The “valid-when-made doctrine” is an important component of usury law. It provides that a loan that has a non-usurious interest rate when it is made cannot become usurious if the loan is subsequently transferred to a third party, even if the third party is in a different state with different lending laws. For example, if a lender charges interest in Wisconsin that is not usurious under Wisconsin law, a third party in Texas can buy that loan without having to conform the interest rate to Texas’s more conservative interest cap. Because of federal preemption, the new third party servicer in Texas is not subject to a usury claim under Texas law so long as they continue to charge the original interest rate that was valid in Wisconsin at the time the loan originated.
This doctrine dates back to at least the Supreme Court’s 1828 opinion in Gaither v. Farmers’ & Mechanics’ Bank of Georgetown, and it has been widely accepted for close to 200 years as a “cardinal rule” of American jurisprudence. In 2015, however, the United States Court of Appeals for the Second Circuit issued a controversial opinion in the case of Madden v. Midland Funding, LLC that called the future of the valid-when-made doctrine into question by disregarding it in the case of a third party loan purchaser that was not a bank. Specifically, Madden held that the National Banking Act did not preempt a debtor’s state-law usury claim against a non-bank entity because that entity was acting as a third-party debt collector rather than on behalf of the originating bank. The Second Circuit’s opinion did not apply—or even discuss—the longstanding valid-when-made doctrine, creating some fear and uncertainty among lenders and debt servicers about the doctrine’s future viability as a defense to usury lawsuits (particularly lawsuits against non-bank assignees of loans).
In the five years since Madden, however, those initial fears appear to have been proven wrong as the opinion has been collaterally attacked in all three branches of the federal government. First, the “Protecting Consumers’ Access to Credit Act of 2017” (HR 3299 and S.1642) represents a pending Congressional effort to abrogate (effectively nullify) the Second Circuit’s holding in Madden. Without waiting for this Act to finish making its way through Congress, the Office of the Comptroller of the Currency (OCC)—an administrative agency under the U.S. Department of the Treasury—is currently moving forward with its own proposed rule 84 FR 64229 (published Nov. 21, 2019 and expected to be finalized later this year). This executive regulation would, likewise, abrogate the Madden holding and clarify that interest permissible under federal law at the time of a loan or contract origination “shall not be affected by the sale, assignment, or other transfer of the loan,” including to a non-bank assignee. The judiciary has also weighed in, with several federal courts outside the Second Circuit calling the legal reasoning of Madden into question. For example, in the 2019 opinion In re: Rent-Rite Superkegs West, Ltd., the U.S. Bankruptcy Court for the District of Colorado criticized the Second Circuit’s reasoning and noted that it “respectfully disagrees with Madden[.]” That decision was supported by several amicus briefs filed in the case, including briefs filed by the FDIC and the OCC which argued for the continuing application of the valid-when-made doctrine.
In Texas, Madden appears to have had virtually no legal impact. The United States Court of Appeals for the Fifth Circuit (which sits over Texas, Louisiana, and Mississippi) has never addressed Madden and no federal district court within the Fifth Circuit has ever directly followed it. Similarly, no state court in Texas has ever followed Madden or indicated any approval for its reasoning. A similar response (or, more accurately, lack of response) can be seen in other states and federal circuits from Massachusetts to Colorado.
Rather than drastically altering the landscape of banking law in the United States as once feared, it would appear that the first five years of Madden’s existence have actually proven the case to be a remote outlier that is viewed with general disfavor by both the private sector and the federal government. Particularly in jurisdictions outside of the Second Circuit (Connecticut, New York, and Vermont), Madden has largely been either cited with disfavor or disregarded altogether. It is always possible that a future case may give new life to Madden in the years to come. But, more likely, the OCC and/or Congress will soon succeed in relegating this problematic opinion to legal history as a short-lived anomaly.