Maryland Legal Alert for Financial Services
Maryland Legal Alert July 2016
In this issue:
• UPDATES ON CONSUMER CREDIT – A CONSTANTLY EVOLVING LEGAL LANDSCAPE
• CFPB PROPOSES RULES TO ELIMINATE SOME ANNUAL PRIVACY NOTICES
• NOTICE CONCERNING TRADE SECRETS
• LENDER/BLOCKING MEMBER PROVISION HELD TO VIOLATE PUBLIC POLICY
• FRAUDULENT TRANSFER MAY BE GROUNDS FOR OBJECTION TO DISCHARGE
UPDATES ON CONSUMER CREDIT – A CONSTANTLY EVOLVING LEGAL LANDSCAPE
On June 23, 2016, the Court of Appeals of Maryland issued its decision in CashCall, Inc. v. Maryland Comm'r of Fin. Regulation. The Court upheld the decision of the Court of Special Appeals of Maryland, which we reported in our November 2015 Maryland Legal Alert. The decision broadens the application of Maryland's Credit Services Business Act (MCSBA), clarifying the Court's prior holding in Gomez v. Jackson Hewitt, Inc. by limiting its discussion of a "direct payment" requirement to the circumstances of that case. As a result, under the MCSBA, a person or entity is no longer required to receive payment of money or other valuable consideration directly from a consumer in order to come within the definition of a "credit services business" – compensation can come from any source. This decision is a departure from what many considered established case law in Maryland concerning the application of the MCSBA and its impact should be carefully evaluated by any business involved with the extension of consumer credit in Maryland by a third party. In another matter of interest to consumer lenders in Maryland, the U.S. Supreme Court denied certiorari to review the decision of the U.S. Court of Appeals for the Second Circuit in Madden v. Midland Funding, LLC. The Madden decision has sowed uncertainty and confusion among debt buying and bank-partnership model lending businesses, because of its holding that the purchaser of debt from a national bank (charged-off debt in the case of Madden) is not a beneficiary of the preemptive interest rate authority of a national bank under Section 85 of the National Bank Act. As a result, the purchaser of such debt, unlike a national bank, could be subject to the usury caps under state law. Denial of certiorari is an unfortunate outcome, as many industry participants were hoping that the U.S. Supreme Court would provide clarification on this issue. However, as it stands, the viability of interest rate preemption in these circumstances continues to be clouded by the Second Circuit decision. If you have any questions about how either of these decisions may impact your business, please contact John Morton.
CFPB PROPOSES RULES TO ELIMINATE SOME ANNUAL PRIVACY NOTICES
On July 1, 2016, the CFPB issued a proposed regulation to implement the law passed by Congress last December 2015, found at 15 U.S.C. §6803(f), which eliminates the requirement that a financial institution provide an annual privacy notice under certain circumstances. The CFPB's proposal, to be a new subsection (e) in 12 C.F.R. §1016.5, will allow a financial institution to skip the requirement to provide an annual privacy notice if (i) the financial institution only shares nonpublic personal information as permitted by express statutory or regulatory exceptions to disclosures and (ii) there have been no changes in that financial institution's policies and practices regarding disclosure of nonpublic personal information since the most recent privacy notice was provided. The CFPB proposal also clarifies how and when the financial institution must provide privacy notices if policies and practices regarding disclosure of nonpublic personal information change. As of the date this Maryland Legal Alert is being published, the proposed regulations have not yet been printed in the Federal Register so it is unclear when the 30-day comment period will end. However, it is likely the comment period will end sometime in August 2016. We anticipate the CFPB wants this regulation to become final before many financial institutions need to prepare for the next round of annual privacy notices (which often is at the beginning of a new calendar year). Please contact Margie Corwin, Christopher Rahl, or John Morton if you would like to discuss this subject further.
NOTICE CONCERNING TRADE SECRETS
A recent change in federal law may impact agreements with employees, contractors, and consultants. The Federal Defend Trade Secrets Act (Act), effective May 11, 2016, is intended to bolster protections for those who develop and own trade secrets. A portion of the Act focuses on "whistleblowers" and provides protections for employees, contractors, and consultants who have access to and disclose trade secrets under certain circumstances. The Act provides that an individual will not be held criminally or civilly liable for disclosing trade secrets of an employer/contracting party if the disclosure is solely for the purpose of reporting/investigating a suspected violation of law; or is made in a court filing (if made under Seal). The Act also allows disclosure of trade secrets to an attorney and/or in a court proceeding in connection with a retaliation lawsuit (if an employee brings a lawsuit claiming retaliation for reporting a suspected violation of law and so long as the filing is made under Seal). The Act provides an incentive for employers/contracting parties to provide notice of these rights in connection with the confidentiality terms of their employee, contractor, and consultant agreements. If a notice is given concerning rights under the Act, the employer/contracting party preserves its right to seek "exemplary damages" and attorneys' fees under the Act. Without including this kind of notice, an employer/contracting party will not be able to obtain these enhanced damages, and will be left with actual damages under federal law, damages that may be pursued under state law, and (assuming the underlying agreement contains an attorneys' fee provision) pursing attorneys' fees based on the terms of the agreement. The Act applies to new agreements and those that are updated after May 11, 2016 (not to existing agreements). Employers should review their employment policy documents and form of agreement used for employees, contractors, and consultants in light of the provisions of the Act. Employers should consider providing a notice of rights under the Act in order to preserve the most damage/cost-recovery options possible. Please contact Christopher Rahl for more information concerning this topic.
LENDER/BLOCKING MEMBER PROVISION HELD TO VIOLATE PUBLIC POLICY
Two recent bankruptcy court decisions are of interest to lenders making loans to commercial borrowers. The Delaware Bankruptcy Court recently issued a decision holding that a provision in an operating agreement of a Delaware limited liability company (LLC) requiring the consent of all members to a bankruptcy filing was void as contrary to federal public policy. The case involved a lender's forbearance agreement with an LLC borrower under which the LLC amended its operating agreement to admit the lender as a limited member and required the unanimous consent of all members (including the lender) to any bankruptcy filing. The LLC subsequently filed bankruptcy without the lender's consent. The lender moved to dismiss the bankruptcy filing on the basis that the bankruptcy was not authorized by the LLC's operating agreement. The Delaware Bankruptcy Court held in favor of the LLC, finding that requiring the consent of all members of the LLC to a bankruptcy filing (including the lender) equated to an impermissible waiver of the right to file for bankruptcy protection. The Bankruptcy Court for the Northern District of Illinois also issued a recent decision reaching the same result; holding that a debtor's bankruptcy filing – notwithstanding the lender's failure to consent in its capacity as a "special member" of the debtor – was contrary to state and federal public policy. While these decisions dealt with provisions added to operating agreements at a lender's insistence in connection with distressed loan workouts, the reasoning of these cases could be extended to the terms of a new loan made to a single purpose entity (SPE). It is common for lenders who lend to a SPE to include in their loan terms a requirement that the SPE add an independent director or member whose vote is necessary for a bankruptcy filing by the SPE borrower. We believe that as long as the independent director or member is not relieved of the fiduciary duty to act in the best interest of the borrower, and has no duty to the lender, such provisions should not be held to run afoul of the public policy discussed by the Delaware and Illinois decisions. For questions concerning this topic, please contact Larry Coppel.
FRAUDULENT TRANSFER MAY BE GROUNDS FOR OBJECTION TO DISCHARGE
In a recent decision, the U.S. Supreme Court held that the term "actual fraud" in a Chapter 7 bankruptcy proceeding objecting to the discharge of a creditor's claim includes a fraudulent transfer. The facts of the case involved the sale of goods where the purchaser owed the seller nearly $164,000. One of the shareholders of the purchaser drained the assets of the purchaser by transferring the assets to other entities in which the shareholder held an interest. The seller of the goods sued the shareholder claiming the inter-company transfers were "actual fraud" for purposes of a Texas law that allows creditors to hold shareholders responsible for corporate debt. After the seller obtained a judgment against the shareholder, the shareholder filed a Chapter 7 bankruptcy petition. The seller objected to the discharge of the debt owed by the shareholder to the seller based on language in 11 U.S.C. §523(a)(2)(A) that excepts from a debtor's discharge any debt "for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by – false pretenses, a false representation, or actual fraud …." Both the District Court and the Fifth Circuit Court of Appeals ruled the debt was not "obtained by … actual fraud" within the meaning of the statute, and the shareholder was granted a discharge. The Supreme Court reversed, holding that "actual fraud" encompassed fraudulent transfer schemes designed to hinder the collection of a debt, even when those schemes do not involve a false representation. For more information concerning this topic, please contact Susan Klein.