Holding payday lenders accountable

Payday lenders trap consumers in a cycle of debt; class-action suits can hold them accountable

2016 February

Abusive practices by payday lenders are a great danger to consumers’ rights. All plaintiffs’ attorneys should be aware of them. The industry is huge. Payday loan customers in need of cash “spend approximately $7.4 billion annually at 20,000 storefronts and hundreds of Websites, plus additional sums at a growing number of banks.” (Pew Charitable Trusts, Payday Lending in America: Who Borrows, Where They Borrow, and Why, at 2 (July 2012).) Struggling financially to begin with, borrowers end up paying far more than they imagined because payday loans – in which, for example, a customer borrows $255 in cash and gives the lender a check for $300 to be cashed on the customer’s next payday – “fail to work as advertised. They are packaged as two-week, flat-fee products but in reality have unaffordable lump-sum repayment requirements that leave borrowers in debt for an average of five months per year, causing them to spend $520 on interest for $375 in credit.” (Pew Charitable Trusts, Fraud and Abuse Online: Harmful Practices in Internet Payday Lending, at 1 (Oct. 2014).) Payday loans are, moreover, frequently accompanied by “consumer harassment, threats, dissemination of borrowers’ personal information, fraud, unauthorized accessing of checking accounts, and automated payments that do not reduce loan principal.” (Ibid.)

Payday lending is illegal in 14 states, including Arizona, and the District of Columbia. All of the other states, including California, regulate it to some extent. In no state are payday lenders allowed to cheat or mislead consumers.

In the past, litigation against payday lenders has been extremely successful in enforcing the law and vindicating consumers’ rights. In recent years, however, the U.S. Supreme Court has issued several decisions making it harder to hold payday lenders accountable and the lenders have developed increasingly creative and far-reaching legal maneuvers to avoid liability for violating state consumer protection laws. Thankfully, there is room for optimism on all of these fronts.

This article will briefly summarize how payday lenders hurt consumers, some past successes holding them accountable, the legal tactics payday lenders are using to try to gain immunity, applicable law in California and other states, and potential new federal regulations now in the works that could dramatically change the law and increase protections for consumers nationwide.

How payday lenders are hurting consumers

Payday lending has grown to such an extent that there are now more payday lending storefronts in America than there are McDonald’s and Starbucks combined. Payday lenders use a business model that depends on trapping consumers in a cycle of debt and especially targets economically vulnerable individuals and communities of color. A recent study by the Center for Responsible Lending found that race and ethnicity are the leading factors in determining payday lender locations, with concentrations of these businesses in lower-income and minority communities. (Wei Li, et al., Center for Responsible Lending, Predatory Profiling: The Role of Race and Ethnicity in the Location of Payday Lenders in California (2009).) Of the 12 million Americans that take out a payday loan each year, 79 percent are unable to pay it back on time. (Paul Leonard and Graciela Aponte, Center for Responsible Lending, Analysis: New State Data Show California Payday Lenders Continue to Rely on Trapping Borrowers in Debt (2014).) So they take out another payday loan and go deeper in debt. In California, 76 percent of all payday loan fees come from borrowers who took out seven or more payday loans per year. (Ibid.) Even when they are as careful as possible, the effects can be never-ending.

Maria Cervantes is a client of Montebello Housing Development Corporation in Los Angeles, which works with members of the Latino community looking to purchase their first home. Here is her story, told to the California Senate Banking Committee:

My name is Maria Cervantes and I would like to share my experience with payday loans. Although I knew about the pitfalls of payday loans, I found myself in a situation where I thought I had no other choice but to take out a payday loan. What I thought would be a short term loan turned into five years. It’s been approximately five years of paying three loans at $45 each, every two weeks. I was paying $135 biweekly and $270 a month. Every time I thought I was going to pay off the $300 loan, something always happened so I found myself in a cycle.

I regret ever taking the loan that from the start the lender gives you only $245 and not the full $300. If I had to do it all over again, I would ask a friend or family member instead of paying the hundreds of dollars I gave the payday lenders. Not only did I have to pay the high interest, but [there were also] the harassing phone calls about late payment at work or to my references I wrote on my applications.

(Statement from the National Council of La Raza, California Senate Banking Committee, Informational Hearing on the Consumer Financial Protection Bureau Rulemaking for Payday, Vehicle Title and Similar Loans (May 6, 2015)). Maria’s credit dropped to a FICO score of 500; she filed bankruptcy twice and was unable to obtain preapproval for a home loan because of her credit history (Ibid). See also Testimony by Liana Molina, California Reinvestment Coalition, California Senate Banking Committee Informational Hearing on the Consumer Financial Protection Bureau’s Proposal to End Debt Traps (May 6, 2015) (Carmen in Los Angeles, through repeated payday loans, is paying finance charges of $16,748 to borrow $5,000).

As bad as stories like this are, the growth of online payday lending has made things even worse. Online loans account for about one-third of the market, but are the subject of nine out of every ten complaints to the Better Business Bureau about payday lenders. (Pew Charitable Trusts, Fraud and Abuse Online: Harmful Practices in Internet Payday Lending (October, 2014).) The practices complained of are outrageous: 30 percent of online borrowers reported threats, including contacts with families, friends, and employers and threats of arrest by the police; 32 percent reported unauthorized withdrawals from their accounts; and 39 percent reported fraud and sale of their personal or financial information to a third party without their knowledge. (Pew Charitable Trusts, Key Findings from Fraud and Abuse Online (Oct. 2014).)

Some past successes

In the past, litigation has played a critical role holding payday lenders accountable. In Florida, before September 2001 (when the law was changed to create an exception for payday lending), making a loan with an annual interest rate above 45 percent was a crime. Between 1996 and 2001, however, several payday lenders were charging Florida consumers rates from 300 percent to over 1000 percent. And a series of class actions were filed on the consumers’ behalf. In four of the cases, the lenders settled for a total of about $20 million. (Reuter v. Check ‘N Go settled for $10.275 million. After fees and expenses were deducted, checks were issued and cashed by 21,973 consumers, for an average recovery of $310. Close to another $10 million was recovered in lawsuits against The Check Cashing Store, Ace Cash Express, Inc., and Buckeye Check Cashing, Inc. (See www.publicjustice.net/blog/class-actions-against-payday-lenders-show-how-concepcion-has-been-used-gut-state-consumer-prote))

Similarly, in 2004, Public Justice and a team of private and public interest lawyers filed class actions in North Carolina against three of the state’s largest payday lenders – Advance America, Check Into Cash, and Check ‘N Go. The suits charged that the lenders exploited poor people by luring them into quick loans carrying annual interest rates of up to 500 percent. After years of litigation, landmark settlements were reached. Kucan v. Advance America settled for $18.25 million – to our knowledge the largest recovery for consumers against payday lenders in America. McQuillan v. Check ‘N Go settled for $14 million. Hager v. Check Into Cash settled for $12 million. Checks were distributed to and cashed by tens of thousands of class members in all three cases. See http://www.publicjustice.net/content/terrible-north-carolina-supreme-court-decision-underscores-need-cfpb-action. While these cases were being litigated, the attendant publicity and an investigation by North Carolina Attorney General Ray Cooper resulted in a dramatic conclusion: payday lending was eliminated in North Carolina.

Since these and other consumer protection victories took place, however, times – and the law – have changed. The U.S. Supreme Court has issued several rulings making it harder to hold payday lenders liable for breaking the law. Not surprisingly, payday lenders are trying to take full advantage of these rulings – and create a number of additional barriers to accountability themselves.

Barriers to accountability

• Mandatory arbitration clauses with class-action bans

For decades, payday lenders have been including non-negotiable mandatory arbitration clauses with class-action bans in their form “agreements” with customers. In some of the past successes listed above, the courts found these contractual terms unconscionable and unenforceable. Four years ago, however, the U.S. Supreme Court issued AT&T Mobility, LLC v. Concepcion (2011)131 S.Ct. 1740, and held that the Federal Arbitration Act preempts most state laws invalidating class bans in mandatory arbitration clauses. And two years ago, in American Express Co. v. Italian Colors Restaurant (2013) 133 S.Ct. 2304, the Court held that class-action bans in arbitration agreements will be enforced even if they effectively preclude class members from enforcing their rights. (I won’t go into the Court’s other recent decisions expanding mandatory arbitration and limiting class actions here.) As a result, class-action bans in mandatory arbitration clauses now pose a very serious barrier to holding payday lenders accountable. (Few customers or lawyers find pursuing claims individually in arbitration worthwhile.) There are, however, potential ways around them.

First, while this is increasingly rare, the payday lender’s form contract may not have a mandatory arbitration clause with a class-action ban; it may have one, but the class-action ban may not be well drafted; or the mandatory arbitration clause may implicitly leave it to the arbitrator to decide whether a class action can be pursued in arbitration. One of the cases Public Justice and a team of lawyers filed years ago against a payday lender in Florida is still proceeding – as a class action in arbitration.

Second, the mandatory arbitration clause may be unconscionable or unenforceable for a large number of reasons unrelated to the class-action ban. If it is, then, unless the illegal provision(s) can be severed from the arbitration clause and the clause can be enforced without them, the class action ban will not be enforceable either. It is beyond the scope of this paper to delineate all of the ways in which an arbitration clause may violate the law, but see Bland, et al., Consumer Arbitration Agreements: Enforceability and Other Topics (7th edition 2015). For more specific assistance, contact Public Justice’s Mandatory Arbitration Abuse Prevention Project.

Third, there is now a significant chance that the U.S. Consumer Financial Protection Bureau (CFPB) will issue federal regulations prohibiting mandatory arbitration clauses with class-action bans in consumer agreements in the financial services industry, which includes all payday lenders. When Congress passed the Dodd-Frank Act in 2010, it created the CFPB and required the new agency to study the use of arbitration clauses by lenders. Congress also gave the CFPB the power to prohibit or limit their use if its study found they harmed consumers. On March 10, the CFPB issued its study, the most comprehensive ever conducted of arbitration and class actions. The study found that arbitration and class-action bans in them were bad for consumers in numerous ways. See www.publicjustice.net/content/cfpb-report-finds-forced-arbitration-bad-consumers. On Oct. 7, 2015, based on the study, the CFPB announced it was considering proposed rules that would, among other things, prohibit the use of arbitration clauses that ban class actions. See http://www.consumerfinance.gov/newsroom/cfpb-considers-proposal-to-ban-arbitration-clauses-that-allow-companies-to-avoid-accountability-to-their-customers.

The agency is now drafting proposed regulations and is expected to announce them soon.

• Rent-A-Bank

A second barrier to accountability payday lenders have tried to construct is the “rent-a-bank” scheme – where payday lenders agree to give a small portion of their profits to federally insured banks chartered in states with no or very high interest rate limits and then claim the exemption from other states’ usury laws that those banks have. Section 27(a) of the Federal Deposit Insurance Act, 12 U.S.C. section 1831d(a), authorizes a state-chartered bank to charge the interest rate allowed under the law of its charter state in any other state in which it does business. If payday lenders could claim the immunity these banks have from other states’ usury limits, the payday lenders could violate the laws of those other states with impunity. That’s what the payday lenders have tried to do. See Consumer Federation of America (CFA) and U.S. PIRG, Rent-a-Bank Payday Lending: How Banks Help Payday Lenders Evade State Consumer Protection (Nov. 2001); CFA, Unsafe and Unsound: Payday Lenders Hide Behind FDIC Bank Charters to Peddle Usury (March 30, 2014).

For two reasons, however, these efforts are all but over. To begin with, the FDIC and the federal regulatory agencies have taken a number of actions to stop them. See, e.g., CFA, FDIC Guidelines Turn up the Heat on Rent-a-Bank Payday Lending (July 2, 2003); Guidance on Supervisory Concerns and Expectations Regarding Deposit Advance Products, (Nov. 21, 2013). In 2003, the Office of the Comptroller of the Currency ordered “[a]ll national banks with known payday lending activities through third-party vendors… to exit the business.” OCC, Annual Report Fiscal Year 2003, at 17. In addition, when payday lenders tried to assert the out-of-state banks’ immunity in litigation, courts focused on the facts: the banks weren’t making these loans; the payday lenders were. See, e.g., Bankwest, Inc. v. Baker (MD. Ga. 2004)324 F.Supp.2d 1333, vacated as moot, 446 F.3d 1358 (11th Cir. 2006); Flowers v. EZ Pawn (N.D. Okla. 2004) 307 F.Supp.2d 1191; Goleta Nat’l Bank v. Lingerfelt (E.D.N.C. 2002) 211 F.Supp.2d 711; Salazar v. ACE Cash Express, Inc. (D. Colo. 2002)188 F.Supp.2d 1282.

As a result, payday lenders have now developed an even more ingenious and disturbing potential barrier to accountability.

• Rent-A-Tribe

The payday lenders’ latest attempt to avoid accountability is a variation on their rent-a-bank scheme: they agree to give Native American tribes a portion of their profits and then try to claim tribal sovereign immunity from both state and federal law. See B. Walsh, “Outlawed by the States, Payday Lenders Take Refuge on Reservations,” Huffington Post (June 29, 2015). This is the hottest area in payday lending litigation now, with the lenders’ tribal immunity claims being challenged by government officials, public interest lawyers, and private practitioners across the country.

In California v. Miami Nation Enterprises (Cal. May 21, 2014) S216878, the California Supreme Court has agreed to hear a challenge by the Commissioner of the former Department of Corporations (now the Department of Business Oversight) to the Court of Appeal’s ruling in People v. Miami Nation Enterprises, 223 Cal.App.4th 21, 116 Cal.Rptr.3d 800 (2014), that five payday lenders created, controlled, and operated through a network of businesses by non-Indian Kansas race car driver and millionaire Scott Tucker have tribal sovereign immunity from California law. In Rosas v. Miami Tribe of Oklahoma, Ct. App. No. A139147, Public Justice and its co-counsel are appealing a trial court decision that other payday lending organizations in Tucker’s network are entitled to tribal sovereign immunity, without allowing discovery to prove that the lenders are controlled and operated by the Tuckers, not the Native American tribe. (Contrary to what the caption of the case suggests, we are not suing any tribes.) As a reflection of what is really going on here, on January 16, 2015, despite their sovereign immunity claims, two payday lenders in the Tucker enterprise agreed to pay $21 million to the Federal Trade Commission (FTC) – the largest FTC recovery in a payday lending case – and write off another $285 million in uncollected sums to settle charges that they violated the law by misrepresenting how much the loans would cost consumers and charging undisclosed and inflated fees: “On Oct. 12, 2015, Public Justice won a motion to unseal the documents in the FTC case. The predatory conduct they reveal is truly disturbing. See http://www.publicjustice.net/content/payday-lenders-race-bottom.”

Payday lenders’ arrangements with Native American tribes are spreading, as are legal challenges to the lenders’ tribal immunity claims. In Felts v. Paycheck Today, No. D-202-cv-2008-13084 (N.M. Dist. Ct.), Public Justice’s team is battling payday lenders’ assertion of tribal immunity from liability under New Mexico law. In Pennsylvania, the Attorney General has sued Think Cash and payday lending magnate Ken Kees with violating the state’s racketeering, consumer protection, and lending laws by trying to use several tribes as part of a conspiracy to violate the law. See B. Walsh, supra. In Vermont, two women have sued payday lenders under the Consumer Financial Protection Act, the Federal Trade Commission Act, the Electronic Funds Transfer Act, and the Vermont Consumer Protection Act. The lenders have moved to dismiss the case on tribal sovereign immunity grounds (Ibid). The State of Vermont filed an amicus brief supporting the women.

Some believe that, as the facts come out and the limited nature of the tribes’ involvement in the payday lending operations is discovered, the payday lenders’ claims of sovereign immunity will be rejected. Others believe that, if that does not happen, the judge-made doctrine of tribal sovereign immunity may be severely limited. Much remains to be seen, but the Pew Charitable Trusts’ Nick Bourne, an expert on payday lending, says, “The tribal lending model seems to be failing because, on the one hand, it’s not providing enough protection for consumers and, on the other hand, courts are increasingly saying that it is not sufficient for lenders to only get a license in association with a Native American tribe.” (Walsh, supra.)

• Avoiding Jurisdiction

A fourth way some Internet payday lenders are trying to obtain immunity is by avoiding regulation and jurisdiction entirely. Internet payday lending is the fastest-growing part of the industry and, as noted above, is the subject of far more consumer complaints than storefront lending. Instead of being paid cash, internet lenders are given direct access to customers’ bank accounts, which makes many abuses possible. Many companies on the internet do not register under applicable state law, may be hard to find and sue, and, if served, may not respond or may contest the state’s jurisdiction over them.

Courts tend to reject these jurisdictional challenges when they are presented. (CFA, “States Have Jurisdiction Over Online Payday Lenders” (May 2010).) But the practical difficulties of presenting them and collecting on any judgments are real. See, e.g., Hunter Stuart, “Payday Lenders are Using the Internet to Evade State Law,” Huffington Post (Jan. 12, 2015). The problems are big enough that California’s Department of Business Oversight has issued multiple consumer alerts warning people to avoid doing business with internet lenders. See www.dbo.ca.gov/ENF/Alerts/payday.asp.

• California Law and Other Payday Lending Laws

Payday lending in California is governed by the California Deferred Deposit Transaction Law (CDDTL), 10 CA Fin. Code section 2300 (2013). The regulations under the CDDTL are contained in Chapter 3, Title 10 of the California Code of Regulations, commencing with Section 2020. (10 CCR section 2020, et seq.)

Among other things, the CDDTL provides:

• Consumers’ checks cannot exceed $300 and the lender cannot charge a fee higher than 15 percent. (Note: this works out to over 400 percent annually.)
• The term of the loan cannot exceed 31 days.
• Payday lenders need to be licensed by the state.
• Lenders cannot:
• Accept collateral on a loan,
• Require borrowers to purchase another product, such as insurance, as a condition of providing a loan,
• Take blank checks,
• Provide a loan to a borrower to whom they already have an outstanding payday loan, or
• Commit any unlawful, unfair or deceptive act, or make any misleading statements.

(www.dbo.ca.gov/Licensees/Payday_lenders/what_consumers_need_to_know.asp

As the last bullet above makes clear, payday lenders can be sued under California law both for violating any provisions of the CDDTL and for otherwise cheating or misleading consumers. Thus, the full panoply of consumer protection claims is available for use against payday lenders. Note that there are other, more demanding protections under the CDDTL regulations (for example, the agreement must be in the same language principally used in oral discussions or negotiations) that could form the basis for a suit under California’s consumer protection laws.

In addition, federal law specifically limits payday loans to military service members and their families. Among other things, it caps annual percentage rates at 36 percent, precludes rolling over loans, and prohibits mandatory arbitration. (www.consumerfinance.gov/newsroom/cfpb- lays-out-guidelines-for-protecting-servicemembers-in-the-payday-lending-market/.) And, depending on the payday lenders’ conduct, other federal statutes, like the Truth in Lending Act, 15 U.S.C. section 1601 et seq., may provide separate causes of action, too. For a summary of and links to details on other state payday lending laws, see www.pewtrusts.org/en/multimedia/data-visualizations/2014/state-payday-loan-regulations-and-usage-rates.

Potential new federal regulations

Potential new federal regulations could change – and tighten – the law applicable to payday lenders nationwide. The CFPB is considering proposed rules aimed at regulating short-term credit products, including payday loans. Under the proposals, payday lenders would either have to take specific steps to prevent debt traps before making loans or act to protect customers after making loans.

For example, before extending a loan, a payday lender would be required to evaluate a customer’s ability to repay the loan, accounting for major financial obligations and living expenses. Only after deciding that a customer has the ability to repay a loan – including interest, principal, and any fees – could the loan be offered. Or, lenders would have to limit the number of loans that a consumer could take out in a row, among other things. Consumer advocates have urged the CFPB to require payday lenders to protect consumers both be-fore and after loans are made. An abridged summary of the potential CFPB proposal is attached to this paper as Appendix I. For the details, see http://www.consumerfinance.gov/newsroom/cfpb-considers-proposal-to-end-payday-debt-traps.

Conclusion

Payday lending is an area in which profit-seeking corporations are trapping already-struggling people in ongoing financial sinkholes. CAALA members interested in advancing and protecting consumers’ rights should take a hard look at challenging abusive practices by payday lenders.

For additional reading:

The Consumer Financial Protection Bureau considers proposal to end payday debt traps