A federal district court in California handed the Consumer Financial Protection Bureau (CFPB) a big win on Wednesday, August 31, 2016, granting the agency summary judgment on liability in its lawsuit against CashCall, Inc., its affiliated entities and its owner. In a 16-page decision and order, the US District Court for the Central District of California ruled that CashCall engaged in deceptive practices by servicing and collecting on loans in certain states where the interest rate on the loans exceeded the state usury limit and/or where CashCall was not a licensed lender. The decision represents an additional judicial touchpoint on the important question of who is a “true lender” in a transaction and validates, at least for now, the CFPB’s theory that collecting on loans that state law renders void and/or uncollectable constitutes a violation of federal law.

The court first ruled that CashCall was the true lender on the loans that were issued by Western Sky Financial because “the entire monetary burden and risk of the loan program was placed on CashCall, such that CashCall, and not Western Sky, had the predominant economic interest.” The court reached this conclusion based on the facts that, although Western Sky was the nominal lender on the loans, CashCall funded a reserve account to fund two days’ worth of loans; agreed to, and did, purchase all of the loans originated by Western Sky after a three-day holding period and before any consumer payments were made on the loans; and agreed to indemnify Western Sky for any liability it might incur in connection with the loans. In reaching its decision, the court adopted a “totality of the circumstances” test to determine which party to the transaction had the “predominant economic interest” in the transaction. This approach to determining “true lender” status has important implications for other lending arrangements, such as those commonly found in the marketplace lending arena, in which lenders rely on bank partners to make and fund loans that may be subsequently purchased by the non-bank partner.

Having reached this conclusion, the court then determined that because CashCall was the “true lender,” the choice of law provision in the loan agreements at issue—which provided that the laws of the Cheyenne River Sioux Tribe (CRST) would apply—should be disregarded in favor of the laws of the borrowers’ home states. The court reasoned that because Western Sky—which had contacts with the CRST—was not the true lender, the CRST did not have a substantial relationship to the parties.

The choice-of-law determination was critical, as the CFPB’s claims hinged on state laws in 16 states that render loans made by unlicensed lenders and/or in excess of the state usury limits void and/or uncollectable. The CFPB alleged that servicing and collecting on such loans constituted unfair, deceptive and abusive conduct. The court held that by “servicing and collecting on Western Sky loans, CashCall [and its affiliate] created the ‘net impression’ that the loans were enforceable and that borrowers were obligated to repay the loans in accordance with the terms of their loan agreements.” In light of the state laws rendering the loans void, the court found this “net impression” to be false and, thus, deceptive. The court did not address whether the conduct was also unfair or abusive.

Finally, the court held that CashCall’s founder, sole owner and president was also liable for CashCall’s corporate violations because he participated in and had the authority to control the conduct at issue, and because he knew of or was recklessly indifferent to the misrepresentations. In reaching this conclusion, the court relied on a decision from an early CFPB enforcement action in which the Ninth Circuit applied the standard for individual liability applicable to actions brought by the Federal Trade Commission. The court, therefore, did not address the meaning of the Dodd-Frank Act’s “related person” provision, upon which the CFPB has relied to impose individual liability on owners or operators of non-bank companies. The court also rejected defendants’ advice of counsel defense, finding that because the individual defendant had the “requisite factual knowledge” he could be held individually liable notwithstanding the uncertainty in the law.

The court’s decision is important both to CFPB enforcement efforts and to the validity of bank partner programs. The CFPB has at least one other pending lawsuit in which it has asserted a similar theory of liability that collecting on loans rendered void by state law constitutes unfair, deceptive and abusive conduct (UDAAP). Moreover, the CFPB may be emboldened by this decision to identify additional ways to “federalize” state law violations under its expansive UDAAP authority.

With respect to the “true lender” question, the decision is inconsistent with standards adopted by other courts. Some courts have determined the “true lender” based solely on the creditor named in the loan agreement. Other courts have determined the true lender through a narrow evaluation of facts regarding which party engages in the three non-ministerial acts that banking regulators have identified: (i) the determination to extend credit; (ii) the extension of credit itself; and (iii) the disbursement of funds resulting from the extension of credit. Finally, some courts have taken the more fact-intensive approach adopted here, evaluating the totality of circumstances to determine who has the predominant economic interest. The CashCall decision raises questions about the validity of certain bank partner programs that entities use to avail themselves of a bank’s ability to “export” the interest rate of its home state or a state in which the bank is “located” without regard to the varied usury laws of 50 states. Given the fact-intensive nature of this approach, the details of marketplace lending and other bank partner programs may lead to different conclusions even in those jurisdictions where courts adopt the “totality of the circumstances” approach. If CashCall appeals the decision, the Ninth Circuit will have an opportunity to address this important but unsettled issue.