The United States Court of Appeals for the Third Circuit recently ruled that the application of Pennsylvania usury laws to auto title loans issued to Pennsylvania residents who travel outside of Pennsylvania to obtain such loans do not violate the Commerce Clause of the United States Constitution. The decision could have significant implications for all consumer credit providers whose operations involve cross-border lending.
In TitleMax of Delaware, Inc. c. Weissmann, the Pennsylvania Department of Banking (DOB) has issued a subpoena to TitleMax requesting documents regarding TitleMax’s interactions with Pennsylvania residents, including loan agreements between TitleMax and Pennsylvania residents. TitleMax provides auto title loans from physical locations outside of Pennsylvania. The entire lending process – from application to execution of a loan agreement to disbursement of funds – takes place in these locations, with the borrower receiving the loan proceeds at a physical location in the form of a check drawn on a bank outside of Pennsylvania. TitleMax has no offices, employees, agents or physical locations in Pennsylvania and is not licensed in Pennsylvania. He claimed that he never used employees or agents to solicit business in Pennsylvania, and while his advertisements may reach Pennsylvania residents, he did not run television commercials in Pennsylvania.
Under the loan agreement, a borrower grants TitleMax a security interest in the vehicle that TitleMax files with the appropriate authority in the borrower’s state, such as the Pennsylvania Department of Transportation (PennDOT). TitleMax also conducts various activities in the borrower’s state (which the Third Circuit refers to as “service activities”), such as collecting payments, sending phone calls or text messages, and repossessing vehicles. Borrowers can make loan repayments using a variety of methods (e.g., mail, call TitleMax to use a debit card, use a local money transmitter to send funds to a TitleMax location) that allow them to remain physically present in their country of origin.
TitleMax charges interest rates that are significantly higher than the rates allowed by the Pennsylvania Consumer Discount Company Act or the state’s Loan Interest and Protection Act. He stopped making loans to Pennsylvania residents after receiving the DOB subpoena and filed a lawsuit in federal district court seeking an injunction for, among other things, violations of the commerce clause. The DOB separately filed a motion to enforce the subpoena in Pennsylvania state court. The district court, after finding that the DOB’s motion did not require it to refrain from hearing the case under the Younger forbearance doctrine, held that the effect of the subpoena was to enforce Pennsylvania usury laws extraterritorially in violation of the Commerce Clause.
The Third Circuit reversed and ordered the District Court to enter judgment in favor of the DOB. After agreeing with the district court that Younger forbearance was not a bar on the merits, the Third Circuit stated the law applicable to a Commerce Clause analysis as follows:
A state law that directly controls commerce entirely outside its borders violates the dormant Commerce Clause, whether or not the state legislature intended the law to do so. If the state law does not have such extraterritorial reach or discriminate against foreigners, it will stand unless the burden on interstate commerce is “clearly excessive in relation to the effects putative premises”. (quotes omitted.)
In the first step of its analysis, the Third Circuit concluded that the application of Pennsylvania usury laws to TitleMax did not violate the principle of extraterritoriality because TitleMax was carrying out service activities in Pennsylvania and had obtained security interests. on properties located in Pennsylvania. The Third Circuit said:
TitleMax’s transaction with Pennsylvanians involves both loans and collections, and these activities do not occur “entirely outside” Pennsylvania. TitleMax transactions involve more than just transferring money to a physical store located across the Pennsylvania border. On the contrary, the loan creates a creditor-debtor relationship which imposes obligations on both the borrower and the lender until the debt is paid in full. For example, Pennsylvanians with TitleMax loans made payments to TitleMax while physically present in the state. In addition, TitleMax’s loan agreements grant TitleMax “a security interest in the motor vehicle”, which, in the case of a Pennsylvania borrower, is an automobile registered in Pennsylvania. TitleMax registers these liens with PennDOT and can repossess the vehicle if the consumer defaults on their loan. Thus, by making loans to Pennsylvanians, TitleMax is taking an interest in property located and operated in Pennsylvania. (quotes omitted.)
Although the Third Circuit’s finding of extraterritoriality appears to have been based on TitleMax’s “service activities” and security interests, the Court suggested in a footnote that the extraterritoriality principle would not have may not have been infringed even if TitleMax had not engaged in such activities or taken any security interests. . The Third Circuit said:
[E]Even if TitleMax transactions were understood to be limited to the “origin” of the loan, our precedent makes it clear that contracts between a Pennsylvanian and a foreigner do not occur “entirely outside” Pennsylvania… As part of the “traditional” approach [to the territorial scope of contracts], a contract is “made” in the state where the offer is accepted. According to the “modern” approach, contracts between citizens of different states “involve the regulatory interests of both states”. Here, TitleMax extended credit to Pennsylvanians, and according to the modern view, it doesn’t matter that the consumers were physically outside of Pennsylvania when the transaction was initiated.
In the second step of its analysis, the Third Circuit considered whether the burdens of Pennsylvania’s usury laws applied to interstate commerce significantly outweighed the local benefits. The Third Circuit found that (1) the application of Pennsylvania usury laws to transactions with Pennsylvanians did not place TitleMax in a different position from that of a state lender, and (2) the fact that TitleMax could be subject to different usury limits depending on the borrower’s state of residence was not a grossly excessive burden on interstate commerce because “a charge on a lender is not a charge on interstate commerce and “a lack of uniformity in state interest rates is not an undue burden.” As for local benefits, the court found that they weigh in favor of applying Pennsylvania law to TitleMax because they protect state residents from usurious loan rates.
In finding that there was no violation of the Commerce Clause, the Third Circuit expressly declined to follow the Seventh Circuit’s decision in Midwest Title Loans, Inc. v. Mills, which he called “unconvincing”. In Midwestern title, which dealt with very similar facts, the Seventh Circuit found that the application of Indiana law to auto title loans made in Illinois violated the Commerce Clause. (The Third Circuit said in a footnote that Midwestern title relied on the decision of the Supreme Court of the United States in Quill Corp. vs. North Dakota, which is no longer a good law. However, in explaining in his memoir why the Seventh Circuit should follow Midwestern titleTitleMax argued that Midwestern title is not based on Penne and is instead based on current Supreme Court precedent which, applying the doctrine of extraterritoriality, focuses on where the activity a state seeks to regulate is physically located to determine whether such regulation is constitutional.)
The Third Circuit’s decision thus creates a circuit split that could result in Supreme Court review if requested by TitleMax. More importantly, the decision also creates a risk for consumer credit providers with customers residing outside the Seventh Circuit, particularly those with customers residing in the Third Circuit, that credit agreements entered into exclusively in locations physicals could nevertheless be subject to the challenges of attrition by regulators and state attorneys general where they do not have a location but are a source of customers. It is also likely to affect choice of law analysis in usury and other civil litigation brought by borrowers against lenders located in other states where the interest rates in question are legal.