Like many people, I am still digesting the Bureau’s proposed rule on payday lending. It’s been three months, I know; but it’s a complicated proposal with a lot of moving parts.
One feature has become clear, though, and that is the simplicity with which the proposed rule would identify an unfair practice. For all that the rule would set up various off-ramps, exceptions, and safe harbors, it would begin with this statement: It is an unfair practice for a lender to make a loan, if it is among certain types, without reasonably determining that the borrower will have the ability to repay the loan. That simple statement on its own could be quite dangerous for the industry, even if the Bureau makes much more generous exceptions in the final rule, or even if it doesn’t finalize the rule.
The Bureau has been studying short-term, small-dollar loans for at least a few years. Its primary concern appears to be that—as the Bureau describes it—lenders market their loans as short-term debt, while fully expecting and indeed relying on borrowers not to be able to repay in the short run, so that they refinance repeatedly and end up paying astronomical amounts of interest. To prevent that behavior, the Bureau proposes to determine that it is an unfair (and an abusive) practice to make a covered loan without making a reasonable determination of ability to repay. (The proposal would cover two defined sets of loans, which it calls “covered short-term loans” and “covered longer-term loans.” For purposes of this discussion, we can set aside the scope of those definitions, and the differences between them.) The proposal would specify in further detail how to conduct an acceptable underwriting process, and it would also set up alternative lending models that a company could pursue instead of doing traditional underwriting. For example, a lender could make short-term loans without underwriting if (among other conditions) the loans were designed to prevent borrowers from refinancing more than two times, and the lender made certain disclosures.
Perhaps the underwriting model the Bureau sets forth would be workable for some small-dollar lenders, and perhaps the alternative models would work for others. (Or perhaps not, as the comment record for the rulemaking suggests.) But because of the way the proposal is structured, those features may not matter much as a practical matter. Given the authority that the Bureau claims in the proposal to prescribe a broad range of measures so long as they “have a reasonable relation” to an unfair practice, the Bureau had some latitude about what to identify as the unfair practice and how to connect its other provisions to that determination. What the Bureau has proposed is the broadest possible description of the unfair practice: lending “without reasonably determining that the consumer will have the ability to repay the loan.” Much of what the Bureau could have framed as ancillary regulations “reasonably related” to an unfairness determination is presented, in the proposal, as exceptions from what would otherwise be an absolute prohibition.
Why does this matter? The Bureau is not the only locus of enforcement regarding unfair practices. States can enforce the Consumer Financial Protection Act, including its prohibition on unfair practices. Of course the Bureau could make clear that a lender using its alternative models is exempt from the statutory prohibition on unfair practices, as well as the regulatory requirements of the Bureau’s putative rule. But states, and in many states consumers, can also enforce state laws prohibiting unfair practices. In many states, the unfair practices law is essentially identical to the one governing the Bureau; many others borrow from federal law, in that an act that is wrongful under federal law can be an unfair practice under state law.
So let us suppose the Bureau issues a rule like what it has proposed. A lender opts to use the alternative lending models the Bureau makes available. Doing so would protect the lender from liability under the Consumer Financial Protection Act. But a consumer plaintiff—or a class of consumer plaintiffs—could still sue under state law, charging that the failure to do reasonable underwriting is an unfair practice. Such a plaintiff would point out that the Bureau has determined it is unfair to issue a covered loan without making a reasonable determination of ability to repay. That the Bureau offers the alternative lending models as an exemption from the federal prohibition on unfair practices, the plaintiff would continue, does not immunize the lender’s misconduct under state law.
The problems do not stop there. Suppose a different lender performed underwriting compliant with the rule’s specifications on how to make ability-to-repay assessments. That lender might like to think compliance would protect it from unfair-practices liability. But the Bureau’s proposal doesn’t include those underwriting specifications in the definition of the unfair practice. It identifies the unlawful practice as not “reasonably determining that the consumer will have the ability to repay.” What is “reasonable,” and what is “ability to repay”? The proposed rule would elaborate on those concepts only for use in the Bureau’s ancillary regulations related to the unfair practice. In a lawsuit under state law based on the premise that not reasonably determining ability to repay is an unfair practice, the parties would have to litigate what kind of determination is reasonable, and what counts as ability to repay.
Perhaps most difficult of all, a state-law plaintiff would not have to wait for the Bureau’s final rule. So far as one can tell from the proposed rule, the criteria for determining by rule that a practice is unfair are exactly the same as those for finding it unfair in any other proceeding. If the Bureau finds the identified practice unfair, it has always been unfair (or at least since section 1031 of the Dodd-Frank Act took effect)–and it is unfair already. A plaintiff could sue a small-dollar lender for that unfair practice now, both for ongoing business and for past lending stretching as far back as the applicable statute of limitations will allow. The plaintiff would of course need to prove that doing small-dollar lending without reasonable underwriting is an unfair practice. While the Bureau’s proposed rule would not be as powerful an aid as a final rule conclusively determining the point for purposes of the Dodd-Frank Act, it is still a great help. A court or a jury might place substantial weight on the assessment in the Bureau’s proposal, preliminary though it is.
Note also that the alternative lending models will not even be protection from the federal violation unless and until the Bureau issues a final rule granting those exemptions. Until that time, lenders could even be vulnerable to aggressive state-based enforcement of the federal prohibition on unfair practices.
These issues might ultimately be hypothetical, if the rule as proposed would destroy the small-dollar lending industry anyway. However, the Bureau seems to think small-dollar lending will continue, albeit in different forms and with lower volume. The current proposal, because it doesn’t take careful account of state law, may make that outcome less likely.