s ruling has potential implications for any unaffiliated entity taking assignment of a national bank-originated loan. Although the ruling is binding precedent only within the Second Circuit—New York, Connecticut, and Vermont—it is potentially persuasive for courts around the country interpreting preemption defenses for debt buyers and others.

The Second Circuit added in its ruling that operating subsidiaries and agents of national banks are entitled to the same preemption defenses given the equivalent powers they can exercise. By comparison, it concluded, third party debt buyers operate in a functionally different manner.

As a result, the debt buyers did not possess a close enough relationship with a national bank such that they could invoke the same preemption defenses.  “The defendants did not act on behalf of BoA or FIA in attempting to collect on [plaintiff’s] debt.  The defendants acted solely on their own behalves, as the owners of the debt.”  Id. at 250.

The Court added that allowing state-law usury claims against third party debt buyers as assignees of national banks “would not significantly interfere with any national bank’s ability to exercise its powers under the NBA.”  Id. at 249.

The plaintiff also alleged FDCPA violations against the debt buyers for misrepresenting the amount of debt they were entitled to collect.  The district court ruled that because plaintiff’s state-law usury claims were preempted, so were her FDCPA claims because the state-law maximum rate was not applicable and no misrepresentation occurred.  The Second Circuit’s reversal allows plaintiff to renew her FDCPA claims.

The Court noted that its ruling may cost national banks by making bad debt less attractive for debt buyers in states with stricter usury laws.  The ruling also potentially opens the door to increased class action lawsuits alleging state-law usury violations by purchasers of debt from national banks, including credit card issuers.

The ruling may also force national banks to revisit their agreements with debt buyers and other unaffiliated third parties who take assignment of their loans. One related possibility is that national banks will need to retain some interest in loans following assignment such that the assignee can continue to enjoy federal preemption defenses.

PLA will also watch the impact if any of the case on FDIC-regulated banks; on programs involving WebBank, Celtic Bank, and the like; and on credit card receivable securitizations. We will report further as warranted.