Interest-Rate Cap Appeal Draws U.S. Supreme Court Inquiry

The U.S. Supreme Court asked the Obama administration for its views on a financial services industry challenge to a ruling that gives borrowers more power to fight off high interest rates.

The federal appeals court decision allowed a class action lawsuit against a debt-collection company on behalf of New York credit card holders who were trying to enforce state caps on rates. The appeal of that ruling has support across the financial-services industry.

Lenders say the decision is already having far-reaching effects, undercutting the burgeoning Internet lending business and raising questions about debt-backed securities that contain high-interest loans.

The practical effects “are difficult to overstate,” the debt collector, Encore Capital Group Inc.’s Midland unit, argued in the appeal.

The 2nd U.S. Circuit Court of Appeals in New York said borrowers in some circumstances can invoke their state’s usury law, as the interest-rate caps are known, even if the loan originates elsewhere.

1864 Act Cited

In arguing that New York’s usury law didn’t apply, Midland pointed to the National Bank Act of 1864, which established the U.S. system of national banking and shields the lenders it regulates from state rate caps. Although Midland isn’t a national bank directly protected by that law, it bought the lead plaintiff’s loan from a Bank of America Corp. unit that is. The appeals court said the federal statute doesn’t block the lawsuit because Midland isn’t a national bank and wasn’t acting on behalf of one.

The appeals court decision was a blow to LendingClub Corp., Prosper Marketplace Inc. and other companies that arrange consumer loans online. It may prevent those so-called marketplace lenders from bypassing rate caps by originating loans in states without limits.

Some marketplace lenders have already stopped lending above state rate caps, though LendingClub has tried to circumvent the ruling by changing its relationship with its issuing bank. Marketplace lenders, also known as peer-to-peer lenders, match people seeking consumer or small-business loans with investors such as hedge funds.

‘Narrow Segment’

The lawyers pressing the suit told the Supreme Court that critics of the ruling were exaggerating its significance. They called marketplace lending “a new and narrow segment of the lending industry that has nothing to do with this case.”

“The decision below will not have a substantial impact on secondary markets going forward -- and certainly will not impede national banks’ ability to issue credit,” the lawyers argued.

Almost a dozen business trade associations joined Midland in urging a Supreme Court review. Five groups led by the Clearing House Association, a trade association which represents many of the world’s largest commercial banks, pointed to the longstanding “cardinal rule” that a loan which complies with usury laws doesn’t fall out of compliance because of a sale.

“The cardinal rule is critically important to the functioning of the multitrillion dollar U.S. credit markets,” the groups argued.

The request suggests the justices are considering taking up the case for the nine-month term that starts in October. The justices directed the request to U.S. Solicitor General Don Verrilli, President Barack Obama’s top courtroom lawyer.

The case is Midland Funding v. Madden, 15-610.

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