Payday Lender Wins Over South Dakota Banking Regulator

Financial Services Law

A payday lender in South Dakota scored a victory in its lawsuit against the state’s banking regulator when a federal court judge agreed that the South Dakota Division of Banking exceeded its authority by revoking the plaintiff’s operating licenses.

The plaintiff’s due process rights were violated by the revocation, the court found, and the regulator should have taken less aggressive action.

What happened

In 2010, a payday lending company applied for a money lender’s license pursuant to South Dakota law. Over the next several years, the lender filed renewal applications as well as new applications for additional licenses to open branches in different communities in the state.

The lender made loans at interest rates exceeding 300 percent per year and expanded to a dozen locations throughout South Dakota. Largely in response to the lender’s practices, a measure was placed on the state ballot in 2016 to set a usury rate cap. Voters passed the measure, which prohibits all money lenders licensed in the state from making a loan that imposes total interest, fees and charges at an annual percentage rate (APR) greater than 36 percent, or from evading that rate limitation by indirect means.

After the measure took effect, the lender did not seek renewal of eight branch licenses and advised the division that it planned to begin making loans using a new contract. Expressing concern, the regulator conducted a targeted examination of the lender in July 2017 before determining that it needed additional information and a larger loan sample to review.

With much more back-and-forth, the division conducted a full-scope examination in August 2017. The examiners concluded that the late fees associated with the signature loan product were “anticipated late payments,” which they believed were not excluded from finance charge calculations. When included in the finance charge, the APR of the signature loan product ranged from 350 to 487 percent, the regulator said.

On Sept. 13, 2017, Bret Afdahl, the director of the division, issued a license revocation order instructing the lender to “cease engaging in the business of money lending in South Dakota” and notify all consumers of loans issued after June 21, 2017, that the loans were void and uncollectible. The order also required the company to surrender all of its South Dakota money lender licenses and return them to the division.

The lender filed suit in response, arguing that the director deprived it of procedural due process required under the 14th Amendment. Afdahl issued a limited stay of the order (which allowed the lender to continue servicing some of the loans) and served the company with a notice of hearing (on the issue of whether the lender violated the state’s usury cap), which was continued.

On cross motions for summary judgment, U.S. District Judge Roberto A. Lange sided with the lender.

South Dakota state law authorizes the director of the division to revoke a money lender’s license for good cause, but it must be done in conformity with the state’s Administrative Procedures and Rules, the court explained. Pursuant to the relevant chapter, no license is to be suspended or revoked before the licensee is notified by mail “of facts or conduct which warrant the intended action, and the licensee [is] given an opportunity to show compliance with all lawful requirements for the retention of the license.”

That provision also allows for the summary suspension of a license pending proceedings if the director determines “public health, safety or welfare imperatively require emergency action” and such findings are incorporated in the order.

Unfortunately for Director Afdahl, he failed to follow these rules and regulations and did not provide the lender adequate notice and the opportunity to be heard as required by state law prior to the revocation of its licenses, the court said.

The procedures used by the division “failed to provide adequate notice of revocation to [the lender] of the apparent violations which formed the basis of Afdahl’s decision to issue the Order,” the court wrote. “Although [the lender] was certainly alerted to the Division’s suspicions, [it] received no notice that the Division had concluded [its] late fees violated state law justifying revocation of [its] money lending licenses until Afdahl issued the Order. While adequate notice is a flexible concept, a total absence of notice regarding one of the two primary bases for revocation of [the lender’s] licenses does not satisfy the requirements of due process.”

The division must have known “well in advance” of the order that it had deemed the lender to be issuing illegal loans, yet at no point was the lender advised of this violation prior to receiving the order. “Such an absence of notice for revocation does not comport with due process,” Judge Lange said.

Further, the order did not give the lender a meaningful opportunity to be heard concerning the revocation of its licenses. “Afdahl’s Order provided [the lender] no chance to bring its lending practices in conformity with its approved licenses or to rework its loan product, nor even the opportunity to receive an explanation from the Division as to why those would not be acceptable courses of action,” the court explained. “This is precisely what South Dakota law normally requires before the revocation of a license.”

Nor did the court find that Afdahl was able to justify his actions based on the necessity of quick action by the state to protect the public from further harm pursuant to the limited exception to the notice and hearing requirement. The director’s own actions demonstrated this conclusion, as he stayed the order and gave notice of a hearing, essentially transforming his order into a cease and desist order.

If a cease and desist order was sufficient 15 days later, “it certainly was a viable option on September 13, 2017, when Afdahl issued the initial Order revoking [the lender’s] licenses,” the court noted. “Any need to protect the public from further harm could have been achieved without revoking the licenses and compromising [the lender’s] protected property interest, and thus the quick action doctrine does not shelter Afdahl’s Order from a procedural due process challenge.”

The court found that the lender was deprived of a “clearly established” constitutional right, leaving Afdahl without the protection of qualified immunity. Absolute immunity was also out of the question, the court said. “[G]ranting absolute immunity under circumstances where, as here, an agency official ignores or exceeds his authority would impermissibly insulate that official from the consequences of those actions,” the court said. “This result is contrary to the very justifying purposes which absolute immunity’s application is meant to promote.”

Although the court granted summary judgment in favor of the lender, it recognized that the plaintiff’s damages appeared to be limited because Afdahl stayed the order just 15 days after it was issued.

“Afdahl had the authority to halt the issuance of [the lender’s] signature loan product via a cease and desist order,” the court wrote. “Had he done so, procedural due process concerns would not have been implicated, [the lender] would have no claim to seek damages under section 1983 and its remedy would have been further administrative proceedings challenging Afdahl’s decision, unless it chose to abandon or substantially alter the signature loan product. The practical consequences of Afdahl’s Order and subsequent stay have essentially brought [the lender], fifteen days after the revocation, close to where it would have been if Afdahl issued a cease and desist order in the first place.”

To read the opinion and order in the case, click here.

Why it matters

Sometimes regulators overstep their bounds. In recent years, both state and federal actors have taken a hard line against payday lenders, as the director of the South Dakota Division of Banking did in the case discussed. However, the director failed to follow the due process requirements set forth in state law, necessitating that the lender fight back.