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[havastat]

When Prosper first started, it was subject to state usury laws. Lending Club figured out a business model that would let it avoid these laws. It would have a national bank, which has a federal exemption from these laws, originate all the loans, then it would buy them from it. Prosper followed suit.  That's why Webbank has originated all loans on both platforms. The idea is that once a national bank originates the loan, a subsequent purchaser is entitled to collect the same interest rate the bank could have.

A few months ago, a decision of the United States Court of Appeals for the 2nd Circuit, which declared the whole arrangement illegal. It said that only national banks are exempt from usury laws. If a national bank sells a loan to a non-national-bank entity, the national bank's exemption doesn't come along with it. The buyer can't collect any more interest than state usury law allows. The limit is 12.5% in New York.

The case is being appealed to the Supreme Court. If the Supreme Court doesn't take the case, the rule will be limited to mostly New York unless other lower courts agree with it in future cases. If it takes the case, anything could happen. It could overturn the 2nd Circuit and restore business as usual. Or it could uphold it, in which case P2P lending is going to have to find a new business model.

Perhaps, instead of Webbank selling the loans to Prosper and Lending Club, WebBank could hold them in its own name, issuing notes to Prosper and Lending Club payable from the proceeds of the loans similar to the ones Prosper and LendingClub issue to investors. It could then contract with Prosper and LendingClub to collect from borrowers on its behalf. Such a procedure might be sufficient to keep everything within the 2nd Circuit rule.

Prosper and Lending Club might want to consider such a change in structure, to avoid the risk that would be incurred if the 2nd Circuit's decision were upheld.

[havastat]

The case is Madden v. Midland Funding.

The opinion of the 2nd Circuit Court of Appeals is here:

http://law.justia.com/cases/federal/appellate-courts/ca2/14-2131/14-2131-2015-05-22.html

[havastat]

Lobby.

[havastat]

Correction: WebBank, the loan originator of choice for both Prosper and Lending Club, is not a federally chartered bank. It is a Utah state chartered bank. However, another provision of FederaL law makes FDIC insured state banks subject only to the usury laws of their home state and not the borrower's state. WebBank is FDIC insured. And Utah has no interest cap on consumer loans.

[havastat]

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[faithful_steward2]

I don't think this is a big problem. Prosper currently receives the notes from webbank after origination. If the court rules the local laws would apply when transferred, prosper would just tell webbank to continue owning the notes after origination but that prosper would be the sole investor in the originated notes. Nothing else would need to change. From the Joe Lender perspective, he doesn't own the notes currently when he "lends" money on prosper so it wouldn't affect him much.

[havastat]

I realize there's some precedent for changing the legal structure midstream. When Prosper was near bankruptcy a couple of years ago, it  created Prosper Funding as a way of separating ownership of the notes from the lawsuits and possible bankruptcy claims against it. But there may be problems with it. I gather LendingClub might prefer to defend the point and hope it retains the right to hold the loans evolved in its own right. Perhaps it can wait until the legal issues are settled, and rearrange things if the Supreme Court finds it is subject to state usury laws.

[ira01]

Perhaps it can wait until the legal issues are settled, and rearrange things if the Supreme Court finds it is subject to state usury laws.

The Supreme Court hears VERY few cases -- it agrees to hear about 1% of the cases in which a litigant requests it to after losing in the Courts of Appeal.  And usually the SCOTUS would hear a case like this after there is a split in the lower courts, which there isn't here.  So while it's possible, it doesn't seem especially likely the SCOTUS will agree to hear it.