Spotlight on the Military Lending Act, Part 1: Did the Final Rule Improve on the Proposal?

On July 22, 2015, the Department of Defense (“Department”) released its final rule amending the regulations that implement the Military Lending Act (“MLA”), which means that a wider range of credit products—including open-end credit—offered or extended to active duty service members and their dependents (“covered borrowers”) will now be subject to the MLA and its “all-in” 36% military annual percentage rate (“MAPR”) cap.

Specifically, the Department expanded the definition of “consumer credit” to be consistent with credit that is subject to the Truth-in-Lending Act (“TILA”)—credit offered or extended to a covered borrower primarily for personal, family, or household purposes, and that is (i) subject to a finance charge or (ii) payable by a written agreement in more than four installments.

In response to the initial proposed rule, financial services industry stakeholders undertook a substantial effort to show how proposed modifications to the MLA regulations were overly broad and, in parts, inconsistent with the Department’s mandate under the MLA. At a high level, industry comment letters fell into five categories:

• The Department was asked to provide creditors with “a substantial time period” to implement the operational changes needed to comply with the regulation.
• The Department was asked to take a more targeted approach to redefining “consumer credit,” either by focusing exclusively on certain predatory loans or by excluding certain products (such as credit cards) entirely or narrowing the requirements for such products. A link to Orrick’s comment letter in this regard can be found here.
• The Department was asked to exempt from the final rule certain institutions (such as all insured
  depository institutions).
• The Department was asked to exempt certain charges, such as application or participation fees, from the MAPR calculation.
• The Department was asked to broaden the safe-harbor methods for determining whether a consumer is a covered borrower.

The final rule largely rejected the requests and instead retains the approach in the proposed rule.

Three features stand out in this regard:

• The final rule tracks the proposed rule regarding how the regulation defines the “consumer credit” products to which it applies.
• The Department did not provide an exemption for insured depository institutions or insured credit unions.
• While credit card issuers were given until October 3, 2017 to come into compliance, the Department gave other creditors until October 3, 2016, which is only 12 months from the October 1, 2015 effective date, to comply with the final rule, as opposed to “at least 18 months,” which some commenters requested.

With that said, the final rule does contain some positive modifications that relieve onerous compliance burdens, including abandonment of the proposed requirement that a “bona fide” fee charged to a credit card account also be “customary.” These modifications are discussed below.

Modifications or requests that the Department denied

First, the Department rejected requests to change the scope of the definition of “consumer credit,” either by targeting only specific types or by excluding entirely certain types. The Department stated that, in its view, a broad definition of “consumer credit” was preferable, in part, because expanding the scope of products subject to MLA compliance would “preserve access to a wide range of products” while protecting covered borrowers. Next, the Department refused to exempt credit card accounts from the “consumer credit” definition because it determined that compliance with the CARD Act could not displace the benefits of the MLA. The Department expressed concern that lenders could exploit such an exemption by transforming high-cost open-end products into credit cards, which do not have a maximum interest rate under the CARD Act.

Second, the final rule does not completely exempt insured depository institutions or insured credit unions. Broadly speaking, the arguments for exemption included that (i) failing to provide exemption would lead to the exclusion of service members from credit products and services, and (ii) a robust regulatory and supervisory framework already exists for such institutions. The Department responded that it was “confident that…[these institutions] could find appropriate methods to provide borrowers credit products that comply with the [MLA] interest-rate limit….” Next, the Department rejected the notion that the robust regulatory and supervisory regime for insured depository institutions justifies an exclusion from the MLA because that regime was not designed to lower the costs of credit for covered borrowers.

Many commenters requested that the Department provide “a substantial period of time for compliance,” such as “at least 18 months,” because of the operational difficulties presented. The Department stated that creditors need only a “reasonable period of time” to modify their operations. Therefore, except for credit card accounts (discussed more fully below), creditors have only 12 months to comply with the requirements in the final rule.

Modifications or requests that the Department granted

In general, credit card issuers were the largest beneficiary of the Department’s modifications, notwithstanding that the Department declined to exempt credit card accounts from the final rule. First, the Department granted a complete exemption from the definition of “consumer credit” for credit extended to a covered borrower under a credit card account for a minimum of two years. The exemption expires on October 3, 2017.

Second, the final rule continues to provide a qualified exclusion for credit card accounts from the MAPR calculation for a “bona fide” fee, but it modified the proposed rule to eliminate the requirement that the bona fide fee be “customary.” This provides relief from the operational difficulties and uncertainties associated with defining “customary,” and means that credit card issuers will have a wider berth for innovation in products and services without the risk of liability under the MLA insofar as fees could be deemed not “customary.”

Finally, the final rule included the following positive modifications:

• For insured credit unions and insured depository institutions, an application fee may be excluded from the computation of the MAPR for a short-term, small amount loan, subject to certain conditions.
• The Department adopted a new “covered borrower” safe harbor to permit a creditor to “legally conclusively determine” that a consumer is a covered borrower by using information obtained in a “consumer report from a nationwide consumer reporting agency or a reseller who provides such a report.” The final rule retains the original safe harbor—permitting creditors to “legally conclusively determine” that a consumer is a covered borrower by using information obtained directly or indirectly from the MLA database—thereby giving creditors two safe-harbor options.
• Removed the “actual knowledge” clawback from the “covered borrower” safe harbor, meaning that a creditor who concludes that a borrower is not a covered borrower after conducting a covered-borrower safe-harbor check using either the MLA database or a permissible consumer report will not be liable even if the consumer is a covered borrower.