Introduction

In 2005, New York resident Saliha Madden opened a credit card account with Bank of America.1 Under New York state usury law, a lender is allowed to charge up to 25 percent interest. However, because Bank of America is a national bank, it was able to charge Madden 27 percent interest. Three years later, after having amassed over $5,000 of debt, Madden stopped making payments to the bank, and the bank sold Madden’s debt to Midland Funding, LLC, a debt collector. Midland attempted to collect the 27 percent interest to which Madden originally agreed, but Madden protested and filed suit, claiming that, because Midland was not a national bank, the 27 percent interest rate was usurious under New York state law.

The National Bank Act of 18642 (NBA or “the Act”) allows national banks to charge an interest rate higher than the state’s cap on interest under certain circumstances.3 Despite the fact that the Act was passed in 1864, questions about its effect remain unans­wered. Notably, the question whether interest rates on national bank–originated debt become usurious when transferred remains unresolved. Historically, Supreme Court opinions have generally favored national banks, as the Court has deemed them “[n]ational favorites.”4 However, a recent decision in the Second Circuit calls into question whether deference continues after a national bank has sold its interest in the original loan.5

This question is important because it affects the interest rates that consumers will be charged on their loans and could affect how national banks manage their balance sheets.6 A restriction on the ability to sell loans may decrease the amount of credit available to consumers, as banks will be forced to retain more risk on their balance sheets.7 Yet some contest the impact this may have on lenders, and the general enforcement of usury laws may in fact relieve consumers from heavy interest burdens.8 This Comment explores the issue; it concludes that a national bank should be allowed to sell its loans, and that the new owner should be allowed to continue to collect interest that would be usurious if the new owner had originated the loan.

Applying transaction cost economics, this Comment ultimately argues that a court’s decision on preemptive effect will not dissuade banks from selling these loans and allowing third-party purchasers to collect at the original interest rate. Of course, preventing a third party from inheriting the preemptive effect of the NBA will make selling loans more costly (that is, it will increase transaction costs) for the bank, but consumers will ultimately have to bear these costs in the form of either higher interest rates or reduced credit. As such, this Comment shows that allowing a third party to inherit preemption not only is supported by an ana­lysis of existing preemption law and the common law but also benefits consumers.

To show that the preemptive force of the NBA should continue upon the sale of a loan to a third party by a national bank, this Comment proceeds in three parts. Part I discusses the history of the NBA; the Supreme Court’s jurisprudence on preemption generally, as well as with respect to the NBA; the history and purpose of state usury laws; and the growth in national banks and lending by national banks in the latter part of the twentieth century. Part II discusses the current preemption issue and the differences in interpretation between the Second Circuit and the Fifth and Eighth Circuits. Finally, Part III provides three frameworks—preemption analysis, application of the common law and constitutional law, and a transaction cost framework—to support a conclusion that the preemptive effect of the NBA continues upon the sale of a loan to a third party.

  • 1. These facts are largely drawn from Madden v Midland Funding, LLC, 786 F3d 246, 247–48 (2d Cir 2015).
  • 2. 13 Stat 99, codified as amended at 12 USC § 21 et seq. While the Act was not originally named the National Bank Act, Congress has since formally adopted the name. See 12 USC § 38.
  • 3. See 12 USC § 85 (applying the usury law only of the state “where the bank is located” to a national bank regardless of where the national bank conducts business).
  • 4. Tiffany v National Bank of Missouri, 85 US (18 Wall) 409, 413 (1874).
  • 5. See generally Madden, 786 F3d 246. See also Part II.B.
  • 6. See Brief of the American Bankers Association, Independent Community Bankers of America, California Bankers Association, and Utah Bankers Association as Amici Curiae in Support of the Petition for Rehearing and Rehearing En Banc, Madden v Midland Funding, LLC, Civil Action No 14-2131, *7–15 (2d Cir filed June 26, 2015) (available on Westlaw at 2015 WL 4153962) (arguing that not allowing a third party to inherit preemption upon a loan sale will cause a “serious disruption of the lending markets”).
  • 7. For example, an inability to sell loans made for the purpose of securitizing them into a securitization vehicle may force the bank to hold on to more loans than it usually would. If the bank could sell the loans, it could use the cash generated from such sales to fund new loans; a restriction on the ability to do so may impair the bank’s ability to issue credit to consumers and corporations.
  • 8. See Brief in Opposition, Midland Funding, LLC v Madden, Docket No 15-610, *16–23 (US filed Feb 12, 2016) (available on Westlaw at 2016 WL 552718).