Passive Investors in Payday Lending Operations Get Partial Reprieve

Financial Services Law

While tossing certain claims brought by Pennsylvania’s attorney general, a federal judge denied part of a motion to dismiss brought by online short-term lenders in an action accusing them of “renting” Native American tribes and out-of-state banks.

What happened

In 2014, Pennsylvania filed suit against a lender and several passive investors, alleging they violated state and federal laws prohibiting usurious and otherwise illegal lending practices by partnering with Native American tribes and banks located outside Pennsylvania to charge interest rates in excess of the state cap.

Pennsylvania’s Loan Interest and Protection Law prohibits unlicensed lenders from charging an interest rate in excess of 6 percent per year on a loan amount less than $50,000. None of the defendants were licensed and, therefore, if subjected to Pennsylvania law, prohibited from making or collecting on any loans in excess of 6 percent per year. In addition, Pennsylvania’s state RICO statute, the Corrupt Organizations Act (COA), prohibits a broad array of activities relating to companies that infiltrate and corrupt legitimate businesses.

Pennsylvania alleged that, to circumvent the LIPL, the defendants designed, implemented and profited from a scheme colloquially dubbed “rent-a-bank” and “rent-a-tribe.” In the alleged “rent-a-bank” scheme, the lender defendants partnered in the 2000s with an out-of-state bank. The bank acted as the nominal lender while the defendants were the de facto lender in charge of marketing, funding and collecting the loans, Pennsylvania said.

In the face of mounting regulatory pressure against the rent-a-bank scheme, the state claimed the defendants devised the tribal alternative. As part of the plan, the lender defendants recruited additional investors, the state said. The company not only invested but also determined the volume of lending and closely monitored the regulatory landscape, even putting restrictions in place after relevant court rulings, according to the state.

The investor defendants moved to dismiss. They argued that the court lacked personal jurisdiction over them and that Pennsylvania failed to state a claim.

First, U.S. District Judge J. Curtis Joyner determined the court had jurisdiction over the investor defendants even though they were Delaware limited liability companies headquartered in Chicago and did not maintain any offices, bank accounts, PO boxes, telephone listings or real property in Pennsylvania.

The investor defendants’ out-of-state conduct at issue in the litigation created a sufficient relationship between them and the forum to support personal jurisdiction, the court found. The state “has shown that the movants actively participated in the design, implementation, and direction of a scheme that targeted customers located in Pennsylvania with the payday loans that are the subject of this litigation,” the court wrote. “This conduct constitutes sufficient suit-related contacts with Pennsylvania to support specific jurisdiction.”

In support, the state submitted an email from an investor principal with a “No-State List” of locations where the scheme did not offer its loan product.

“Notably absent from the ‘No-State List’ is Pennsylvania, where the Defendants collected on the third- to sixth-highest volume of loans,” Judge Joyner wrote. “Moreover, [the lender’s] answers to interrogatories establish that the scheme issued about $133 million in loans to 97,000 Pennsylvania consumers, which resulted in an additional $127 million in interest and fees. Both the purpose and result of the scheme establish that its participants, including the movants, targeted customers located in Pennsylvania.”

Further, the investor defendants were “early participants and helped develop” the “rent-a-tribe” scheme as well as active participants with actual control over the scheme, forcing a temporary halt when concerned about regulatory pressure, the court said.

“This level of engagement takes the movants from passive investors to collaborators in a scheme that targeted Pennsylvania residents,” the court said. “Even though this conduct occurred outside of Pennsylvania, it connects them ‘to the forum in a meaningful way.’”

The court denied the motion to dismiss for lack of personal jurisdiction.

But the court did toss the “rent-a-bank” scheme allegations against the passive investors. Although Pennsylvania argued that the “rent-a-bank” and “rent-a-tribe” were two phases of a single scheme under the COA, Judge Joyner found that while the two were connected in some sense, the investor defendants could not be liable for their alleged conduct during the “rent-a-bank” scheme.

“In contrast to the [state’s] allegations about [the investors’] conduct in the ‘rent-a-tribe’ scheme, the [state] fails to show how [the investors] could be liable … for its alleged participation in the ‘rent-a-bank’ scheme,” the court said. While Pennsylvania provided plenty of allegations about the investors’ conduct in the “rent-a-tribe” scheme, it lacked sufficient allegations for the “rent-a-bank” phase.

“[T]he [state] only alleges that [the company] joined the scheme by being a primary investor and created [another corporate entity] to purchase participation interests from the ‘rented’ bank,” the court wrote. “But a defendant does not incur liability under [Pennsylvania state law] for merely funding an alleged unlawful enterprise. Given the lack of allegations regarding [the investors’] conduct in the ‘rent-a-bank’ scheme—either as a principal or as a participant involved in the operation and management of that scheme—the [state] has failed to plead sufficient allegations that would render [the investors] liable under [Pennsylvania state law].”

To read the opinion, click here.

Why it matters

The decision offers something of a mixed bag for the investor defendants. While the court found sufficient suit-related contacts with Pennsylvania to support jurisdiction, it also dismissed half the counts against them. While Pennsylvania’s complaint included multiple “rent-a-tribe” allegations, the court concluded that those claims were insufficient to maintain causes of action under the LIPL or COA, and the court specifically rejected that such investors participated in racketeering activities because they were mere passive investors in the alleged scheme. Tribal lending remains a hot button issue in both state and federal enforcement. The CFPB recently voluntarily dismissed an enforcement action against a California-based tribal lender in a case also involving tribal sovereignty issues.



pursuant to New York DR 2-101(f)

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