Nixon Gets Landmark State Court Victory

Supreme Court says Legislature tried to bypass state usury laws

Fayetteville lawyer David Nixon and The Arkansas Supreme Court threw a small grenade at the payday lending industry March 22, leaving several hundred businesses confused and concerned.

At least one company has reacted by giving away loans for free while pursuing a solution that federal bank regulators have strongly discouraged. Others are continuing business as usual while waiting for a final ruling.

The Supreme Court ruled without dissent that the General Assembly unlawfully tried to circumvent the state’s constitutional ban on usury when it passed a 1999 law saying the fees check-cashing businesses charge for small, short-term loans cannot be considered interest. If calculated as interest, the fees amount to annual percentage rates in the hundreds and thousands.

“These are the carpet baggers of the 21st century,” Nixon said of the payday lending industry.

The ruling reversed a decision by Benton County Circuit Judge Tom J. Keith. The plaintiff, Crystal Luebbers, had sued Money Store Inc., alleging that she was charged usurious interest on a loan from the company’s Lowell location. Keith, citing the Check Cashers Act, granted summary judgment to the lender.

Luebbers, represented by the Nixon Law Firm, successfully appealed.

“We agree with [Luebbers’] contention and hold that section 23-52-104(b) [of the Check Cashers Act of 1999] is an invalid attempt to evade the usury provisions of the Arkansas Constitution and, further, that such an attempt violates the constitutional mandate requiring separation of powers set forth [in the constitution],” Associate Justice Annabelle Clinton Imber wrote for the Arkansas Supreme Court.

While it ruled that a key part of the Check Cashers Act was unconstitutional, the court has not specifically ruled that the payday-advance fees constitute usurious interest. That question has been sent back to Keith, who recently declined to comment on a pending case.

So while Nixon’s landmark victory crippled payday lenders, it didn’t kill them. The business, except for its ability to charge interest, is still on the books. Most of the industry, which has blossomed in the state since passage of the act, is continuing the lucrative payday loans while the case is resolved, said Gene Heinrich, executive director of the Arkansas Check Cashers Association.

“The Supreme Court did not say that these transactions were loans,” Heinrich said. “The lower court may rule that they are not loans. It does nothing to affect the day-to-day operations of a check casher in the state.”

But Nixon is ready for round two. He’s already suing the Money Store Inc. et al for violating Arkansas’ usury laws and the Federal Racketeering and Corruption Organization act, or RICO.

“These cases are going to multiply,” said Nixon, a CPA and lawyer who specializes in bankruptcy and financial-related litigation.

“We have three more pending in Washington County Court and two in federal court. They’re collecting interest at five times the rate allowed by low. The industry knows payday loans are a burden, addictive and that they take advantage of the poor and the weak.”

The Nixon Law Firm, a commercial practice with three attorneys, has operated in Northwest Arkansas since 1986. Nixon said he got involved with the check cashers issue because he noticed a high number of his bankruptcy clients had received payday loans.

Originally, he said, the state voted in usury laws in 1874 as a response to unscrupulous salesmen who preyed on the destitute South during reconstruction. Nixon said although many customers of payday leders are “highly educated people who ought to know better,” the usury law should still protect them today.

“One lady paid $11,000 one year in check cashing fees,” Nixon said. “How is that a service? Maybe the customers do voluntarily sign for payday loans, but many are in a position where they don’t have a choice and this sucks them dry.

“Charging them 400 percent to 1000 percent interest is a burden they can’t afford to bear.”

Free Money

The recent ruling has dramatically affected the operations of at least one check casher. Check ‘n Go of Arkansas, a company based in Ohio with six locations in Arkansas, has notified state regulators that it will make payday loans for free for the time being.

“We’re basically acting as a charity,” said Stephen Schaller, Check ‘n Go general counsel. “What we’re doing is charging no interest or finance charge or fee at all and simply providing a service for free.”

The giveaway is temporary, Schaller said, designed to keep the company’s stores open until Check ‘n Go can affiliate with a national bank, County Bank of Rehoboth Beach, Del., and make payday loans under federal banking guidelines. Check ‘n Go signed a contract with the bank Thursday, Schaller said, and should begin charging for the loans again in four to six weeks.

Under federal law, national banks are allowed to make loans anywhere in the U.S. at the interest rate allowed in their home state if they have an affiliate in the location where the loan is executed, regardless of state law. Several check cashers in the state already operate under such arrangements, known as the national banking model, including First American Cash Advance of Arkansas, based in Cleveland, Tenn., and Ace America’s Cash Express, headquartered in Irving, Texas.

Most check cashers, though, are waiting for resolution in the courts, said Heinrich.

“I don’t know of anybody in our association that has signed a contract,” he said. “[But] there’s a lot of people in the association that are looking for options. I think there’s as many options out there as attorneys.”

Heinrich and Schaller predict that a payday lending market populated mainly by check cashers affiliated with national banks would be smaller and more expensive for the consumer, but would still exist.

Smaller operators would be driven out of business by the cost of affiliation, Schaller said, leaving fewer outlets charging even higher fees.

“That is exactly the message that we sound to state legislatures,” Schaller said. “The way to [regulate the industry] is not to legislate it out of existence. Fewer operators drives up prices.”

“The big companies that are going to be doing business under the national banking model are going to have an advantage,” Heinrich said.

Federal Warning

The affiliation of payday lenders with national banks may be the industry’s option of choice, but federal bank regulators are actively discouraging the practice.

Banks were specifically warned about engaging in payday lending through third parties in a Nov. 27, 2000, advisory letter from Julie L. Williams, first senior deputy comptroller and chief counsel of the U.S. Treasury Department’s Office of the Comptroller of Currency.

“Although the OCC encourages banks to respond to customers’ short-term credit needs, payday lending can pose a variety of safety and soundness, compliance, consumer protection, and other risks to banks,” the advisory letter stated. “Payday lenders entering into such arrangements with national banks should not assume that the benefits of a bank charter, particularly with respect to the application of state and local law, would be available to them.

“The OCC will closely review the activities of national banks engaged or proposing to engage in payday lending, through direct examination of the bank, examination of any third party participating in the transaction under an arrangement described above, and where applicable, review of any licensing proposals involving this activity.”

The letter also warned that OCC could assess “special examination fees on banks to cover the OCC’s additional costs of conducting an examination or investigation of third parties.”

The practice exposes banks to higher credit risks, the letter said, since payday advance customers “frequently have limited financial capacity or blemished or insufficient credit histories that limit their access to other forms of credit at a reasonable cost.” Multiple renewals — including the practice of “rollovers,” prohibited in Arkansas — “are not consistent with safe and sound banking principles,” the advisory stated.

In addition, “because payday loans may be underwritten off-site, there is the risk that agents or employees may misrepresent information about the loans or increase credit risk by failing to adhere to established underwriting guidelines.”

Finally, the advisory warns against a “reputation risk” associated with payday lending.

“Due to the high fees and other characteristics associated with some payday lending programs, many believe payday lending to involve abusive lending practices, such as the use of threats of criminal prosecution in loan collection,” the letter stated. “Engaging in these practices could increase the reputation risk for a national bank and cause it to lose community support and business.”

Debt collection of payday advances, strictly regulated in Arkansas under the Check Cashers Act, could present a problem for national banks and their payday lending partners, OCC said, as collections would be regulated by the federal Fair Debt Collection Practices Act.

“Although the bank itself may not be subject to the FDCPA, it nevertheless faces significant reputation risk — and potential legal risk for approving or assisting in an unfair or deceptive trade practice … if the third party violates the FDCPA and engages in deception, harassment, or threats in the collection of the bank’s loans.”

The advisory letter concluded with some recommendations for banks that engage in payday lending through third-party lenders, including adequate controls over loan transactions and compliance with bank standards and compensation.

“A bank should conduct on-site transaction testing and other audits of third party vendors for compliance with consumer protection laws and these risk guidelines,” the letter stated.

Change Unlikely

In February, Williams underscored her comments in an otherwise upbeat speech concerning banking opportunities.

“Unfortunately, in recent examples of [payday lending agreements] we have seen banks associate their name and special status with products that were abusive to consumers and with third-party vendors that did not conduct their operations with the diligence expected of a regulated financial institution,” Williams told a conference on cyberbanking and electronic commerce.

The change in presidential administrations has not and probably won’t change the federal government’s leery attitude regarding payday lending, OCC spokesman Kevin Mukri said recently.

“I wouldn’t expect a change too much. Normally, banking regulations are fairly apolitical,” Mukri said.

Mukri, stressed, though, that the Treasury Department is not entirely opposed to payday lending.

“Payday lending in itself is not a bad thing,” he said. “Payday loans seem to be a demand by the marketplace. We don’t want to put an end to it but to do it correctly.

“If the only reason a payday lender is affiliated with a national bank is to circumvent state law, that’s not what the [federal law] is there for,” he said.