Marketplace Lending

The “Valid When Made” Rule Strikes Back

Jun 07, 2020 | By JOSEPH CIOFFI

“It’s over, Anakin, I have the high ground.”
— Obi-Wan Kenobi, Star Wars Episode III: Revenge of the Sith

Last January, we reported on the Office of the Comptroller of the Currency’s (OCC) proposal to codify the “valid when made” rule—a longstanding doctrine that has served as the bedrock for bank lending for nearly two centuries—which, in 2015, was thrown under the bus by the Second Circuit in Madden v. Midland Funding.

Valid When Made

Under the “valid when made” principle, loan terms (including interest rates) that are valid when a loan is made remain valid even when the loan is sold to a purchaser from a state with a lower interest rate cap (thus, a non-usurious loan does not become usurious upon assignment or transfer). This principle is important to many core financial system functions, including, inter alia, banks’ ability to maintain liquidity by transferring loans, and marketplace and other fintech lenders’ ability to buy/sell bank-originated loans in secondary markets.

Final Rule

On May 29, 2020, the OCC issued its final rule that will go into effect 60 days after being published in the Federal Register. Adding a new paragraph to 12 CFR § 7.4001 (applicable to national banks) and 12 CFR § 160.110 (applicable to savings associations), the new language provides that interest on a loan will not be affected by the sale, assignment, or other transfer of the loan.

In text accompanying the final rule, the OCC states the “primary problem the OCC seeks to address is the legal uncertainty resulting from the Madden decision.” The OCC also refers to evidence that “Madden restricted access to credit for higher-risk borrowers in states within the Second Circuit and [] it caused a rise in personal bankruptcies due to a decline in marketplace lending, especially for low-income households.”

Looking Ahead

Although the “valid when made” rule may have been codified into a federal regulation, the saga may not be over yet. To date, Madden has not been overturned by another court. In future litigations involving the enforceability of interest rates of assigned/transferred loan agreements—particularly in the Second Circuit—courts may have to decide whether the force of the OCC has brought the “valid when made” rule back for good. Further, the preemption and “true lender” issues we’ve discussed will continue to impact court decisions in transactions where a federally chartered bank transfers a loan to an entity that is not federally chartered.

Adam Levy and Nicole Serratore, attorneys in the Insolvency, Creditors’ Rights and Financial Products Group, each contributed to this post.