The recent opinion of Consumer Financial Protection Bureau v. CashCall,
Inc., et al., issued by the U.S. District Court for the Central District
of California, posed a challenge to internet-based lenders seeking to
obtain preemption by making loans through a third-party. The case puts
into question the validity of a true lender in loans involving more than
one financing party. It also provides insight as to what factors the court
considers when ruling that a non-bank, conducting transactions with a
bank, should be judged as a true lender.
The Consumer Financial Protection Bureau (CFPB) filed suit challenging
CashCall’s latest business model where the documents associated
with the advertising, processing, and issuing of loans were originated
by Western Sky Financial—an organization affiliated with the Cheyenne
River Sioux Tribe, with the loans serviced and collected by CashCall.
According to the suit, CashCall intended to use this approach to exploit
the benefits of Tribal statutes on a national basis, thereby avoiding
state licensing regulations and lending limitations to offer higher interest
The District Court found that although the documents in question listed
Western Sky as the lender of record, based on the “totality”
of the circumstances, CashCall was, in fact, the true lender. In doing
so, the court concentrated their analysis not on which entity was indicated
as the lender in the documents, but what took place behind the scenes
of the transaction and who actually issued the credit.
CashCall’s operational framework mirrors a widely used model within
the online lending industry. It involves using an internet software provider
cooperating with a government-endorsed insured depository entity that
is subsequently listed as the primary creditor on the loan documents.
The set-up enables a non-banking organization, lacking the necessary state
lending licensing, to engage clients nationwide for loans extended behind
the scenes by the partnering creditor. These loans carried interest rates
that were based on where the non-banking organization was incorporated,
allowing the true-lender to bypass state lending guidelines.
The court determined that the relationship between CashCall and Western
Sky resulted in a situation in which the entire financial burden and risk
of the loan structure was shouldered by CashCall—meaning it, not
Western Sky, possessed the overriding economic interest. Ignoring that
Western Sky would have been potentially liable had CashCall breached its
contractual obligations, the court instead pointed out that CashCall pre-paid
loans for two days on behalf of Western Sky; bought all originating loans
following a minimum three-day window after the loan’s closing; guaranteed
a minimum price point; and consented to fully indemnify Western Sky in
the event of any legal liability related to its loans.
Furthermore, the court ruled that the relationship between CashCall’s
customers and the Cheyenne River Sioux Tribe did not constitute a substantial
relationship to the extent that Tribal laws should preempt applicable
state laws as a matter of public policy. Accordingly, the court invalidated
the Tribal choice of law stipulations and mandated that the usury and
licensing regulations of the customers’ residence State should apply
to the loan agreements.
The ruling indicates that several loans originating from the partnership
of CashCall with Western Sky were voided as a result of violating state
law and therefore non-collectible. The court additionally accepted the
CFPB’s position that CashCall’s processing of loans rendered
uncollectible constituted a deceptive practice that violated the Dodd-Frank
Act’s restriction on unfair, deceptive, and abusive practices. The
CFPB argued that CashCall fabricated the impression to customers that
the loans were valid and collectible.
While it is common for contracts within the online lending industry to
designate counter-party risk, guarantee minimum price points, stipulate
receivable financing, and require some level of pre-payment penalty, the
CashCall opinion provides some guidance as to when courts will determine
the non-bank entity is, in fact, the true lender. Additionally, the CFPB
petitioned the court to hold CashCall’s managers and executive officers
personally liable for the entity’s unlawful actions.
The court subsequently held CashCall’s CEO, and sole shareholder,
liable for the deceptive practices violation after finding he either knew
of the practice, or was recklessly indifferent regarding the consumer
misrepresentations. If future courts were to rule that non-banks regularly
function as genuine lenders in similar partnerships, the effect on these
holdings will be a significant increase in the degree of risk for internet-based
lenders and a corresponding rise in costs and exposure to litigation.
The CashCall decision accentuates how vital it is for lenders to routinely
monitor the regulatory risks associated with significant changes in their
business structure. Non-banking entities entering into contracts with
depository organizations should stipulate the amount of risk that is shared
between, on top of any contractual requirements.
In situations where the non-lending party purchases loans originated by
the face lender, an extended retention window is preferable, helping to
clarify how the lending party shares in the credit risks. Internet lenders
should be aware that the CFPB is coordinating with State Attorney Generals
to enforce consumer protection compliance, as a growing trend, and appropriate
actions should be taken to avoid future potential litigation and penalties.