California state court rejects DFPI’s motion for preliminary injunction in true lender challenge

True lender
Opportunity Financial LLC v. Clothilde Hewlett
Date: Oct. 30, 2023

Issue:  Whether Opportunity Financial (OppFi) engaged in a “rent-a-bank” partnership scheme with FinWise Bank to evade California interest rate caps.

Case Summary: A California state court denied the California Department of Financial Protection and Innovation (DFPI)’s motion for a preliminary injunction to stop fintech OppFi from facilitating loans to California borrowers from its partner FinWise Bank at interest rates above the interest rate cap.

In 2019, California passed California’s Fair Access to Credit Act (also known as AB 539), which limits the interest rate on loans of $2,500 to $10,000 by lenders licensed under the California Financing Law (CFL) to 36% plus the federal funds rate.

On March 7, 2022, OppFi sued in California state court to block the DFPI from applying California usury law to loans made through OppFi’s partnership with FinWise Bank, a state-chartered, FDIC-insured bank located in Utah. According to the complaint, the state regulator threatened enforcement because OppFi—and not FinWise Bank—is the “true lender” for assessing the validity of the loans’ interest rates. If OppFi is the true lender, the interest rates would exceed California’s interest rate caps under California’s Fair Access to Credit Act. OppFi sought a declaratory statement declaring its activities were lawful under California law, and an injunction restraining the DFPI from enforcing AB 539 against OppFi.

The DFPI filed a cross-complaint seeking to enjoin OppFi from collecting on the program loans and to declare the loans void, alleging OppFi was the true lender based on the “substance of the transaction” and the “totality of the circumstances.” The DFPI contended the primary factor was whether the nonbank had the predominant economic interest in the transaction. DFPI alleged OppFi holds the predominant economic interest in the loans because OppFi purchases 95% to 98% of the loans’ receivables; on average, OppFi purchases the receivables from FinWise Bank within three days after the bank funds the loan; OppFi insulates FinWise Bank from credit risk by creating a guaranteed secondary market for the loans; and OppFi pays FinWise Bank a guaranteed monthly fee based on a percentage of the principal amount of loans originated by the bank.

Afterward, the DFPI filed a motion for a preliminary injunction and sought to immediately prohibit OppFi from making loans exceeding California’s maximum rate of up to 36% to California borrowers. In opposition, OppFi argued federal and California law prohibit application of the true lender doctrine; federal law preempts that application; California does not recognize application of the true lender doctrine; and the DFPI cannot enforce application of the true lender doctrine without first complying with the Administrative Procedure Act.

Judge Timothy Dillon denied the DFPI’s motion for a preliminary injunction. Judge Dillon examined whether the form of the transaction “was a mere sham and subterfuge to cover up a usurious transaction.” Judge Dillon focused on Janisse v. Winston Inv. Co. and Anderson v. Lee, the cases the DFPI relied on for its claim OppFi was the true lender. In Janisse, the lender of record served the role of “dummy” in an arrangement designed to conceal a usurious transaction by a later “assignee” of the loan. The Court of Appeal found the assignee to be the true lender, with the named lender serving as a straw lender to conceal usury. In Anderson, the court of appeal found the loan and its sale were a sham designed to hide the real lender. Unlike Janisse and Anderson, Judge Dillon determined “there was not sufficient evidence that FinWise was merely a dummy.”

Additionally, Judge Dillon highlighted 10-K filings and witness testimony showing FinWise uses its own funds to originate the loans from accounts it controls under the bank’s agreement with OppFi. Judge Dillon also emphasized FinWise retains title and ownership of the OppLoans throughout the life of the loan. FinWise sells only loan receivables, which are the right to payments on the loans to an OppFi affiliate. The affiliate then sells the receivables to outside investors within days of origination. Judge Dillon highlighted FinWise retains 5% interest in the loan receivables, and FinWise collects a percentage fee on each OppLoan. Judge Dillion emphasized the DFPI had “not sufficiently shown that the OppFi-FinWise partnership was a mere sham and subterfuge to cover up a usurious transaction.”

Judge Dillon also determined DFPI did not sufficiently show the OppLoans were usurious at inception. DFPI argued OppFi “underwrites” the OppLoans, and OppFi’s involvement in the underwriting process is enough to render the OppLoans usurious at inception. But in Judge Dillion’s view, “the fact that 10-K filings state OppFi uses its technology to provide underwriting services to FinWise is insufficient for the court to conclude such service makes the loan at issue usurious at inception.”

Judge Dillon also concluded that the DFPI’s motion did not meet the standard necessary for granting a preliminary injunction. According to Judge Dillon, the DFPI failed to show a reasonable probability of prevailing on the merits of its first cause of action for violating the CFL. The court thus did not find a rebuttable presumption that potential harm to the public outweighed potential harm to OppFi. Additionally, Judge Dillon explained the court did not need to determine whether OppFi has shown it would have suffered grave or irreparable harm from the issuance of preliminary injunction.

Bottom Line: A case management conference is scheduled for Dec. 13, 2023.

Documents: Opinion