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Usury
in Arkansas:
Bears and Borders and Buicks, Oh My!
By W. Christopher Barrier |
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A. Context and Conundrums.
As
of last summer, the bears of Wall Street had pushed
interest rates to a half-century low. Earlier in the
year, the Federal Reserve Board revised its Regulation
A and threw bankers and lawyers into fits of semantic
head scratching. The revisions seemed to add a little
breathing room in rates for nonpreempted lenders.
But even Arkansas-based banks appeared to develop some
doubts about the interest rate preemptions provided
to them by Section 731 of the federal Financial Services
Modernization Act of 1999 ("FSMA"; see The
Arkansas Lawyer, Vol. 35, No. 2, Spring 2000).
Head for the border…
Banks branching into Arkansas
under the federal Riegle-Neal Act remained calm and
confident that they could continue to choose the usury
laws of their home state, as controlling, if they did
it right. (If loans are "approved" in the
home state—which can include credit scoring applied
locally, but adopted at the home office—the choice
is the lender's.) So did first mortgage lenders relying
on the preemptions of the venerable Depository Institutions
Act.
Even the scope of this
last preemption seemed subject to occasional misinterpretation.
And non-bank lenders—primarily in the real estate
and automobile business—remained unsteady about
where they stood.
He who has the gold…
The rules dictated by
the Depository Institutions Act are still a little confusing,
but they have not changed in 20 years. As a practical
matter, they eliminate interest rate ceilings
only for (1) first mortgages (2) secured
by residential real property (3) made by regulated
lenders. Or stated another way, the preemptions
are simply not available to most individuals
or to businesses that are not banks or mortgage companies
or high volume lot sellers. (You can sell your own house
and take a first mortgage back, but not other
real estate and not with second mortgages.)
In fact, the Regulation
A confusion resolved itself rather quickly. Bankers
discovered that FSMA made life simpler in several ways.
Other border questions got answered. And automobile
dealers and their bankers discovered new sources of
rate flexibility.
B. Regulation A and Amendment
60
Regulation A was revised
effective January 9, 2003. It deals with the "discount
window" programs which are available to banks,
allowing short term borrowing from the Federal Reserve
to address temporary liquidity problems.
The essential feature
of the revisions was to tie what is commonly referred
to as the "Federal Reserve Discount Rate"
to the Federal Open Market Committee's targeted federal
funds rate. Typically, the "primary credit rate"
(which is what the discount rate will now be referred
to as, although the term "discount rate" remains
in the staff commentary) will stay 100 basis points
above this federal funds rate.
Good bank, bad bank…
Banks which do not qualify
to borrow at the discount window at the "primary
credit rate" based on their capital, assets, management
and other criteria may be able to borrow at the "secondary
credit rate," which will be 50 basis points above
the primary credit rate.
Low impact revisions…
These revisions to Regulation
A should have no impact on borrowers and lenders
subject to Amendment 60 to the Arkansas Constitution,
which incorporates the "Federal Reserve Discount
Rate on ninety-day commercial paper" as the starting
point for determining the maximum permissible interest
rate, except to the extent that the new tie to the federal
funds rate produces credit rates which are higher (generally,
a couple of percentage points) than they were prior
to the revisions.
Ask a lawyer…
Non-preempted Arkansas
loans are now subject to a ceiling which is five points
above the primary credit rate, which banking lawyers
uniformly believe is the equivalent of the Federal Reserve
Discount Rate for these purposes, in the minds of
the Federal Reserve Board, the staff and the financial
press.
The Arkansas Attorney
General, in his Opinion No. 2002-334, has agreed with
the conclusion that the primary credit rate is the equivalent
of the Federal Reserve Discount Rate for purposes of
applying Amendment 60, citing cases and rules of statutory
construction.
An older model…
This conclusion is reinforced
by reading 12 USC § 85, which sets the permissible
rates for national banks, and upon which Amendment 60
was modeled. The federal statute simply uses the term
"discount rate," with some definitional language.
Even this section has
required some interpretation. It uses the term "interest"
but doesn't define it. Faced with the question, a federal
court has ruled that it should be construed by giving
the term its common, every day meaning, a practical
approach. Video Trax, Inc. v Nationsbank, N. A.
The same approach should be taken to construing "discount
rate." Otherwise, the result would be nullification
or significant modification of a federal statute by
regulation.
C. Extensions and Renewals
after FSMA Sec. 731
For years, Arkansas bankers
and their lawyers struggled with the impact of six words
in Amendment 60, words which pegged the maximum rate
on loans to the maximum in effect "at the time
of the contract." That seemingly innocuous
phrase made use of floating rates difficult (although
perhaps not for national banks).
Section 731 of the FSMA
changed all of that for pre-empted loans (which, as
a practical matter, comprehends virtually all commercial
loans and lines of credit). By removing any practical
limit on the interest chargeable, the "time of
the contract" is now totally irrelevant, except
perhaps as to loans originated prior to FSMA's effective
date, which have simply been extended on the same terms
year after year (which, for many banks, will comprehend
almost none of their portfolio of loans).
D. Catch You on the Flip-Flop
Almost immediately upon
the passage of FSMA, Arkansas lenders wondered about
the flip side of Riegle-Neal, specifically whether pre-empted
Arkansas lenders could take those preemptions into
other states. In Jessup v. Pulaski Bank,
the 8th Circuit said yes.
The classic choice of
law rules turn on where a loan is "made."
The loan in question was generated from a Texas loan
production office, a device specifically permitted under
federal banking laws. (LPO's are not branches if they
didn't approve loans there or directly disburse funds.)
Since Pulaski Bank had
no branches in Texas and it abided by the LPO rules,
the court held that the loan was necessarily an Arkansas
loan, subject to Arkansas (preempted) interest rate
limits.
It is not precisely the
flip side of Riegel-Neal, because LPO's can deliver
commitments and can disburse through title companies
in another state. But, the result is the same.
E. Indirect Lending and Federal Preemptions
Much of the financing
for automobile purchases by consumers is the result
of "indirect lending" — that is, origination
of the debt by the automobile dealer and its purchase
by an institutional lender, frequently an Arkansas-based
bank, especially as to "A" and "B"
paper. (Subprime lending is apparently done largely
by out-of-state "acceptance" companies.)
Indirect lending raises
two related issues:
1. Can the federal
pre-emption effectuated by Section 731 of the FSMA ("Section
731") apply to dealer paper purchased by a bank
if it establishes the proper procedures?
2. If so, must the bank
affirmatively "choose" the state law which
it wants applied to those purchased loans?
In brief, under the procedures
for purchasing dealer paper available to a bank and
described hereafter, the bank is the extender of credit,
not the dealer, and Arkansas case law and the
terms of Section 731 dictate that the federal pre-emption
would apply. Further, the loan documents purchased by
the bank need not affirmatively "choose"
the law of a particular state in order for the pre-emption
to be effective, other than perhaps in very general
terms.
The bank's typical secured,
indirect lending transactions should conform to the
following patterns:
1. In connection with
retail sales installment operations, a borrower selects
merchandise, typically an automobile or recreational
vehicle, at an Arkansas dealership. The dealer takes
a credit application, which is faxed to the bank.
2. Each dealer has a set
of guidelines provided by the bank, which enable the
dealer to submit to the bank only applications which
the dealer can reasonably expect to be approved.
3. Approval and acceptance
are communicated to the dealer, generally by telephone,
by the bank.
4. Only if the
application is so accepted does the dealer enter into
a conditional sale contract with the borrower, which
contract recites on its face its contemporaneous assignment
to the bank.
In Arkansas Appliance
Dist. Co. v Tandy Electronics, Inc., the Arkansas Supreme
Court held that the purchase and finance transaction
"originated" in Arkansas, but that Texas bore
a "reasonable relation" to that transaction,
because Tandy was genuinely located there; had approved
the loan there; and accepted the payments there, which
permitted the explicit choice of Texas law in the contract.
Wouldn't you really rather have…
The Arkansas Appliance
case was cited with approval by the court in Evans
v. Harry Robinson Pontiac-Buick, Inc. In that case,
in a typical automobile financing transaction, the dealer
filled out a conditional sales contract which the dealer
and the purchaser/borrower signed. The contract recited
within the text its simultaneous assignment to a Texas
finance company, and a choice of Texas law. The sale
was conditioned on the approval of the loan by the finance
company, which occurred in Texas.
Who was that…
The validity of the choice
of law in the Evans case depended on the identity
of the actual extender of credit, regardless of
the nominal parties to the conditional sales contract.
The court noted that the
plaintiff admitted that the assignment to the
finance company was on the face of the contract
when he signed it, and that he was aware that the credit
application was sent to the finance company for its
approval. The same is true of the foregoing procedures.
Follow your inclinations…
In short, it is reasonable
to believe that the same analysis applied by the supreme
court in the Arkansas Appliance and Evans
cases to identify the actual extender of credit
would dictate that the bank be so identified in its
indirect lending program, as described above.
The analysis presumes
that the bank is an FDIC-insured lender which was organized
in and has its home office in Arkansas. For the bank,
Section 731 is not merely permissive in its language,
rather it states what the maximum permissible rate "shall
be" for lenders such as the bank, which is
the highest rate permissible in the home state of a
bank which has branched into Arkansas.
Sweet Home, Alabama…
As explained in The
Arkansas Lawyer article on FSMA, Arkansas-based
banks now have no interest rate limit on credit
cards and loans over $2,000, and at least an 18% limit
otherwise, because of the laws of Alabama and Texas.
Ideally, the form of contract
used by Arkansas-based banks should contain an explicit
choice of law, rather than simply state an intention
not to collect "any finance charge or fee, that
is more than the maximum amount permitted for this sale
by state or federal law," as some do.
In the absence of an explicit
choice of law, in a transaction where all of
the contacts were in Arkansas, Arkansas law would govern,
subject to any federal preemptions. Ark. Code Ann §4-1-105
(a).
However, the United States
Supreme Court has repeatedly stated that the Constitution,
laws and treaties of the United States "are as
much a part of the law of every State as its own local
laws and Constitution…" Fidelity Federal
S & L Assn. v. de la Cuesta. The Eleventh Circuit
of Apeals cited Fidelity Federal in Atkinson v. GECC,
and applied it specifically to a form note that recited
that it was to be governed by Georgia law.
The Atkinson court
specifically held that the note (which qualified for
the preemption provided by the Depository Institutions
Act) and its governing law section (which had no specific
reference to interest rates) should be read as incorporating
the federal preemptions, especially since it expressed
no intention to override those preemptions.
Controlling law provisions
such as that in the Atkinson case frequently
appear in form notes produced by "systems"
used by many banks. And in fact, an elaborate, specific
provision is neither required nor advisable. You should
not reference the laws of another state, in view
of the wording of Section 731, and the Atkinson
decision.
The substance of the following
may be included in any non-form contracts, simply for
clarity, although banks may safely use most existing
forms: THIS CONTRACT SHALL BE CONSTRUED UNDER AND
GOVERNED BY THE LAWS OF ARKANSAS AND APPLICABLE FEDERAL
LAW.
F. Summing Up.
Selling real estate (other
than your house) and taking a note back remains subject
to rigid restrictions on interest rates, as does almost
all non-bank lending.
There is basically no
legal interest rate ceiling for loans in excess of $2000
made by Arkansas-based banks after the effective date
of FSMA, which was November 12, 1999, or for credit
cards issued after that date. This applies to loans
to out-of-state borrowers generated by LPO's, if the
rules are observed. It is also reasonable to believe
the courts of Arkansas would treat an Arkansas bank's
indirect lending transactions as loans "made"
by the bank itself.
The pre-emption would
also apply to renewals of loans made prior to that date
when there was no commitment to effect the extension,
under the Bank of Evening Shade reasoning. Loans
with an initial balance under $2000 have a maximum permissible
interest rate of at least 18%. No other federal preemptions
are disturbed by these new preemptions, or by the amendments
to Regulation A.
No affirmative choice
of another state's laws is required in order to take
advantage of the preemption and you are not limited
to the laws of a single state in this regard. A simple
reference to state and federal law, as noted previously,
is sufficient to take advantage of the pre-emption.
In fact, despite some
momentary confusion, the rules regarding usury in Arkansas
are really more consistent and simple and the preemptions
are broader than they originally appeared to be. And
that's a good thing.
ENDNOTES
1. The Riegle-Neal Interstate Banking Act of 1994.
2. Depository Institutions Deregulation and Monetary
Control Act of 1980; 12 U.S.C.
§ 226 (1980), amended by 42 U.S.C. § 5301
(1980).
3. Constn. Ark., Art 19, § 13.
4. 33F. Supp. 2nd 1041.
5. 327 F3rd 682 (8th Cir., 2003).
6. 292 Ark. 482, 730 S.W. 2d 899 (1987).
7. 336 Ark. 155, 983 S.W. 2d 946 (1999).
8. 458 U. S. 141, 157, 102 S. Ct. 3014, 3024.
9. 866 F. 2d 396 (11th Cir., 1989).
10. Bank of Evening Shade v. Lindsey, 278 Ark.
132, 644 S.W.2d 920 (1983). |
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