California Supreme Court Declines to Extend Tribal Sovereign Immunity to Payday Loan Companies Orrick, Herrington & Sutcliffe LLP


[co-author: Ned Hirschfeld]

On December 22, 2016, the California Supreme Court rendered People ex rel. Owen v. Miami Nation Enterprises. The ruling concluded that some tribal business entities that provided loans in California are not “arms of the tribe” entitled to immunity from the state of California law regulating payday loans.

In 2005, two federally recognized tribes, the Miami Tribe of Oklahoma and the Santee Sioux Nation, established business entities under tribal law with the goal of offering online payday loans nationwide. These tribal entities have hired a series of management companies to operate their payday lending business. Although the tribal entities retained the power to set loan parameters and to approve or disapprove any loan, they received only a small portion of the income related to the loans; under agreements with a management company, for example, they were entitled to either 1% of gross income or a small guaranteed monthly payment.

In 2007, the state of California sued tribal entities for violating state law by granting unlicensed payday loans and exceeding statutory limits on loan size and related fees. The entities claimed they were immune from prosecution under state law as Miami Tribe and Sioux Nation weapons, both of which enjoy tribal sovereign immunity. A state appeals court sided with the tribal entities, concluding that they shared tribal immunity due to several formal ties. In particular, the entities had been formed under tribal law for the purpose of developing the tribal economy, and their leadership – which nominally retained final authority over loan decisions – was put in place by the tribes.

The California Supreme Court overturned. The court first announced a five-factor test to determine whether a tribal business entity is entitled to sovereign immunity as an “arm of the tribe.” California courts must consider “(1) the method of creating the entity, (2) whether the tribe intended the entity to share its immunity, (3) the purpose of the entity, (4) the tribe’s control over the entity, and (5) the financial relationship between the tribe and the entity. Contrasting its approach with that of other states, the court explained that “this test takes into account both formal and functional considerations, that is, not only the legal or organizational relationship between the tribe and the entity, but also the practical functioning of the entity in relation to the tribe.

After weighing the relevant factors, the tribunal concluded that tribal entities are not considered weapons of the tribes. The court recognized that they nominally served to foster tribal economic development by conducting payday lending operations, over which they technically retained final authority. “Despite these formal arrangements,” however, the tribal entities have in fact provided minimal economic benefits to the tribes and exercised only limited control over the lending operations of the management companies. The court found it significant that the tribal entities received only a fraction of the gross revenues of the management companies, failed to oversee lending decisions, and allowed one of the management companies to spend commercial funds at his discretion. Moreover, although the tribal entities were formed under tribal law, their initial capital and intellectual property came from non-tribal corporations. In light of these functional considerations, the five-factor test runs counter to a finding of tribal immunity.

The California Supreme Court ruling is notable for its potential impact on the lending industry in the marketplace and on the body of law that governs the applicability of state usury and consumer protection law to loan models in the market.

  • The comprehensive five-factor test for tribal immunity likely makes it more difficult for a tribal entity to establish immunity from state law. In addition, it may be more difficult for a tribal entity to establish immunity under this test than it is for a market lender to demonstrate the right to federal preemption under the Federal Act. National Bank or the Act on Deregulation of Depository Institutions and Monetary Control. If so, it could be an incentive for market lenders to pursue a particular goal. national bank charter or to come together around a banking partnership model instead of a tribal loan model.
  • The California Supreme Court found it “instructive” to compare its decision with that of the United States Court of Appeals for the Tenth Circuit in which the court said that a tribal entity in the casino industry was entitled to immunity. The court noted that in the Tenth Circuit case, the financial arrangement was such that “any shortfall in the casino’s business operations would result in a reduction in the tribe’s income.” Payday loan agreements, on the other hand, have eliminated some of that risk by guaranteeing a minimum monthly payment to tribal entities. This suggests that an important touchstone in the analysis of tribal immunity will continue to be the exposure to business risk that the various parties bear in a loan agreement.
  • The California Supreme Court’s approach to tribal immunity arguably reflects recent decisions applying the so-called “real lender” doctrine to analyze not only formal but also functional aspects of a market loan agreement. to determine the applicability of state law. The court’s ruling in this case was relevant to the tribe’s continued limited financial participation and limited effective control over loan decisions. This bottom-to-form approach parallels analysis in cases like Consumer Financial Protection Bureau c. CashCall (covered here) and departs from the emphasis on the formal nature of the lending partnership in Beechum v. Navient Solutions, Inc. (covered here).

Orrick will continue to monitor developments related to the enforcement of state loan regulations and provide updates as appropriate.

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