Validity Put in Question: Madden and the “Valid-When-Made” Doctrine

by C/A Staff

There’s a long-standing legal doctrine dating back to colonial times known as “valid-when-made.”  For over 200 years, it has supplied stability and certainty to lenders and market participants who lend, or supply credit, to borrowers via acquisition.  Recently the venerable doctrine has been called into question by a meandering decision emanating from the 2015 Second Circuit Court of Appeals. The serpentine ruling has quietly slithered into the weeds creating a situation where one must tread very carefully. Here’s why:

The doctrine provides that a loan, if valid at the time of inception, cannot be deemed invalid or its terms determined unenforceable due to its transfer, sale or assignment to another person.  Madden v. Midland Funding, LLC calls that principle into question.

In Madden, Midland Funding purchased the plaintiffs’ charged-off credit card debt from a national bank (FIA National Bank), which had purchased the debt from Bank of America, the original lender.  As owner, Midland sought to collect the debt.  The Second Circuit held that Midland Funding violated the Fair Debt Collection Practices Act by falsely representing the amount of interest it was entitled to collect, ruling the purchaser of charged-off debt from a national bank does not inherit the preemptive interest rate authority of the national bank under Section 85 of the National Bank Act.  This makes credit debt subject to the usury limitations provided by state law (in this case, NY).  The U.S. Supreme Court denied the defendants’ petition for writ of certiorari (legalese for re-review).

Following the Madden decision, lending plummeted in the states comprising of the Second Circuit (VT, CT, NY), with marketplace lending and securitization industries attempting to engage lawmakers to overturn Madden. While passing the House, it was not taken up by the Senate Banking Committee.  In November 2019, the OCC and FDIC proposed rules to codify “valid-when-made:” “Interest on a loan that is permissible under 12 U.S.C. 85 shall not be affected by the sale, assignment or other transfer of the loan.”  The Proposed Rule would solidify US lending practices that a national bank or insured state bank could enter into a loan contract, charge interest at the maximum rate permitted by the state where it’s located, and then assign the loan with preemption of usury laws in the states where investors are located.  What these Proposed Rules fail to address is the companion “true lender” doctrine—the entity that makes a loan and then assigns it to a third party is the “true lender.”  This issue remained outside of the scope of the Proposed Rules because the FDIC and OCC are concerned using bank charters to evade valid legal restrictions.

The Agencies believe Madden diminishes the value and liquidity of bank loan portfolios and negatively impacts safety and soundness.  Assuming the Proposed Rules are adopted, the likelihood of lawsuits affecting the sales of loans outside the Second Circuit becomes moot.  But failing to address the “true lender” doctrine would still present litigation on loan sales and enforcement.  As always there is a comment period for 60 days after publication in the Federal Register.