By: David L. Beam, Christopher Shelton*
*Mr. Shelton is a law clerk and not admitted to the practice of law.
The Internet has been with us for about two decades, and financial service companies have been offering products over the Internet for nearly as long. One would have thought that there would be final resolution by now on the question of whether, and under what circumstances, a state may regulate an online lender with no physical presence in the state. However, this issue continues to be a thorny one.
A recent decision by the United States District Court for the Southern District of New York touches on this issue. In Otoe-Missouria Tribe of Indians v. New York State Department of Financial Services, 2013 U.S. Dist. LEXIS 144656, 2013 WL 5460185 (S.D.N.Y. Sep. 30, 2013), the State of New York successfully argued that it can regulate online loans made by Native American tribes to New York residents. The case primarily involved the question of whether a state could regulate an enterprise owned by a Native American tribe located in another state. But the decision potentially has implications for other situations where a company offers financial services over the Internet. Moreover, it is part of a wider campaign by New York authorities to target online lenders for alleged usury.
Overview of the Decision
On August 5, 2013, New York Superintendent of Financial Services Benjamin Lawsky wrote letters to 35 online payday lenders, directing them to cease and desist from offering usurious loans in New York and threatening “appropriate enforcement action” if they failed to comply. Additionally, Superintendent Lawsky wrote letters to the National Automated Clearing House Association and over a hundred third-party banks, requesting that they help to “choke off ACH access to the 35 illegal lenders . . . .”
In the wake of Lawsky’s letters, three online payday lenders discovered that financial institutions were refusing to process some or all of their payments. These three lenders were owned by Native American tribes with tribal reservations in Oklahoma and Michigan. Facing a “potentially ruinous threat to the Tribes’ financial viability,” the lenders and tribal governments filed a motion for a preliminary injunction against the Department of Financial Services, represented by the New York Attorney General’s Office.
After addressing the plaintiffs’ standing, District Judge Richard J. Sullivan framed the merits question as “whether Tribal lending services that are projected over the Internet into New York may be regulated by the State” (emphasis added). This framing was decisive to the outcome. The court rejected the tribes’ alternative framing that the consumer “travels to Tribal land via the Internet,” which could have meant that New York violated the Indian Commerce Clause by regulating activity on tribal land. According to the court:
“The State’s action is directed at activity that takes place entirely off tribal land, involving New York residents who never leave New York State. These consumers are not on a reservation when they apply for a loan, agree to the loan, spend loan proceeds, or repay those proceeds with interest.”
The district court cited two cases, both from 2008, in support of its view that the locus of the loans was New York. First, in Colorado v. Cash Advance & Preferred Cash Loans, 205 P.3d 389, 400-01 (Colo. App. 2008), a Colorado intermediate court of appeals held that the locus of a tribe’s online lending operation was off-reservation. Second, in Quik Payday, Inc. v. Stork, 549 F.3d 1302, 1304 (10th Cir. 2008), the Tenth Circuit held that although a Utah lender did not have any physical presence in Kansas, Kansas could regulate the activity because the Utah lender was making loan agreements with Kansas residents located in Kansas who had Kansas bank accounts. In the Tenth Circuit case, the Utah lender was not affiliated with a Native American tribe.
The district court’s reliance on the Tenth Circuit case is potentially worrying for all out-of-state online lenders. The district court stated that although the Tenth Circuit had been applying the Interstate Commerce Clause to an ordinary out-of-state online lender, not applying the Indian Commerce Clause to a tribal lender, “the Tenth Circuit’s analysis as to the locus of the regulated activity is compelling.”
Thus, the district court opinion could be read to indicate that a state can generally regulate online loans made to its residents, without violating the Interstate or Indian Commerce Clauses. According to this view, a state can regulate an online lender even if the online lender has no physical presence in the state.
It is unclear whether the plaintiffs will appeal the district court decision to the United States Court of Appeals for the Second Circuit.
Wider Implications of the Decision
In addition to the Otoe-Missouria Tribe case, two enforcement actions by New York Attorney General Eric Schneiderman against South Dakota- and California-based online lenders, accusing them of usury, have been pending since August 2013. Also, on the same day as the district court’s decision, Schneiderman announced a settlement with five New York-based collectors of allegedly usurious loans.
Otoe-Missouria Tribe could be the first of many judicial clashes, as Superintendent Lawsky and Attorney General Schneiderman target online lenders regardless of location for alleged violations of New York usury law.