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Post date: May 28 2004

Spitzer Not Preempted In Suit To Stop Illegal Payday Lending Scheme

Attorney General Spitzer today hailed a decision issued by a federal district court rejecting a claim that the state is preempted by federal law from pursuing claims against companies engaged in payday lending schemes.

"The ‘rent-a-bank' scheme of this illegal payday lending operation is a blatant attempt to circumvent state consumer protection laws," Spitzer said. "This decision affirms my office's position that state regulators are empowered to protect their residents from these types of predatory lending scams."

The opinion issued yesterday by the Honorable Lawrence Kahn, United States District Judge for the Northern District of New York rejected the claims of the bank and the two companies engaged in the rent-a-bank scheme that they could not be sued in state court because they had entered into arrangements with an out-of-state bank. The court held that Spitzer could pursue his claims that the Delaware-based bank was simply a ‘front' for two out-of-state companies operating an illegal "payday" loan scam.

Last October, County Bank of Rehoboth Beach, Delaware and the two companies, CRA Services, d/b/a Cashnet, and TC Services Corporation, d/b/a Telecash, removed Spitzer's lawsuit from state court in Albany to federal court. The defendants claimed that the case was preempted by a federal banking law, the Federal Deposit Insurance Act, which permits federally-insured state banks to charge any rate of interest permitted by the bank's home state.

Spitzer challenged the removal by seeking to remand the case back to state court arguing that the preemption doctrine did not apply to his case.

In granting Spitzer's motion for remand, the federal court held that because the State did not allege a usury claim against County Bank, which would have been preempted, but rather alleged that the bank engaged in a fraudulent "rent-a-bank" scheme with the defendants, the case is not preempted under federal law. The Court further held that Spitzer's usury claims against Cashnet and Telecash were not preempted because those companies are not federally insured financial institutions and thus could not seek protection under the Federal Deposit Insurance Act.

Spitzer's lawsuit alleges that County Bank was the payday lender in name only. Both Cashnet and Telecash provided the capital to market, advertise, originate, service and collect the payday loans. According to the complaint, Cashnet and Telecash pay County Bank an annual fee to use County Bank's name and charter to make loans, pay County Bank a percentage of the finance charge received on each loan, and agree to indemnify County Bank for losses and liabilities (other than credit losses) arising out of the loan operation. After the borrower receives the payday loan, Cashnet and Telecash collect additional illegal and usurious fees from borrowers by permitting rollovers of the loans.

Payday loans are one of the fastest growing segments of the fringe banking economy, generating nearly $45 billion in the year 2002. Payday loans are small dollar ($100-500) short-term loans with extremely high interest rates that the borrower promises to repay out of his or her next paycheck or income. The average interest rate for a payday loan on an annualized basis is generally 500 percent, which far exceeds the 16-25 percent that can be charged on a loan or forbearance under New York laws. The annualized interest rate for a payday loan can be even higher if the consumer is unable to payoff the loan on its original due date because the consumer is allowed to extend the repayment time in exchange for an additional interest payment, which often is referred to as a rollover of the loan.

Individuals who believe they have been victimized by a payday loan are encouraged to contact the Attorney General's Office at 1-800-771-7755.

The case is being handled by Mark Fleischer, Assistant Attorney General, Consumer Frauds and Protection Bureau and by Carrie H. Cohen, Assistant Attorney General in Charge, Public Integrity Unit.