The Loan of Last Resort

By: 
Al Jacobs

The headline emblazoned in the April 20, 2017, finance section of the website is certainly striking: “CashCall suing law firm, partner.” For those of you unfamiliar with CashCall, it’s an Orange County, California-based lending firm specializing in, among other things, what are known as payday loans.

Before we delve into the lurid details of the lawsuit, it will be helpful to describe the specifics of a payday loan for whoever may be fortunate enough to possess no knowledge at all of what it is or how it works. In the personal loan business, this is a small, short-term unsecured loan normally scheduled to be repaid at the borrower’s next payday. In the traditional model, on the maturity date the borrower is expected to return to the lender’s office to repay the loan in person.

A typical such loan may be for $200, where repayment 15 days later totals $225. Though this total charge of $25 may seem reasonable enough for a borrower who vitally needs the money for something important, a little calculation reveals the annual interest rate (APR) on this loan to be 304 percent.

The truly insidious aspect of the payday loan is not the rare one-time use by a borrower temporarily short of money for an important purpose, but rather the repeated use by the same persons whose lives are perpetually on the edge of financial insolvency.

According to a study by the Pew Charitable Trusts, most payday borrowers fall into one or more of the five following categories: those with lower education, apartment renters, African Americans, those earning below $40,000 annually and persons divorced or separated. It’s further revealed most borrowers use payday loans to cover ordinary living expenses over the course of months, not unexpected emergencies over the course of weeks. The average borrower is indebted about five months of the year.

As for the practicalities of the payday loan business, in many instances it’s clearly predatory by design. For those loans with a term under 30 days, there are no payments, and the lender is invariably willing to roll the loan over at the end of the period upon payment of another fee. Accordingly, such loans are extremely expensive and borrowers who take payday loans are at an inherent disadvantage.

It’s not hard to understand why these cash-strapped payday customers are left with fewer resources than before the loan. This explains why, in 2016, Google announced it intended to ban all ads for payday loans from its systems, defined as loans requiring repayment within 60 days or having an APR of 36 percent or more.

As you’re now somewhat abreast of what’s going on in the world of the high interest loan, let’s tune in on CashCall, to see how they conduct themselves. A visit to their website shows a benign message: “How can we help you? CashCall Personal Loans.” How nice; you certainly can’t be friendlier.

So why are they filing legal action against a law firm and a former partner? We must go back to August 31, 2016, when U.S. District Judge John F. Walter, in collaboration with the Consumer Financial Protection Bureau (CFPB), ruled loans made by CashCall from 2009 through 2013 violated the laws of 16 states. The crux of the argument centered upon the identity of the actual lender, for they partnered with Western Sky Financial, a company based on the Cheyenne River Sioux reservation in South Dakota.

Inasmuch as federal law provides that Native American tribal lenders are not subject to state usury laws, the loans were placed in Western Sky’s name, despite the fact CashCall actually funded, marketed and serviced them.

Judge Walter’s ruling specified the deal between the two firms “was structured in such a way that CashCall, and not Western Sky, placed its money at risk.” Because the loans lacked governance by tribal law, and were therefore void, “CashCall was the real lender, the loans were illegal and CashCall could not collect on them.” As you might guess, hundreds of millions of dollars in these loans are now officially worthless.

This, then, brings us to the here and now. Why is CashCall, in the aftermath of a ruling against the company for failure to abide by state laws, now filing lawsuits against both attorney Katten Muchin Rosenman and partner Claudia Callaway? It relates to the way the parties appear to have conspired together to orchestrate the payday loan operation.

According to the complaint, filed April 14, 2016, CashCall owner and sole shareholder, J. Paul Reddam claims to have built a successful business making unsecured loans to California consumers with poor credit. But when he attempted to expand nationally, he found himself prevented from doing so because of other states’ stricter usury laws and lender regulations.

In 2006 he hired Callaway, who moved to Katten Muchin in 2009, to help with the expansion. Callaway recommended partnering with a Native American tribe or entity she said would be subject to tribal laws, not state laws, and thereby enjoy the benefit of the doctrine of tribal immunity. She called it the “tribal model.”

Under this model, a lender operating on a reservation might make loans to borrowers in any state over the internet or by phone. Working with a new subsidiary, WS Funding, hundreds of millions dollars worth of loans were made, with APRs in triple digits.

In its lawsuit, CashCall says Katten Muchin and Callaway endorsed the tribal model “even though they understood at the time that, among other things, borrowers did not physically visit the Cheyenne River Sioux Indian Reservation to make the loans, Western Sky was not a tribal entity, CashCall provided Western Sky with funding and acquired all interests in all loans and CashCall bore all of the risks of the loans once it purchased them from Western Sky.”

In March 2013, it appears “Katten Muchin and Callaway abruptly reversed course, and disclaimed their earlier advice to plaintiffs regarding the tribal model and the Western Sky lending program,” and added they never endorsed the Western Sky program, while “falsely claiming she and Katten never knew how Western Sky loans were made and administered.”

It’s clear this lawsuit will drag on for a while, as charges and countercharges are hurled around among the participants. If you’re searching to find the aggrieved party with whom you may side, I’m not certain where to look. Should the entity which employs a devious method of stripping poor innocents of their worldly possessions be entitled to compensation from those persons who devise and participate in the scheme, in the event things don’t go quite as smoothly and profitably as either intended?

I’ll leave you with a final thought: There appear to be some deserving winners here. They are those hapless borrowers whose loans have been declared by Judge Walter to be unenforceable. It isn’t often the truly destitute come out ahead; for once justice actually prevails.

Al Jacobs, a professional investor for nearly a half-century, issues a monthly newsletter in which he shares his financial knowledge and experience. You may view it on http://www.roadwaytoprosperity.com.

al@beachcomber.news

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