Online lenders reach landmark settlement with Colorado

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Authorities in Colorado have reached a settlement with two online lenders and their partner banks, ending years of legal wrangling and offering a way forward for fintechs that have been hesitant to do business in the state.

Under the agreement, which was announced Tuesday, the companies can qualify for a legal safe harbor in Colorado if they comply with a detailed new regime that includes a ban on loans with annual percentage rates in excess of 36%.

The state’s settlement with online lenders Avant and Marlette Funding, as well as WebBank and Cross River Bank, marks a milestone in the legal fight over which company is the so-called true lender in consumer transactions.

“It provides a ton of clarity with respect to this area of the law that has caused a lot of confusion,” said Roxy Bargoz, the general counsel at Chicago-based Avant.

The Colorado attorney general’s office sued the four companies in 2017. The suit argued that Avant and Marlette, which offers personal loans under the Best Egg brand, were charging interest and some fees in excess of those allowed under state law.

Though the loans were made by Utah-based WebBank and New Jersey-based Cross River, which are allowed to export their home states’ interest rate caps, Colorado authorities contended that Avant and Marlette were the true lenders because they held the predominant economic interest.

The settlement offers a potential solution to a problem that has long vexed online lenders — the state-by-state patchwork of interest rate caps. Online lenders often work with banks that have the authority to export their home states’ rules, but some of those partnerships have been challenged in court under the same theory that Colorado used.

Just last week, a federal court in Colorado ruled that a small-business borrower deserved the opportunity to conduct discovery on whether its loan came from a Wisconsin-based bank or the bank’s partner.

Technically, only four companies are bound by the terms of the settlement. But the agreement could have wider implications, both in Colorado and across the country. In the Centennial State, other online lenders could decide to structure their businesses in a way that aligns with the settlement’s requirements for a legal safe harbor.

“This agreement protects Colorado consumers and creates a model for how other lenders can comply with Colorado law and treat consumers fairly,” Colorado Attorney General Phil Weiser said in a press release.

Officials in other states — particularly Democratic-leaning states with relatively strict interest rate rules — may also look to the terms of the Colorado settlement for guidance on how to allow partnerships between banks and fintechs in a way that is designed to prevent consumer harm.

The online lending industry might prefer a federal solution, but it is unclear whether an enduring answer is forthcoming from Washington. While the Office of the Comptroller of the Currency proposed a rule in July that would determine when the bank is the true lender, that approach could prove to be short-lived if Democrats prevail in the upcoming election.

The settlement announced Tuesday establishes detailed rules for qualifying for a legal safe harbor in Colorado.

In addition to the interest rate cap, the partnership between the bank and online lender must meet various oversight standards. For example, regulators must have access to examine and audit the online lender, and the bank must control all terms of credit, including the right to approve and deny loans.

In addition, the settlement offers several options with respect to how the bank may retain a degree of risk in connection with the partnership. Perceptions that the banks involved in online lending partnerships are not shouldering enough risk have fueled suspicions about which company is the true lender.

Under the settlement, the four companies will also pay a total of $1.55 million, including a $500,000 contribution to a program that supports financial education in Colorado schools.

The 2017 lawsuits had significant economic consequences for the U.S. online lending industry. After the suits were filed, Avant and Marlette excluded Colorado loans from new securitizations, and WebBank stopped originating loans in the state.

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Consumer lending Fintech Law and regulation Colorado